ECON 157 University of California Irvine Economic Development Worksheet

Econ 157
Homework II
1. Explain what is meant by capital flight. How would you distinguish capital flight
from the normal desire of investors to diversify their portfolios by investing
abroad?
2. Why may the debt crisis be only “sleeping” rather than “dead?”
3. It has been argued that tied aid leads to inefficiencies in the recipient country’s
economy. Explain how this could occur.
4. State three major potential advantages of foreign direct investment for a
developing country. State three major potential disadvantages.
5. Explain the motives of developed countries in providing foreign aid.
6. Why does multinational corporation investment not necessarily offer the
advantage of domestic employment expansion?
7. What are the main forms through which foreign capital flows into LDCs? Discuss
the evolution of the various forms across the last decade.
8. Compare and contrast the workings of the organized and unorganized money markets in
developing countries.
9. What are some of the major characteristics of financial repression? To what degree may
financial liberalization be expected to address the issue of inadequate saving?
10. In what ways do the actual and potential roles of central banks differ between developed
and developing countries?
11. What is a development bank? What are some of the reasons they have not had greater
success?
12. Describe the costs and benefits of privatization of state-owned enterprises. In which cases
would privatization seem most advisable?
Chapter 13
Balance of
Payments, Debt,
Financial Crises,
and Stabilization
Policies
13.1 International Finance and Investment:
Key Issues for Developing Countries
• How major debt crises emerged during the
1980s
• Financial Crisis
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13-2
13.2 The Balance of Payments
Account
• General considerations:
–
–
–
–
–
Balance of Payments (BOP)
Current Account
Surplus and Deficit
Capital Account
Cash Account or International Reserve Account
• Three forms:
– Hard currency ($$$)
– Gold
– Deposits with IMF such as SDRs (an int’l financial asset to
supplement gold and $ in settling international BOP
accounts
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13-3
Table 13.1 A Schematic Balance of
Payments Account
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13-4
Table 13.2 Credits and Debits in the
Balance of Payments Account
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13-5
13.2 The Balance of Payments
Account (cont’d)
• A hypothetical illustration: deficits and debts
–
–
–
–
–
Current Account
Capital Account
Inflow
Outflow
Amortization
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13-6
Table 13.3 A Hypothetical Balance of Payments
Table for a Developing Nation
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13-7
Table 13.4 Before and After the 1980s Debt Crisis: Current
Account Balances and Capital Account Net financial Transfers of
Developing Countries, 1978-1990 (billions of dollars)
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13-8
13.3 The Issue of Payments
Deficits
• Some initial policy issues
– International reserves:
• To finance a deficit in both current and capital accounts
a country needs to use its int’l reserves
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13-9
13.3 The Issue of Payments
Deficits
• Policy options in the case of deficits in both
CA and KA:
– Promoting export expansion / limiting import /
private FDI and FPI
– Structural adjustment loans:
• Provided by the World Bank and the IMF
• Comes with conditions such as undertaking fiscal and
monetary reform and to remove excessive govt controls
and promote market competition
– Stabilization policies (discussed later)
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13-10
13.3 The Issue of Payments
Deficits (cont’d)
• Trends in the Balance of Payments
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13-11
Table 13.5 Developing Country Payments
Balances on Current Account, 1980–2009
(billions of dollars)
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13-12
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s
• Background and analysis
– External debt:
• combination of a private and public foreign debt owed
by a nation
– Debt service:
• Payment of amortization (principal) and interest
– Basic transfer:
• Net foreign capital inflow or outflow to a nation’s int’l
borrowing
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13-13
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s (cont’d)
Net capital inflow, FN, is
FN = dD
(13.1)
Basic transfer, BT, is
(13.2)
Where
d is percent increase in total debt
D is total debt
r is the average interest rate
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13-14
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s (cont’d)
• Origins of the 1980s Debt Crisis
–
–
–
–
OPEC oil price increase
Increased borrowing
Excess of imports
Lagging exports
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13-15
Figure 13.1 The Mechanics of
Petrodollar Recycling
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13-16
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s (cont’d)
• Origins of the Debt Crisis (cont’d)
–
–
–
–
Debt-servicing obligations
Debt-service payments
Debt-servicing difficulty
Oil shocks (spike in prices in the late 70s)
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13-17
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s (cont’d)
• Origins of the Debt Crisis (cont’d)
– Developing countries’ two options:
• Curtail imports and restrictive fiscal and monetary
measures
• More external borrowing
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13-18
13.5 Attempts at Alleviation: Macroeconomic
Instability, Classic IMF Stabilization Policies,
and Their Critics
• The IMF stabilization program
– Macroeconomic instability
– Stabilization policies
– Four basic components of IMF stabilization
program:
•
•
•
•
Liberalization of foreign exchange and imports control
Devaluation of the official exchange rate
Stringent domestic anti-inflation program
Opening up of the economy to international commerce
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13-19
13.5 Attempts at Alleviation: Macroeconomic
Instability, Classic IMF Stabilization Policies,
and Their Critics (cont’d)
• The IMF stabilization program (cont’d)
– Such policies can be politically unpopular
because they hurt the lower- and middle-income
groups.
