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Perspectives on ‘buy-outs’ and the Ramaswami effect
Journal of International Economics 27 (1989) 363-371. North-Wolland
University of Rochester,
Rochester,
NY 14427, USA
Stephen T. EASTON* Simon Fraser University, Burnaby, BC V5A IS6, Canada
Received March 1987, revised version received December 1988 In a simple two-factor, one-commodity model in which foreign labor can be hired at low foreign wage rates and technology is common to both countries, optimal strategy at home involves hiring almost all factors abroad at their autarlcy prices - a ‘buy-out’ strategy. This paper shows that when technologies differ, partial or, at times, complete buy-out of factors from the technologically superior country may still be optimal. Alternatively, a partial buy-out may be appropriate when there exists a third internationally immobile productive factor.
In the literature on international factor mobility Ramaswami’s name is associated with the proposition that a relatively capital abundant country sharing a ccxmmon technology -;iith a low-wage foreign country gains more by hiring foreign workers to produce at home than it does by sending its capital abroad to earn the relatively high return found there [Ramaswami (1968)]. His contribution spawned a subsequent series of papers’ devoted to explaining the asymmetrical nature of the proposition and emphasizing its country can obtain active dependence on the assumption that or, alternatively, can ailing a foreign labor at the (low) wage rates to earn the foreign rate of send its capital the analysis by demonstra Easton (1986) Ramaswami argument can be applied to reveal how the best strategy for an *Support for this research comes, in part, from Jones’ NSF grant #SES-8510697. Easton is grateful to the Social Sciences nnd Hlumanities Research Council of Canada, which provided a Sabbatical leave F wati (1979) Calve and Wellisz (1983), ‘See, in particu Srinivasan (19833,
364
R.W. Jones and S.T. Easton, Perspectives on ‘buy-outs’
active country calls for hiring both capital and labor from abroad.2 particular, if these hires are made in the proportions found abroad in autarky, foreign factor prices are no: disturbed and the home country can syphon off all the gains from the international mobility of factors without pursuing overtly discriminatory pricing policies. Such a ‘buy-out’ strategy reveals the simplicity of the basic model used by maswami, and it is perhaps not surprising that subsequent work, e.g. uhn and Wooton (1987) and Bond (1986), was devoted to extending the model to include a productive factor (land) which is not mobile between countries. Not only is a ‘buy-out’ strategy rendered impossible by assumption, but even a strategy of hiring those factors which are available in the market is called into question.3 In the present paper we focus on the logic underlying the Ramaswami effect both in this case of immobile factors and in the case in which technologies differ between countries. The basic question we ask in these more realistic settings is: Can the home country gain by a partialhire of those factors available in the market abroad in the proportions found in autarky? If so, what limits the extent of such purchases? We establish that in many cases the home country can benefit by hiring some bundle of all available factors abroad, although such a move makes no sense either if foreign technology is significantly superior or if the foreign country has relatively limited supplies of the immobile factor. However, there may be cases m which a virtual buy-out of all foreign factors is optimal for the home country despite some superiority in foreign technology, a move which obviously runs counter to maximizing world output. i effect
The factor price frontier is a useful device for illustrating the Ramaswami effect when both countries share a common technology in producing a single commodity as well as (in the next section) when technology abroad is superior. The autarky capital/labor endowment ratio abroad, k*, is reflected by the slope of the tangent line to the factor price frontier at point w*, which shows foreign autarky factor prices. The horizontal intercept of this line depicts foreign output per w&e of its i&or z?rcc; Y*/z*.4 Home 2Brecher and Choudri (1987) assume there is unemployment at Frlomeand that any foreign migrants would displace home workers. As they demonstrate, in such a setting any inflows of labor should be discouraged. ‘For an earlier discussion of the Ramaswaml logic when some factors are not mobile internationally, see Jones and Coelho (1985). 4Note the dual relationship between the factor price frontier and the unit isoquant: the horizontal intercept of a tangent line to the frontier is the inverse of the labor input coefficient, a variable on the axis of the diagram showing the unit isoquant, while the horizontal intercept of a tangent line to the unit isoquant is the inverse of the real wage, a variable on the axis of the factor-price-frontier diagram.
