2.1.4 Allocational Optimization and Factor Movements

Academic Research paper and Study of the Economy of Romania and Romanian Business

After this quick insight in trade theory a more controversial issue remains to be addressed: trade in factors or factor movements; often simply denoted as relocation of factors, reallocation or allocational optimization. Neoclassical models typically assume for both of the factors, labor and capital, a diminishing marginal product.[1] This is a quite reasonable assumption as normal workers (labor) in e.g. construction will not process double the amount of soil just for being equipped each with an additional handbarrow (capital).[2] Nonetheless, wisely deployed it might fasten the working process and increase the overall productivity. Likewise, the productivity will not double, though increase, if each two workers (labor) use the handbarrows. This simple example also clarifies that the marginal product of labor (MPL) increases in capital and vice versa that the marginal product of capital (MPK) increases in labor. This increase, though, is only a de­clining one. In addition, every factor is rewarded with its marginal product as income.

Incentives for Factor Movements – Relocation of Capital and Labor

As discussed above, countries might have a different factor endowment. Trade may not always be sufficient to balance factor productivities among them. Thus, a crucial incentive for factor movements arises. First, overall productivity can be increased by moving factors with a relatively low MP to regions with a higher MP and second, the respective factor income will increase via this relocation (for the movers). Optimal factor allocation is achieved when MP across regions is equilibrated. Overall welfare improves and all regions will enjoy a higher income. The controversial point here is that the augmented net welfare can be unevenly distributed and might produce losers, too.

First, workers from capital-scarce, lower-income regions are attracted by higher wages in capital-rich regions. Their migration from the capital-scarce regions towards the capital-rich regions increases the total output of the latter but lowers their MPL to some extent. Hence, wages there. The MPK on the contrary increases and so does income from capital. For capital the story works the other way round. Movements of capital from capital-rich regions to capital-scarce regions mean a higher income from capital for the capital-movers and higher wages for labor in the capital-scarce regions, as MPL rises in additional capital. Capital-owners in the formerly capital-scarce zones are worse off, because the additional capital has decreased their MPK to some extent. The same is true for the MPL in the regions the capital has been moved from.

Welfare Assessment for Factor Movements

In general, neoclassical models predict an overall improvement with unevenly distributed gains. Capital owners from richer regions and workers from poorer regions will both be better off.  Their gains are considered to outweigh the losses of capital owners from poorer zones and from workers in the richer regions in terms of numbers.[3] This process often causes tensions in public debates. The recent case of Nokia, relocating a part of its pro­duction and some R&D from Germany to Romania, demonstrated this in some regards. Anyhow, whether such a relocation of factors is desirable, and if so, how to (re-)distribute the gains from it is not the concern of this paper. Nonetheless, a noteworthy argument in favor of factor movements is given by Brasche (2003: 191) and shall be repeated here. Especially trade unions blamed factor relocation for wage dumping. On the contrary, the trade union’s demand of not moving capital to poorer regions could be seen as hampering a MS of not making use of its comparative advantages. Finally, richer regions are likewise not accused of technology dumping, when making use of their technological advan­tages to dominate foreign markets.

This far, a great deal of the economic ratio behind regional integration has been captured. A further effect of regional integration is (additional) growth and convergence. This effect must not be underestimated and will be discussed in the next subchapter.


[1] The notion of marginal product or marginal productivity refers to the additional output generated by an addi­tional unit of input, such as an extra hour of work or another machine added to the production line. Likewise marginal costs are the additional costs for the production of an additional unit of output. The name “marginal” indicates that marginal productivities are typically derived with calculus and not as simple fractions as in the case of elasticities or average values.

[2] The example is inspired by Feess (2000: 85f.), who reasons about the effects of additional shovels in the con­text of partial factor variation.

[3] However, if trade unions or minimum wages block an adjustment of wages downwards no additional jobs in the capital-rich-zones will be created. The excess of labor force will result in a rise of unemployment. The Ger­man reunification might be an ample example.