– Less radical observers view the IMF as neither a
developmental nor an antidevelopmental
institution.
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13-20
13.5 Attempts at Alleviation: Macroeconomic
Instability, Classic IMF Stabilization Policies,
and Their Critics (cont’d)
• The IMF stabilization program (cont’d)
– Tactics for debt relief:
• Debtors’ cartel: group of developing countries trying to
bargain with creditors
• Restructuring: changing the term and conditions of debt
repayments (e.g. lower interest rate over longer period)
• Brady Plan: reducing the size of debt through forgiveness
• Debt for equity swaps: exchanging equity (stocks) of
domestic firms OR government bonds for foreign debt at
large discount
• Debt repudiation: fear in developed countries that
developing countries would stop paying their debt
obligations
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13-21
“Odious Debt” and Its
Prevention
• What is odious debt?
– Sovereign debt used by an undemocratic
government in a manner contrary to the
interests of its people should be deemed invalid
and not the responsibility of successor
governments.
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13-22
Resolution of 1980s-1990s Debt Crises and
Continued Vulnerabilities
• Highly indebted poor countries (HIPCs)
– Group of the world’s most indebted countries as
determined by the World Bank and the IMF
– Eligible for special debt relief
– Some rich countries established a fund to help in
the debt relief of those HIPICs
• Some progress but vulnerabilities remain
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13-23
Figure 13.3 Debt Service Ratios for Selected
HIPC Countries, 2002 and 2012
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13-24
13.6 The Global Financial Crisis and
the Developing Countries
• Causes of the global financial crisis and
challenges to lasting recovery
– The US subprime mortgage crisis and its global
impact which affected many developing nations
– Int’l trade imbalances between East Asia (China)
and the developed world (US) generated capital
inflows into the US and a cheap capital (low
interest rate) which fueled the housing bubble.
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13-25
13.6 The Global Financial Crisis and
the Developing Countries
• Economic impacts on developing countries
– Economic growth
• Slowdown and then recovery after 2013
– Exports
• Fell to lowest level in decades (2009) but than
rebounded strongly before returning to modest growth in
2011
– Foreign investment inflows
• FDI inflows to developing countries declined by 27% in
2009
– Developing-country stock markets
• High volatility but later resumed their rise
– Aid (discuss further in ch. 14)
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13-26
13.6 The Global Financial Crisis and
the Developing Countries (cont’d)
• Economic impacts on developing countries
– Worker remittances
• Fell significantly in the aftermath of the crisis followed
by a strong recovery
– Poverty
• Lower growth led to an increase in the number of
people living in poverty
• By 2009 an additional 50 mil fell to extreme poverty
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13-27
13.6 The Global Financial Crisis and
the Developing Countries (cont’d)
• Differing impacts across developing regions
– China and the exchange rates controversy
• A massive stimulus package in the wake of the crisis
• More reliance on domestic demand
• The “international currency war” and the pressure on
China to revalue it’s currency
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13-28
13.6 The Global Financial Crisis and
the Developing Countries (cont’d)
• Prospects for recovery and stability
• Opportunities as well as dangers?
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13-29
Concepts for Review
•
•
•
•
•
•
•
•
Amortization
Balance of payments
Basic transfer
Brady plan
Capital account
Capital flight
Cash account
Conditionality
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•
•
•
•
•
•
•
Current account
Debt-for-equity swap
Debt-for-nature swap
Debtors’ cartel
Debt repudiation
Debt service
Deficit
13-30
Concepts for Review (cont’d)
•
•
•
•
Euro
External debt
Hard currency
Highly indebted poor
countries (HIPCs)
• International reserve
account
• International reserves
• Macroeconomic instability
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• Odious debt
• Restructuring
• Special drawing rights
(SDRs)
• Stabilization policies
• Structural adjustment loans
• Surplus
13-31
Chapter 12
International
Trade Theory
and Development
Strategy
12.1 Economic Globalization: An
Introduction
• Globalization- many interpretations
• Core economic meaning- the increased
openness of economies to international
trade, financial flows, and foreign direct
investment
• Concerns with globalization center around
the unevenness of the process, and risks
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12-2
12.2 International Trade: Some
Key Issues
• Many developing countries rely heavily on exports of
primary products with risks and uncertainty
• Many developing countries also rely heavily on imports
(typically of machinery, capital goods, intermediate
producer goods, and consumer products)
• Many developing countries have chronic deficits on current
and capital accounts which depletes their reserves, causes
currency instability, and may slow economic growth
• Recently many developing countries sought to promote
exports and accumulate large foreign exchange reserves to
cushion against crises – spurring new policy debates
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12-3
12.2 International Trade: Some
Key Issues (cont’d)
• Five Basic Questions about Trade and
Development
– How does international trade affect economic
growth?
– How does trade alter the distribution of income?
– How can trade promote development?
– Can developing countries determine how much
they trade?
– Is an outward-looking or an inward-looking
trade policy best?