R.W. Jones and S.T. Easton, Perspectives
0
R (0)
OFI‘buy-outs’
365
Wage Rates
Fig. 1
autarky factor prices are shown by point W. The bowed-in shape of the curve reflects the convexity of the technology, and if the foreign autarky bundle could earn the returns shown by point FV,foreign output per unit of the labor force would rise to the level shown by the horizontal intercept of the line through W parallel to the iangent line at m*, Stated in a manner more reflective ofThe Ramaswami logic, if the home country could hire the ioreign factor endowment bundle at its autarky prices and put it to work at home with productivities shown by home autarky prices, V, there would be a gain over and above costs shown by {(w- w*)L*+(r-r*)R*}. The benefit from moving labor from the low-wage foreign country would outweigh the necessity of paying capital more than it earns at home. Hf such a transfer were attempted, diminishing marginal productivities would cause home wage rates to fall (and rentals to capital to rise). gap labelled R(O) in fig. 1 overestimates the gain per unit lab accrue to the home country from such a transfer. Consider movement of the forei of foreign labor acco indicate the fraction of the foreign endow home country. T en home factor prices r’(a)>O since the home country is capital a
R. W. Jones and XT. Easton, Perspectives on ‘buy-outs’
366
extra income that would be earned at home by hiring one unit of labor and E* units of capital from abroad (at autarky foreign factor prices) and employing them at home when the fraction, a, of the foreign bundle has already been hired: R(a)
f
{[w(a)
-
w*]
+ [r(a)
-
r*]E*}.
(1)
The incremental gain to the home country from such transfers diminishes with a: R’(a) 60. However, it does not vanish. If all the world’s resources were employed in one location, factor prices would be shown by point @ in fig. 1, lying between autarky sets W and IV*, with the slope of the frontier at w indicating the world factor endowment ratio. If the home country hires bundles from abroad precisely in the ratio found there in autarky, it does not disturb foreign factor prices, although its own factor prices approach continuously the levels, w, which correspond to those of a single, integrated -world economy. Optimal strategy at home is to continue these hires almost until all foreign factors are hired, the reservation being that some bundle must be left abroad so as to maintain the foreign market. But the finite gap between w and foreign autarky w* implies that even the last bundle the home country can hire yields a finite gain over and above costs. 3.
If home technology is superior to that found abroad, the home country has a clear incentive to hire at low foreign factor prices. It is the reverse situation that tests the robustness of the Ramaswami effect: Can the home country gain by hiring bundles of foreign factors when on average they must be paid more than they can earn with the inferior home technology? F’g. 1 indicates three alternative superior factor price frontiers for the foreig; country by the points of tangency, A, B, C, of such frontiers with lines whose slopes again depict the foreign autarky capital/labor ratio. Let (wt,I+) indicate what foreign factor prices would be in autarky if technology abroad were the same as at home. Then
{Cwl(a) - w*1
-I-rr(e
- 1*I
}={[w(a)-w+]+[r(a)-r+jR
he first term on the right-hand side is positive by the convexity of the technology. Label this R(a) again, to capture the net gains from a transfer 2’ if foreign factor prices
IL IV. Jams and ST. Eastorr, Perspectives on ‘buy-outs*
R(1)
-----
367
---
TA* 0
a @I
1
a
Fig. 2
the increment in income which would be earned by a foreign input bundle, (l,E*), if it switched from the home technology to the foreign technology. Thus, the net increment to the home country of a move of such a bundle from abroad when the home country must pay the level of foreign autarky factor prices corresponding to the superior technology is: A Y = R(a) - T*.
