The transfer of production from rich to poor countries

Abstract

A model with two countries, three factors, and a continuum of goods is used to explain why manufacturing production is being transferred from more to less developed countries over time. The three factors are labor, capital, and infrastructure, where labor and infrastructure are immobile internationally but capital is perfectly mobile through direct investment. Production of a good shifts from the rich to the poor country when lower poor country costs attract direct investment from the rich country. This direct investment is assumed to carry with it the necessary technological and marketing know-how. It is shown that only by adding to its stocks of immobile factors of production will one country lower its relative costs and thus expand the range of goods it produces domestically at the expense of the other country. It is also shown that given optimal investment behavior the stock of infrastructure in the poor country will grow faster than in the rich country. Taking endowments of labor as given, it follows that production must be transferred continuously over time. This process ends because there is enough relative change in the two countries' infrastructure-labor endowment ratios to allow factor-price equalization and incomplete specialization in production.