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12-4
12.2 International Trade: Some
Key Issues (cont’d)
• The Importance of Exports to Different Developing
Nations
• Importance of exports to developing nations
• Exports of developing countries are generally less
diversified than those of developed countries
• Merchandise exports as a share of GDP are often
higher for developing countries
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12-5
Table 12.1 Structure of merchandise exports:
Selected Countries, 2012
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12-6
Demand Elasticities and Export
Earning Instability
• Often low price elasticity of demand (inelastic) for
agricultural commodities
– Supply shocks can lead to a volatile price fluctuations
• Often low price elasticity of supply for basic
commodities (inelastic)
– Demand shocks can lead to a price volatility
• Result can be export earnings instability; risks to
income
• Also, low income elasticity of demand for primary
products
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12-7
The Terms of Trade and the PrebischSinger Hypothesis
• Total export earnings depend upon:
– Total volume of exports sold; and,
– Price paid for exports
• Prebisch and Singer argued commodity export prices fall
over time, so developing countries lose revenue unless
they can continually increase export volumes
• They concluded that developing countries need to avoid
dependence on primary exports
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12-8
12.3 The Traditional Theory of
International Trade
• Comparative advantage
– Producing at lower opportunity cost
– Specialization
– Ricardo and Mill comparative advantage model
is static and based only on one factor (labor
cost)
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12-9
12.3 The Traditional Theory of
International Trade
• Relative factor endowments and
international specialization: the Neoclassical
model
– Heckscher and Ohlin (factor endowment theory)
• Countries specialize in the production of the
commodities that make use of their abundant factors of
production (land, labor, capital)
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12-10
12.3 The Traditional Theory of
International Trade
• Different products require productive factors in
different ratios
– E.g. agricultural products generally require relatively
greater proportions of labor per unit of capital than
manufactured goods
• Countries have different endowments of factors of
production
– U.S. for example has high capital per worker and is
considered a capital abundant country
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12-11
Figure 12.1 Trade with Variable Factor
Proportions and Different Factor Endowments
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12-12
Figure 12.1 Trade with Variable Factor
Proportions and Different Factor Endowments
(continued)
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12-13
12.3 The Traditional Theory of
International Trade (cont’d)
• Main conclusion of the neoclassical model is that
all countries gain from trade
• World output increases with trade
• Countries will tend to specialize in products that
use their abundant resources intensively
• Returns to owners of abundant resources will rise
relatively
• Trade will stimulate economic growth
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12-14
12.3 The Traditional Theory of
International Trade (cont’d)
• Trade theory and Development: The Traditional
Arguments
– Trade stimulates economic growth
– Trade promotes international and domestic equality
– Trade promotes and rewards sectors of comparative
advantage
– International prices and costs of production determine
trading volumes
– Outward-looking international policy is superior to
isolation
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12-15
12.4 The Critique of Traditional FreeTrade Theory in the Context of
Developing-Country Experience
• Alternative Theories
– North-South trade models focus on trade between
rich and poor countries.
– Initial higher endowments of capital in the industrialized
North generate external economies of scale in
manufacturing output and higher profit rates.
– Rise in monopoly power
– Higher Northern growth rates through further capital
accumulation.
– As a result, the rapidly growing North develops a
cumulative competitive advantage over the slowergrowing South.
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12-16
12.4 The Critique of Traditional FreeTrade Theory, in the Context of
Developing-Country Experience (cont’d)
• Alternative Theories
• Porter’s “Competitive Advantage” theory:
– Traditional trade theory applies only to basic
underdeveloped physical factors (unskilled cheap labor,
physical and natural resources)
– But creation of advanced factors (knowledge resources,
highly trained workers, R&D etc…) is (or should be) the
first priority
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12-17
12.4 The Critique of Traditional FreeTrade Theory in the Context of
Developing-Country Experience
• Alternative Theories
– Vent for Surplus theory
– The contention that opening world markets to
developing countries through international
trade allows those countries to make better use
of formerly underutilized land and labor
resources so as to produce larger primaryproduct outputs, the surpluses of which can be
exported.
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12-18
Figure 12.2 The Vent-for-Surplus
Theory of Trade
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12-19
12.4 The Critique of Traditional FreeTrade Theory, in the Context of
Developing-Country Experience (cont’d)
• Critique of traditional free trade theory:
structuralist critics
– Traditional trade theory assumes countries can
adjust their economic structure to changing world
prices
– However, reallocations are difficult in practice
– Productions structures are rigid and factor
movements are restricted
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12-20
12.4 The Critique of Traditional FreeTrade Theory, in the Context of
Developing-Country Experience (cont’d)
– Structural realities in developing countries:
politically and institutionally structural rigidities (e.g.