(3)
Fig. 2 is designed to illustrate how this comparison depends upon the extent to which foreign factors have already been hired to produce at home. If the degree of foreign technological superiority is shown by T& a partial withdrawal of foreign factors, country. Thus, although a su complete ‘buy-out’ strategy i partial buy-out. To this interme possibilities: (1) If the degree o T’, no bundles of factor hires Indeed, the home country would fails snort a’sroad io earn foreigu reeurns. (2) ‘buy-out’ stra by case A, an the existence of a superi
368
R.-N. Jones and S.T. Easton, Perspectives on ‘buy-outs’
The basic model employed by Ramaswami can also be altere supposing that although a common technology is shared by the countries, output employs not only mobile labor and capital, but some factor of production, land, which cannot be relocated from country to country. Obviously it then becomes impossible to consider a hire by the home country of factors abroad in the proportions of the forei bundle. However, it is possible to gauge the robustness of the Ramaswami logic by asking about the effects on home income from hires of labor and capital only, in proportion IE*. In pursuing this question one characteristic which distinguishes this case from those considered previously needs to be pointed out: foreign factor prices are disturbed by the emigration of labor and capital. More particularly, an exodus of labor and capital from abroad in the proportions reflected in R* is similar in its effect on foreign factor prices to an increase in land (T*) with constant endowment of labor and capital. Thus, such a withdrawal lowers the return to land abroad, s*, which implies that the returns to labor and capital as a group rise. That is, L*dw*+K”dr*=
-i-“ds*>O.
(4)
In this expression L* and K* denote the quantities remaining in productive use abroad. Given the yroportion, k*, in which labor and capital are withdrawn, trade flows are proportional to the bundle in use abroad. Therefore the (factor) tesamsof trade must turn against the home country an4 this serves to inhibit a buy-out of foreign mobile factors. Aside from this adverse terms-of-trade effect on home incomes, the question remains as to the net effect on world output of an extra transfer of labor and capital from abroad of amounts (1, I*). World output increases, on net, by dY,: A Yw= {[w(a) - w*(a)] + [r(a) -
r*(a)]k*}
.
(5)
Letting 2 and s,* denote home amd foreign land rentals, by convexity: R(o) = {[w(a) - w*(a)] + [r(a) - r*(a)]k* + [s(a) -s
(6)
indicates the supply ratio of land to labor abroad.’ Rewriting (5):
5R(aj now in&;ab ~h2 net ch productive factors from abroad, (1, capital are internationally mobile.
e in world output of a proportional transfer of n(l t*). Eq. (‘7) serves as a reminder that only labor and
R.W. Jones and S.T. Easton, Perspectives on ‘buy-outs’
A Yw= R(a) - [s(a) - s*(a)] t*.
369
(7)
This should be compared with eq. (3). If technologies are identical in the two countries but the foreign country is relatively land abundant so that home land rentals exceed those abroad, the effect on returns to labor and capital as an aggregate is similar to that expected if foreigners possessed a technological superiority in a process utilizing only labor and capital. term [s(a) - s*(a)]t* can be expected to increase without limit country hires re labor and capital; the gap (s -.F*) will widen as land becomes rela ti scarce at home and abundant abroad and t* in any case reflects ‘i;*/L* and the foreign la& forti is being diminished. As a consequence, it is never optimal for the home country to attempt a complete buy-out of those factors which are internationally mobile? Despite this result the force of the Ramaswami effect can be appreciated by considering the ca5e of factor hires when initially the distribution of land is so balanced that land rentals are the same in the two countries. From (7) it is clear that some inflows of both labor and capital would raise world output and, in neighborhood of autarky in which terms-of-trade effects are weak, raise home real incomes by a roughly comparable amount. This process eventually ceases to yield net gains for the home country even *before AYw in (7) becomes negative because of the deterioration of the terms of trade for factors. Of course optimal strategy for the home country would only by chance entail an exact proportional withdrawal of labor and capital; the precise composition of factor flows is sensitive to varying degrees of factor substitutability or complementarity, as emphasized i and Wooton (1987) and Jones and Easton (1989). balance of factor flows, our previous reasoning shows that with some factor internationally immobile, it never pays to bring in too much of the remaining factors.’
The Ramaswami efiect has introduced an asymmetry into the benefits a country can obtain by shipping out its abundant factor as opposed to hiring the factor found ,clatively cheaply abroad. A crucial ingredient i the Ramaswami proposition is the convexity of technology wher of a country’s endowment bundle is minimized at its own factor prices SO that, if such a b ndle could earn returns found in another country different endowment but the same tee would be enhanced. n the basic model %uch a buy-out may prove feasible if many c mobile factors are involved only in a subset of these. ‘See preceding footnote.
s are produced abroad an s see Jones and Coelho (1985).
370
R.W. Jones and S.T. Easton, Perspectives on ‘buy-outs’
would be enhanced. In the basic model developed by amaswami, this logic supports a ‘buy-out’ strategy for th active country when factors are internationally mobile, an extension of amaswami’s own conclusion that a country gains more by allowing inflows of the factor which is cheap abroad than it would by allowing its own relatively plentiful factor to acquire the higher returns available abroad. Such a strong conclusion reflects the simple structure of the basic model, and this paper considers how two alternative more realistic assumptions moderate the buy-out strategy - technology is superior abroad or there is a third, internationally immobile factor essential to production. If technology is superior abroad, the home country must in general pay more for factors than it can earn at home. Nonethe ess, the force of the Ramaswami effect is such that an almost complete ‘buy-out’ strategy remains optimal if technologies are not too dissimilar. Alternatively, a partial buy-out may prove optimal, although sufficiently superior technology a.broad may militate against any inflow of factors. The case in which the technology is common but a factor such as land is not mobile internationally has been shown to have some similar features. If the foreign country has cheaper land, payments to foreign capital and labor as an aggregate will exceed those available at home, and this discourages home hires much as in the case of technological dissimilarities. This case differs, however, in that no complete buy-out is warranted both because world output is eventually reduced by syphoning off foreign labor and capital and because increasing inflows of labor and capital must turn the terms of trade against the active home country. Th maswami effect is still in evidence, although other influences may prove re powerful in forestalling the (almost) complete buy-out rategy which emerged as optimal in the basic model originally proposed by amaswami.
Bhagwati, J.N., 1979, International factor movements and national advantage, Indian Economic Review, Oct., 73-100. Bhagwati, J.N. and T.N. Srinivasan, 1983, On the choice between capital and labour mobility, Journal of International Economics 14, 209-23’. Brecher, R. and E. Choudri, 1987, Internationi. migration versus foreign investment in the presence of unemployment, Jcurnal of International Economics 23, 329-342. Bond, E., 1986, C~~plezentarity, substitutability and optimal factor flows, unpublished. . .J..nrhnn Calvo, 6. and S. Wellisz, 1983, inreriA-‘YXY! factor mobility and national ZUV~~~~~~~,, .hmnal _ _ of Intemations” Economics 14, 103-l 14. Jones, R. and I. Coelho, 1985, International factor movements and the Ramaswami argument, Economica 52, 35 l-363. nd migration: Analytics and extensions of f i~te~~ati~~al factor flows: T
R.W. Jones and ST. Easton, Perspectives on “buy-outs
371
Kuhn, P. and I. Wooton, 1957,International factor movements in the presence of a fixed factor, Journal of International Econcmics, Feb., 123-140. Ramaswami, V.K., 1968, International factor movement and the national advantage, Economica 35, pp. 309-310. RufIin, R., 1984,International factor movements, in: R. Jones and P. Kenen, eds., Handbook of international economics, Vol. 1 (North-Holland, Amsterdam). Webb, LB., 1970, International factor movement and the national advantage: A comment, Economica 37,8 l-84.
University of Rochester,
Rochester,
NY 14427, USA
Stephen T. EASTON* Simon Fraser University, Burnaby, BC V5A IS6, Canada
Received March 1987, revised version received December 1988 In a simple two-factor, one-commodity model in which foreign labor can be hired at low foreign wage rates and technology is common to both countries, optimal strategy at home involves hiring almost all factors abroad at their autarlcy prices - a ‘buy-out’ strategy. This paper shows that when technologies differ, partial or, at times, complete buy-out of factors from the technologically superior country may still be optimal. Alternatively, a partial buy-out may be appropriate when there exists a third internationally immobile productive factor.