supply inelasticity, limited forex, scarcity of
managerial skills etc…)
– Increasing returns and exercise of monopolistic
control over world markets
– Risk and uncertainty inherent in international
trading arrangements
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12-21
12.4 The Critique of Traditional FreeTrade Theory, in the Context of
Developing-Country Experience (cont’d)
• The Absence of National Governments in
Trading Relations (assumed by traditional model)
– Definite role for State
– Industrial policy is crafted by governments
– Commercial policies instruments (tariffs, quotas)
are state constructs
– International policies can result in uneven
distribution of gains from trade
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12-22
12.4 The Critique of Traditional FreeTrade Theory, in the Context of
Developing-Country Experience (cont’d)
• Some Conclusions on Trade Theory and
Economic Development Strategy
– Trade can lead to rapid economic growth under
some circumstances
– Trade seems to reinforce existing income
inequalities
– Trade can benefit developing countries if they
can extract trade concessions from developed
countries
– Developing countries generally must trade
– Regional cooperation may help developing
countries
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12-23
12.5 Traditional Trade Strategies for
Development: Export Promotion versus
Import Substitution
• Export promotion: looking outward and seeing trade
barriers
– Primary-commodity export expansion, limited demand
• Low income elasticities
• Decline in prices implies low revenue (some periods of price
spikes, including recent years, but very long-run trend has
been downward)
• Lack of success with international commodity agreements
• Development of synthetic substitutes
– Primary-commodity export expansion, supply rigidities
• Expanding Exports of manufactured goods: Greater
successes, particularly China; unevenly distributed across
the developing world
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12-24
12.5 Traditional Trade Strategies for
Development: Export Promotion versus
Import Substitution
• Import substitution: A deliberate effort to
replace consumer imports by promoting
the emergence and expansion of domestic
industries.
– Infant industries: newly established industry,
usually protected by a tariff barrier as part of a
policy of import substitution.
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12-25
12-25
Figure 12.3
Import
Substitution and
the Theory of
Protection
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12-26
12.5 Traditional Trade Strategies for
Development
• The import substitution (IS) industrialization
strategy and results
– Protected industries get inefficient and costly
– Government subsidization of imports of capital goods will
increase the need for more imported capital-good inputs
sending more payments (profit) to foreign firms and
causing the BOP to worsen
– Overvalued exchange (to lower price of import) rates
hurt exports
– Does not stimulate self-reliant integrated
industrialization: many infant industries never grow up
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12-27
12.5 Traditional Trade Strategies and Policy
Mechanisms for Development: Export
Promotion versus Import Substitution (cont’d)
• Standard argument for tariff protection
–
–
–
–
Sources of revenue
Response to chronic BOP problems
Help foster industrial self-reliance (general Import Sub)
Greater control over economic destinies
• Must be applied selectively and wisely
• Infant industry protection argument
– Many examples of perceived failures, but some success in
East Asia
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12-28
12.5 Traditional Trade Strategies and Policy
Mechanisms for Development: Export
Promotion versus Import Substitution (cont’d)
• Foreign-exchange rates, exchange controls,
and the devaluation decision
– Developing country currencies have often been overvalued
based on the ER set by the government (excess of local
demand over available exchange
– A developing country can devalue currency, or
– Can run down foreign reserves in attempt to keep it
overvalued
– Can use exchange controls
– Can switch to freely convertible foreign exchange
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12-29
12.5 Traditional Trade Strategies and Policy
Mechanisms for Development: Export
Promotion versus Import Substitution (cont’d)
• Flexible exchange rate The exchange value of a
national currency that is free to move up and down
in response to shifts in demand and supply arising
from international trade and finance.
• Depreciation vs. devaluation
• Appreciation vs. revaluation
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12-30
12.5 Traditional Trade Strategies for
Development
• Trade Optimists and Trade Pessimists:
Summarizing the Traditional Debate
• Trade pessimist arguments
– Limited growth of world demand for primary exports
– deterioration in the terms of trade for primary producing
nations
– Specializing in comparative advantage inhibits
industrialization, skills accumulation, and
entrepreneurship
– Rise of “new protectionism” by developed nations against
developing countries
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12-31
12.5 Traditional Trade Strategies and Policy
Mechanisms for Development: Export
Promotion versus Import Substitution (cont’d)
• Trade optimist arguments – trade liberalization:
– Promotes competition and efficiency
– Generates pressure for product improvement
– Accelerates overall growth
– Attracts foreign capital and expertise, which are in scarce
supply in most developing countries
– Generates foreign exchange to use for food imports if
agricultural sector lags behind or suffers natural
catastrophes
– Eliminates distortions caused by government interventions
including corruption and rent-seeking activities
– Promotes equal access to scarce resources,
– Enables developing countries to take full advantage of
reforms under the WTO
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12-32
Export-Oriented Industrialization Strategy:
Some arguments in the literature on why, in
principle, it could be effective
• Industrialization strategy approach is a school of thoughts
arguing that government policy can overcome market failure
by encouraging technology transfer and export of
progressively more advanced products.
• Export expansion may facilitate technology transfer through
contacts with foreign firms, industry spillovers, scale
economies
• There may be learning by doing (or “watching”) effects in
manufacturing sectors
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12-33
12.6 The Industrialization Strategy
Approach to Export Policy
– Focus on government interventions to encourage
exports, especially those with higher skill and
technology content (industrial policy)
– Problem: without proper attention to incentives,
industrial policies may be counterproductive too
– Problem: level of competence and political authority of
governments to carry out policies effectively
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12-34
12.7 South-South Trade and Economic
Integration
• Economic Integration: Theory and Practice
– There has been a large increase in the growth of trade
among developing countries.