In the literature on international factor mobility Ramaswami’s name is associated with the proposition that a relatively capital abundant country sharing a ccxmmon technology -;iith a low-wage foreign country gains more by hiring foreign workers to produce at home than it does by sending its capital abroad to earn the relatively high return found there [Ramaswami (1968)]. His contribution spawned a subsequent series of papers’ devoted to explaining the asymmetrical nature of the proposition and emphasizing its country can obtain active dependence on the assumption that or, alternatively, can ailing a foreign labor at the (low) wage rates to earn the foreign rate of send its capital the analysis by demonstra Easton (1986) Ramaswami argument can be applied to reveal how the best strategy for an *Support for this research comes, in part, from Jones’ NSF grant #SES-8510697. Easton is grateful to the Social Sciences nnd Hlumanities Research Council of Canada, which provided a Sabbatical leave F wati (1979) Calve and Wellisz (1983), ‘See, in particu Srinivasan (19833,
364
R.W. Jones and S.T. Easton, Perspectives on ‘buy-outs’
active country calls for hiring both capital and labor from abroad.2 particular, if these hires are made in the proportions found abroad in autarky, foreign factor prices are no: disturbed and the home country can syphon off all the gains from the international mobility of factors without pursuing overtly discriminatory pricing policies. Such a ‘buy-out’ strategy reveals the simplicity of the basic model used by maswami, and it is perhaps not surprising that subsequent work, e.g. uhn and Wooton (1987) and Bond (1986), was devoted to extending the model to include a productive factor (land) which is not mobile between countries. Not only is a ‘buy-out’ strategy rendered impossible by assumption, but even a strategy of hiring those factors which are available in the market is called into question.3 In the present paper we focus on the logic underlying the Ramaswami effect both in this case of immobile factors and in the case in which technologies differ between countries. The basic question we ask in these more realistic settings is: Can the home country gain by a partialhire of those factors available in the market abroad in the proportions found in autarky? If so, what limits the extent of such purchases? We establish that in many cases the home country can benefit by hiring some bundle of all available factors abroad, although such a move makes no sense either if foreign technology is significantly superior or if the foreign country has relatively limited supplies of the immobile factor. However, there may be cases m which a virtual buy-out of all foreign factors is optimal for the home country despite some superiority in foreign technology, a move which obviously runs counter to maximizing world output. i effect
The factor price frontier is a useful device for illustrating the Ramaswami effect when both countries share a common technology in producing a single commodity as well as (in the next section) when technology abroad is superior. The autarky capital/labor endowment ratio abroad, k*, is reflected by the slope of the tangent line to the factor price frontier at point w*, which shows foreign autarky factor prices. The horizontal intercept of this line depicts foreign output per w&e of its i&or z?rcc; Y*/z*.4 Home 2Brecher and Choudri (1987) assume there is unemployment at Frlomeand that any foreign migrants would displace home workers. As they demonstrate, in such a setting any inflows of labor should be discouraged. ‘For an earlier discussion of the Ramaswaml logic when some factors are not mobile internationally, see Jones and Coelho (1985). 4Note the dual relationship between the factor price frontier and the unit isoquant: the horizontal intercept of a tangent line to the frontier is the inverse of the labor input coefficient, a variable on the axis of the diagram showing the unit isoquant, while the horizontal intercept of a tangent line to the unit isoquant is the inverse of the real wage, a variable on the axis of the factor-price-frontier diagram.
R.W. Jones and S.T. Easton, Perspectives
0
R (0)
OFI‘buy-outs’
365
Wage Rates
Fig. 1
autarky factor prices are shown by point W. The bowed-in shape of the curve reflects the convexity of the technology, and if the foreign autarky bundle could earn the returns shown by point FV,foreign output per unit of the labor force would rise to the level shown by the horizontal intercept of the line through W parallel to the iangent line at m*, Stated in a manner more reflective ofThe Ramaswami logic, if the home country could hire the ioreign factor endowment bundle at its autarky prices and put it to work at home with productivities shown by home autarky prices, V, there would be a gain over and above costs shown by {(w- w*)L*+(r-r*)R*}. The benefit from moving labor from the low-wage foreign country would outweigh the necessity of paying capital more than it earns at home. Hf such a transfer were attempted, diminishing marginal productivities would cause home wage rates to fall (and rentals to capital to rise). gap labelled R(O) in fig. 1 overestimates the gain per unit lab accrue to the home country from such a transfer. Consider movement of the forei of foreign labor acco indicate the fraction of the foreign endow home country. T en home factor prices r’(a)>O since the home country is capital a
R. W. Jones and XT. Easton, Perspectives on ‘buy-outs’
366
extra income that would be earned at home by hiring one unit of labor and E* units of capital from abroad (at autarky foreign factor prices) and employing them at home when the fraction, a, of the foreign bundle has already been hired: R(a)
f
{[w(a)
-
w*]
+ [r(a)
-
r*]E*}.