– Integration encourages rational division of labor among a
group of countries and increases market size
– Provides opportunities for a coordinated industrial strategy
to exploit economies of scale
– Should developing countries seek more economic
integration:
• Trade creation
• Trade diversion
– Still not fully answered: Do blocs promote growth or
retard the progress of globalization
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12-35
12.8 Trade Policies of Developed Countries: The
Need for Reform and Resistance to New
Protectionist Pressures
• Rich-nation economic and commercial policies
matter for developing countries
– Tariff and non-tariff barriers to developing country
exports
• World Trade Organization
• Despite 8 liberalization rounds over 50 years,
trade barriers remain in place in agriculture; and,
through various mechanisms, to a degree in other
sectors
• Doha Development Round (trade negotiation
between WTO members) which begun 2001 has
no produced much progress.
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12-36
Figure 12.5 Effective Tariff Faced by
Income Groups, 1997-1998
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12-37
Concepts for Review
•
•
•
•
•
•
•
Absolute advantage
Autarky
Balanced trade
Barter transactions
Capital account
Commodity terms of trade
Common Market
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•
•
•
•
•
•
•
•
Comparative advantage
Current account
Customs Union
Depreciation
Devaluation
Dual exchange rate
Economic Integration
Economic Unions
12-38
Concepts for Review (cont’d)
•
•
•
•
•
•
Effective Rate of Protection
Enclave economies
Exchange Control
Export dependence
Export earnings instability
Factor endowment trade
theory
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•
•
•
•
•
•
Factor price equalization
Flexible exchange rate
Foreign-exchange earnings
Free market exchange rate
Free trade
Free trade area
12-39
Concepts for Review (cont’d)
• Gains from trade
• General Agreement on
Tariffs and Trade (GATT
Globalization
• Globalization
• Growth poles
• Import substitution
• Income elasticity of demand
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• Increasing returns
• Industrialization Strategy
Approach
• Industrial policy
• Infant industry
• International commodity
agreements
• Inward-looking
development policies
12-40
Concepts for Review (cont’d)
• Managed float
• Monopolistic market control
• Multifiber Arrangement
(MFA)
• New protectionism
• Nominal rate of protection
• Nontariff trade barriers
• North-South trade models
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• Official exchange rate
• Oligopolistic market control
• Outward-looking
development policies
• Overvalued exchange rate
• Parallel exchange rate
• Prebisch-Singer thesis
12-41
Concepts for Review (cont’d)
•
•
•
•
•
•
•
Price elasticity of demand
Primary products
Product Cycle
Product differentiation
Quotas
Regional trading bloc
Rent
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•
•
•
•
•
•
•
•
Returns to scale
Risk
Specialization
Subsidy
Synthetic substitutes
Tariffs
Trade creation
Trade deficits
12-42
Concepts for Review (cont’d)
•
•
•
•
•
•
•
•
Trade diversion
Trade liberalization
Trade optimists
Trade pessimists
Uncertainty
Undervalued exchange rate
Uruguay Round
Value added
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• Vent-for-surplus theory of
international trade
• Wage-price spiral
• World Trade Organization
(WTO)
12-43
Chapter 13
Balance of
Payments, Debt,
Financial Crises,
and Stabilization
Policies
13.1 International Finance and Investment:
Key Issues for Developing Countries
• How major debt crises emerged during the
1980s
• Financial Crisis
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13-2
13.2 The Balance of Payments
Account
• General considerations:
–
–
–
–
–
Balance of Payments (BOP)
Current Account
Surplus and Deficit
Capital Account
Cash Account or International Reserve Account
• Three forms:
– Hard currency ($$$)
– Gold
– Deposits with IMF such as SDRs (an int’l financial asset to
supplement gold and $ in settling international BOP
accounts
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13-3
Table 13.1 A Schematic Balance of
Payments Account
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13-4
Table 13.2 Credits and Debits in the
Balance of Payments Account
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13-5
13.2 The Balance of Payments
Account (cont’d)
• A hypothetical illustration: deficits and debts
–
–
–
–
–
Current Account
Capital Account
Inflow
Outflow
Amortization
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13-6
Table 13.3 A Hypothetical Balance of Payments
Table for a Developing Nation
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13-7
Table 13.4 Before and After the 1980s Debt Crisis: Current
Account Balances and Capital Account Net financial Transfers of
Developing Countries, 1978-1990 (billions of dollars)
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13-8
13.3 The Issue of Payments
Deficits
• Some initial policy issues
– International reserves:
• To finance a deficit in both current and capital accounts
a country needs to use its int’l reserves
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13-9
13.3 The Issue of Payments
Deficits
• Policy options in the case of deficits in both
CA and KA:
– Promoting export expansion / limiting import /
private FDI and FPI
– Structural adjustment loans:
• Provided by the World Bank and the IMF
• Comes with conditions such as undertaking fiscal and
monetary reform and to remove excessive govt controls
and promote market competition
– Stabilization policies (discussed later)
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13-10
13.3 The Issue of Payments
Deficits (cont’d)
• Trends in the Balance of Payments
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13-11
Table 13.5 Developing Country Payments
Balances on Current Account, 1980–2009
(billions of dollars)
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13-12
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s