(1)
The incremental gain to the home country from such transfers diminishes with a: R’(a) 60. However, it does not vanish. If all the world’s resources were employed in one location, factor prices would be shown by point @ in fig. 1, lying between autarky sets W and IV*, with the slope of the frontier at w indicating the world factor endowment ratio. If the home country hires bundles from abroad precisely in the ratio found there in autarky, it does not disturb foreign factor prices, although its own factor prices approach continuously the levels, w, which correspond to those of a single, integrated -world economy. Optimal strategy at home is to continue these hires almost until all foreign factors are hired, the reservation being that some bundle must be left abroad so as to maintain the foreign market. But the finite gap between w and foreign autarky w* implies that even the last bundle the home country can hire yields a finite gain over and above costs. 3.
If home technology is superior to that found abroad, the home country has a clear incentive to hire at low foreign factor prices. It is the reverse situation that tests the robustness of the Ramaswami effect: Can the home country gain by hiring bundles of foreign factors when on average they must be paid more than they can earn with the inferior home technology? F’g. 1 indicates three alternative superior factor price frontiers for the foreig; country by the points of tangency, A, B, C, of such frontiers with lines whose slopes again depict the foreign autarky capital/labor ratio. Let (wt,I+) indicate what foreign factor prices would be in autarky if technology abroad were the same as at home. Then
{Cwl(a) - w*1
-I-rr(e
- 1*I
}={[w(a)-w+]+[r(a)-r+jR
he first term on the right-hand side is positive by the convexity of the technology. Label this R(a) again, to capture the net gains from a transfer 2’ if foreign factor prices
IL IV. Jams and ST. Eastorr, Perspectives on ‘buy-outs*
R(1)
-----
367
---
TA* 0
a @I
1
a
Fig. 2
the increment in income which would be earned by a foreign input bundle, (l,E*), if it switched from the home technology to the foreign technology. Thus, the net increment to the home country of a move of such a bundle from abroad when the home country must pay the level of foreign autarky factor prices corresponding to the superior technology is: A Y = R(a) - T*.
(3)
Fig. 2 is designed to illustrate how this comparison depends upon the extent to which foreign factors have already been hired to produce at home. If the degree of foreign technological superiority is shown by T& a partial withdrawal of foreign factors, country. Thus, although a su complete ‘buy-out’ strategy i partial buy-out. To this interme possibilities: (1) If the degree o T’, no bundles of factor hires Indeed, the home country would fails snort a’sroad io earn foreigu reeurns. (2) ‘buy-out’ stra by case A, an the existence of a superi
368
R.-N. Jones and S.T. Easton, Perspectives on ‘buy-outs’
The basic model employed by Ramaswami can also be altere supposing that although a common technology is shared by the countries, output employs not only mobile labor and capital, but some factor of production, land, which cannot be relocated from country to country. Obviously it then becomes impossible to consider a hire by the home country of factors abroad in the proportions of the forei bundle. However, it is possible to gauge the robustness of the Ramaswami logic by asking about the effects on home income from hires of labor and capital only, in proportion IE*. In pursuing this question one characteristic which distinguishes this case from those considered previously needs to be pointed out: foreign factor prices are disturbed by the emigration of labor and capital. More particularly, an exodus of labor and capital from abroad in the proportions reflected in R* is similar in its effect on foreign factor prices to an increase in land (T*) with constant endowment of labor and capital. Thus, such a withdrawal lowers the return to land abroad, s*, which implies that the returns to labor and capital as a group rise. That is, L*dw*+K”dr*=
-i-“ds*>O.
(4)
In this expression L* and K* denote the quantities remaining in productive use abroad. Given the yroportion, k*, in which labor and capital are withdrawn, trade flows are proportional to the bundle in use abroad. Therefore the (factor) tesamsof trade must turn against the home country an4 this serves to inhibit a buy-out of foreign mobile factors. Aside from this adverse terms-of-trade effect on home incomes, the question remains as to the net effect on world output of an extra transfer of labor and capital from abroad of amounts (1, I*). World output increases, on net, by dY,: A Yw= {[w(a) - w*(a)] + [r(a) -
r*(a)]k*}
.