• Background and analysis
– External debt:
• combination of a private and public foreign debt owed
by a nation
– Debt service:
• Payment of amortization (principal) and interest
– Basic transfer:
• Net foreign capital inflow or outflow to a nation’s int’l
borrowing
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13-13
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s (cont’d)
Net capital inflow, FN, is
FN = dD
(13.1)
Basic transfer, BT, is
(13.2)
Where
d is percent increase in total debt
D is total debt
r is the average interest rate
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13-14
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s (cont’d)
• Origins of the 1980s Debt Crisis
–
–
–
–
OPEC oil price increase
Increased borrowing
Excess of imports
Lagging exports
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13-15
Figure 13.1 The Mechanics of
Petrodollar Recycling
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13-16
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s (cont’d)
• Origins of the Debt Crisis (cont’d)
–
–
–
–
Debt-servicing obligations
Debt-service payments
Debt-servicing difficulty
Oil shocks (spike in prices in the late 70s)
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13-17
13.4 Accumulation of Debt and Emergence
of the Debt Crisis in the 1980s (cont’d)
• Origins of the Debt Crisis (cont’d)
– Developing countries’ two options:
• Curtail imports and restrictive fiscal and monetary
measures
• More external borrowing
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13-18
13.5 Attempts at Alleviation: Macroeconomic
Instability, Classic IMF Stabilization Policies,
and Their Critics
• The IMF stabilization program
– Macroeconomic instability
– Stabilization policies
– Four basic components of IMF stabilization
program:
•
•
•
•
Liberalization of foreign exchange and imports control
Devaluation of the official exchange rate
Stringent domestic anti-inflation program
Opening up of the economy to international commerce
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13-19
13.5 Attempts at Alleviation: Macroeconomic
Instability, Classic IMF Stabilization Policies,
and Their Critics (cont’d)
• The IMF stabilization program (cont’d)
– Such policies can be politically unpopular
because they hurt the lower- and middle-income
groups.
– Less radical observers view the IMF as neither a
developmental nor an antidevelopmental
institution.
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13-20
13.5 Attempts at Alleviation: Macroeconomic
Instability, Classic IMF Stabilization Policies,
and Their Critics (cont’d)
• The IMF stabilization program (cont’d)
– Tactics for debt relief:
• Debtors’ cartel: group of developing countries trying to
bargain with creditors
• Restructuring: changing the term and conditions of debt
repayments (e.g. lower interest rate over longer period)
• Brady Plan: reducing the size of debt through forgiveness
• Debt for equity swaps: exchanging equity (stocks) of
domestic firms OR government bonds for foreign debt at
large discount
• Debt repudiation: fear in developed countries that
developing countries would stop paying their debt
obligations
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13-21
“Odious Debt” and Its
Prevention
• What is odious debt?
– Sovereign debt used by an undemocratic
government in a manner contrary to the
interests of its people should be deemed invalid
and not the responsibility of successor
governments.
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13-22
Resolution of 1980s-1990s Debt Crises and
Continued Vulnerabilities
• Highly indebted poor countries (HIPCs)
– Group of the world’s most indebted countries as
determined by the World Bank and the IMF
– Eligible for special debt relief
– Some rich countries established a fund to help in
the debt relief of those HIPICs
• Some progress but vulnerabilities remain
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13-23
Figure 13.3 Debt Service Ratios for Selected
HIPC Countries, 2002 and 2012
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13-24
13.6 The Global Financial Crisis and
the Developing Countries
• Causes of the global financial crisis and
challenges to lasting recovery
– The US subprime mortgage crisis and its global
impact which affected many developing nations
– Int’l trade imbalances between East Asia (China)
and the developed world (US) generated capital
inflows into the US and a cheap capital (low
interest rate) which fueled the housing bubble.
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13-25
13.6 The Global Financial Crisis and
the Developing Countries
• Economic impacts on developing countries
– Economic growth
• Slowdown and then recovery after 2013
– Exports
• Fell to lowest level in decades (2009) but than
rebounded strongly before returning to modest growth in
2011
– Foreign investment inflows
• FDI inflows to developing countries declined by 27% in
2009
– Developing-country stock markets
• High volatility but later resumed their rise
– Aid (discuss further in ch. 14)
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13-26
13.6 The Global Financial Crisis and
the Developing Countries (cont’d)
• Economic impacts on developing countries
– Worker remittances
• Fell significantly in the aftermath of the crisis followed
by a strong recovery
– Poverty
• Lower growth led to an increase in the number of
people living in poverty
• By 2009 an additional 50 mil fell to extreme poverty
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13-27
13.6 The Global Financial Crisis and
the Developing Countries (cont’d)
• Differing impacts across developing regions
– China and the exchange rates controversy
• A massive stimulus package in the wake of the crisis
• More reliance on domestic demand
• The “international currency war” and the pressure on
China to revalue it’s currency
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13-28
13.6 The Global Financial Crisis and
the Developing Countries (cont’d)
• Prospects for recovery and stability
• Opportunities as well as dangers?