(5)
Letting 2 and s,* denote home amd foreign land rentals, by convexity: R(o) = {[w(a) - w*(a)] + [r(a) - r*(a)]k* + [s(a) -s
(6)
indicates the supply ratio of land to labor abroad.’ Rewriting (5):
5R(aj now in&;ab ~h2 net ch productive factors from abroad, (1, capital are internationally mobile.
e in world output of a proportional transfer of n(l t*). Eq. (‘7) serves as a reminder that only labor and
R.W. Jones and S.T. Easton, Perspectives on ‘buy-outs’
A Yw= R(a) - [s(a) - s*(a)] t*.
369
(7)
This should be compared with eq. (3). If technologies are identical in the two countries but the foreign country is relatively land abundant so that home land rentals exceed those abroad, the effect on returns to labor and capital as an aggregate is similar to that expected if foreigners possessed a technological superiority in a process utilizing only labor and capital. term [s(a) - s*(a)]t* can be expected to increase without limit country hires re labor and capital; the gap (s -.F*) will widen as land becomes rela ti scarce at home and abundant abroad and t* in any case reflects ‘i;*/L* and the foreign la& forti is being diminished. As a consequence, it is never optimal for the home country to attempt a complete buy-out of those factors which are internationally mobile? Despite this result the force of the Ramaswami effect can be appreciated by considering the ca5e of factor hires when initially the distribution of land is so balanced that land rentals are the same in the two countries. From (7) it is clear that some inflows of both labor and capital would raise world output and, in neighborhood of autarky in which terms-of-trade effects are weak, raise home real incomes by a roughly comparable amount. This process eventually ceases to yield net gains for the home country even *before AYw in (7) becomes negative because of the deterioration of the terms of trade for factors. Of course optimal strategy for the home country would only by chance entail an exact proportional withdrawal of labor and capital; the precise composition of factor flows is sensitive to varying degrees of factor substitutability or complementarity, as emphasized i and Wooton (1987) and Jones and Easton (1989). balance of factor flows, our previous reasoning shows that with some factor internationally immobile, it never pays to bring in too much of the remaining factors.’
The Ramaswami efiect has introduced an asymmetry into the benefits a country can obtain by shipping out its abundant factor as opposed to hiring the factor found ,clatively cheaply abroad. A crucial ingredient i the Ramaswami proposition is the convexity of technology wher of a country’s endowment bundle is minimized at its own factor prices SO that, if such a b ndle could earn returns found in another country different endowment but the same tee would be enhanced. n the basic model %uch a buy-out may prove feasible if many c mobile factors are involved only in a subset of these. ‘See preceding footnote.
s are produced abroad an s see Jones and Coelho (1985).
370
R.W. Jones and S.T. Easton, Perspectives on ‘buy-outs’
would be enhanced. In the basic model developed by amaswami, this logic supports a ‘buy-out’ strategy for th active country when factors are internationally mobile, an extension of amaswami’s own conclusion that a country gains more by allowing inflows of the factor which is cheap abroad than it would by allowing its own relatively plentiful factor to acquire the higher returns available abroad. Such a strong conclusion reflects the simple structure of the basic model, and this paper considers how two alternative more realistic assumptions moderate the buy-out strategy - technology is superior abroad or there is a third, internationally immobile factor essential to production. If technology is superior abroad, the home country must in general pay more for factors than it can earn at home. Nonethe ess, the force of the Ramaswami effect is such that an almost complete ‘buy-out’ strategy remains optimal if technologies are not too dissimilar. Alternatively, a partial buy-out may prove optimal, although sufficiently superior technology a.broad may militate against any inflow of factors. The case in which the technology is common but a factor such as land is not mobile internationally has been shown to have some similar features. If the foreign country has cheaper land, payments to foreign capital and labor as an aggregate will exceed those available at home, and this discourages home hires much as in the case of technological dissimilarities. This case differs, however, in that no complete buy-out is warranted both because world output is eventually reduced by syphoning off foreign labor and capital and because increasing inflows of labor and capital must turn the terms of trade against the active home country. Th maswami effect is still in evidence, although other influences may prove re powerful in forestalling the (almost) complete buy-out rategy which emerged as optimal in the basic model originally proposed by amaswami.
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