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13-29
Concepts for Review
•
•
•
•
•
•
•
•
Amortization
Balance of payments
Basic transfer
Brady plan
Capital account
Capital flight
Cash account
Conditionality
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•
•
•
•
•
•
•
Current account
Debt-for-equity swap
Debt-for-nature swap
Debtors’ cartel
Debt repudiation
Debt service
Deficit
13-30
Concepts for Review (cont’d)
•
•
•
•
Euro
External debt
Hard currency
Highly indebted poor
countries (HIPCs)
• International reserve
account
• International reserves
• Macroeconomic instability
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• Odious debt
• Restructuring
• Special drawing rights
(SDRs)
• Stabilization policies
• Structural adjustment loans
• Surplus
13-31
Chapter 14
Foreign Finance,
Investment,
Aid, and Conflict:
Controversies and
Opportunities
14.1 The International Flow of
Financial Resources
• Three sources:
– Private direct and portfolio investment
– Remittances of earnings by international
migrants
– Public and private development assistance
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14-2
14.2 Private Foreign Direct
Investment and the Multinational
Corporation
• Multinational Corporation (MNC)
– Recent growth of foreign direct investment (FDI)
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14-3
Figure 14.1 FDI inflows, Global and By Group
of Economies, 1980–2012 (Billions of Dollars)
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14-4
Figure 14.2 Trends in Annual Growth Rates of
FDI Inflows, by Groups of Economies, 1970–
2012 (Percent)
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14-5
14.2 Private Foreign Direct Investment and
the Multinational Corporation (cont’d)
• Private Foreign Direct Investment and the
Multinational Corporation
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14-6
14.2 Private Foreign Direct Investment and
the Multinational Corporation (cont’d)
• Private Foreign Investment: Pros and Cons
for Development
• Traditional arguments in support of private
investment: Filling savings, foreign
exchange, revenue, and management gaps
– Four main arguments
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14-7
14.2 Private Foreign Direct Investment
and the Multinational Corporation (cont’d)
– Saving Investment gap
Foreign private investment (as well as foreign
aid) is typically seen as a way of filling the gap
in domestic saving
– Foreign exchange or trade gap
– Foreign investment can generate a positive net flow of
export earnings easing the trade deficit
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14-8
14-8
14.2 Private Foreign Direct Investment
and the Multinational Corporation (cont’d)
– Targeted tax revenue and locally raised tax gap
• By taxing MNC profits and participating financially in
their local operations, developing country governments
are thought to be better able to mobilize public
financial resources for development projects
– Management, entrepreneurship, technology, and
skill gap
• MNCs can provide needed resources, including
management experience, entrepreneurial abilities, and
technological skills that can then be transferred to their
local counterparts by means of training programs and
the process of learning by doing
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14-9
14-9
14.2 Private Foreign Direct Investment and
the Multinational Corporation (cont’d)
• Private Foreign Investment: Pros and Cons
for Development
• Traditional arguments against private
foreign investment: Widening gaps
– Two main perspectives of the arguments:
Economic and ideological
– Transfer pricing
– See Box 14.1
• Reconciling pros and cons
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14-10
14.2 Private Foreign Direct Investment
and the Multinational Corporation (cont’d)
• Economic: the four gap-filling pro-foreigninvestment positions are countered by the
following arguments:
• 1. MNCs may lower domestic savings and investment
rates
– Substitute for private savings
– Not reinvesting much of their profits
– Importing intermediate goods from overseas affiliates
instead of domestic firms
• MNCs also raise a large fraction of their capital locally
in the developing country itself, and this may lead to
some crowding out of investment of local firms
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14-11
14-11
14.2 Private Foreign Direct Investment
and the Multinational Corporation (cont’d)
• Two main perspectives of the arguments:
Economic and ideological
– Economic
• 2. MNC investment may improve the foreign-exchange
position of the recipient nation, but its long-run impact may
reduce foreign-exchange earnings (or make the net increase
smaller)
– As a result of substantial importation of intermediate products
and capital goods and because of the overseas repatriation of
profits, interest, royalties, management fees, and other funds
• 3. MNCs contribution to public revenue in the form of
corporate taxes, may be less than it might appear:
–
–
–
–
–
liberal tax concessions
“transfer pricing” practices
excessive investment allowances
disguised public subsidies
tariff protection provided by the host government
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14-12
14-12
14.2 Private Foreign Direct Investment
and the Multinational Corporation (cont’d)
• Two main perspectives of the arguments:
Economic and ideological
– Economic
• 4. The management, entrepreneurial skills, ideas,
technology, and overseas contacts provided by MNCs
may have small impact on developing local sources of
these skills
• May inhibit these resources development by
oppressing the growth of indigenous entrepreneurship
as a result of the MNCs’ dominance of local markets
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14-13
14-13
14.2 Private Foreign Direct Investment
and the Multinational Corporation (cont’d)
• Ideological & Political
– Powerful multinational corporations can gain control over
local assets and jobs and can then exert considerable
influence on political decisions at all levels.
– May provide payoffs to corrupt public officials
• Reconciling pros and cons
– Private foreign investment can be an important stimulus
to economic and social development as long as the
interests of MNCs and host-country governments coincide
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14-14
14-14
14.2 Private Foreign Direct Investment
and the Multinational Corporation (cont’d)
• Private Portfolio Investment:
– What is portfolio investment?
• Investing in the stock market
– Benefits and Risks?
• Investors can increase their returns while diversifying
their risks.
• From the perspective of recipient developing countries,
private portfolio flows in local stock and bond markets
are a potentially welcome vehicle for raising capital for
domestic firms.
• Risk in over dependence on foreign capital and capital
outflight as a result of interest rate differential
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14-15
14-15
14.3 The Role and Growth of
Remittances
• Wage differences
– In developed countries 3 times higher than
developing countries
• “Brain Drain”
– Loss of skilled workers via immigration
• Flow of remittances
– Immigrants sending money back home
– Important in reducing poverty
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14-16
14-16
Figure 14.4 Sources of External Financing for
Developing Countries, 1990–2008
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14-17
Table 14.1 Major
Remittance-Receiving
Developing Countries,
by Level and GDP
Share, 2008
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14-18
14.4 Foreign Aid: The Development
Assistance Debate
• Foreign aid: The international transfer of public funds in the
form of loans or grants either directly from one government
to another or from international agency e.g. World Bank, IMF.
• Economists define foreign aid as any flow of capital to a
developing country that meets two criteria:
– (1) Its objective should be noncommercial
– (2) it should be characterized by concessional terms: the interest
rate and repayment period for borrowed capital should be softer
(less stringent) than commercial terms
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14-19
14-19
14.4 Foreign Aid: The Development
Assistance Debate
• Official development assistance(ODA):
– Net disbursements of loans or grants made on
concessional terms by official agencies, historically by
high-income member countries of the Organization for
Economic Cooperation and Development (OECD)
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14-20
14-20
Table 14.2 Official Development Assistance Net
Disbursements from Major Donor Countries, 1985, 2002,
and 2008
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14-21
Table 14.3 Official Development
Assistance (ODA) by Region, 2008
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14-22
14.4 Foreign Aid: The Development
Assistance Debate
• Why donors give aid
– Political motivations
– Economic motivations: two-gap models and
other criteria
• Foreign exchange constraints
– The basic argument of the two-gap model is that most
developing countries face either a shortage of domestic
savings to match investment opportunities or a shortage
of foreign exchange (trade deficit > capital inflows) to
finance needed imports of capital and intermediate goods
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14-23
14-23
14.4 Foreign Aid: The Development
Assistance Debate
• Why donors give aid
– Economic motivations:
• Growth and savings
– External assistance should accelerate the process of
development by generating additional domestic savings
as a result of the higher growth rates that it is presumed
to induce
• Technical assistance
– Sustainable development requires focus on training in
recipient countries.
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14-24
14-24
14.4 Foreign Aid: The Development
Assistance Debate
• Why donors give aid
– Economic motivations:
• Absorptive capacity
– The ability of the recipient country to use aid funds wisely
and productively
• Economic motivations and self-interest
– Donor countries also benefit
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14-25
14-25
14.4 Foreign Aid: The Development
Assistance Debate
• Why recipient countries accept aid
– Aid is a crucial and essential ingredient in the
development process
– Supplements scarce domestic resources
– helps transform the economy structurally
– Contribute to economic growth
• The increase importance of the role of
nongovernmental organizations in aid
(NGOs)
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14-26
14-26
14.4 Foreign Aid: The Development
Assistance Debate
• The effects of aid
– Some argue aid is a waste (e.g. when there’s a
corrupt regime)
– Aid is seen as providing greater political
leverage to the existing leadership to suppress
opposition and maintain itself in power
– Some argue that rich countries have obligation
to provide aid to poor countries
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14-27
14-27
14.4 Foreign Aid: The Development
Assistance Debate
• The effects of aid
– Some argue aid is important in promoting
economic growth
– Others argue the opposite effects
• More dependence
• Worsen BOP (as a result of rising debt and interest
payments)
• Aid focused on promoting modern sector and raising
inequality
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14-28
14-28
Global Wealth Inequality

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14-29
14.5 Conflict and Development
• The scope of violent conflict and conflict risks
• Assurance of security may be the most fundamental
of all institutions for development
• The consequences of armed conflict
–
–
–
–
–
Health
Destruction of wealth
Worsening hunger and poverty
Loss of education
A torn social fabric
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14-30
14.5 Conflict and Development
(cont’d)
• The causes of armed conflict
– Horizontal inequalities
• Inequalities among culturally defined groups
significantly raises the risk of conflict
– Natural resources for basic needs
• Basic needs resource scarcity—especially shortages of
food, fertile land, and water—may contribute to
conflict or ongoing risks of conflict
– Struggle to control exportable natural resources
• When benefits of exportable resources are not “fairly”
distributed, a conflict may take place
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14-31
14-31
14.5 Conflict and Development
(cont’d)
• The resolution and prevention of armed
conflict
–
–
–
–
–
–
Importance of institutions
Global actors
Regional actors: an Africa-wide approach
National actors
Focus on education
Local, “community-driven” economic
development
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14-32
Concepts for Review
•
•
•
•
•
Absorptive capacity
Commitment problem
Concessional terms
Foreign aid
Foreign direct investment
(FDI)
• Foreign-exchange gap
• Global factories
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• Multinational corporation
(MNC)
• Nongovernmental
organizations (NGOs)
• Official development
assistance (ODA)
• Portfolio investment
• Savings gap
• Technical assistance
14-33
Concepts for Review (cont’d)
• Tied aid
• Transfer pricing
• Two-gap model
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14-34

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