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Development Economics - Foreign sources of finance and foreign debt

Terms in this set (129)

The above pattern suggests that multinational corporations are highly selective in their choice of hosts, preferring to invest in countries that display certain characteristics. Aside from seeking host countries that provide low-cost labour and natural resources, they are attracted to countries offering an economic and political environment that is most likely to ensure profitability and safety. The most important of these characteristics include the following:
1. political stability and political institutions that ensure a stable political environment
2. a stable macroeconomic environment (low inflation, stable currency, acceptable levels of foreign debt, absence of major balance of payments problems)
3. an institutional environment that favours foreign direct investment, such as
- freedom to repatriate profits (i.e. send profits to the home country)
- freedom to engage in foreign exchange transactions (no exchange controls, thus can import possible needed inputs without restrictions; see page 495)
- favourable tax rules (to ensure low tax payments)
lack of restrictions regarding foreign ownership
- well-established property rights
- rules that minimise the risk of nationalisation (a takeover of private property by the state)
4. a liberalised (free market) economy with limited government intervention (including privatisation of state-owned enterprises)
5. liberal (free market) trade policy with an emphasis on exports
6. large markets
7. rapid economic growth and expectations of
continued rapid growth
8. well-functioning infrastructure, including transportation and communications, that will facilitate imports and exports
9. a well-educated labour force
1. Rich country agricultural subsidies. As long as these are in place, developing countries that depend on exports of protected goods cannot rely on trade to grow and develop.

2. Developing country dependence on commodity exports. Some of the poorest countries in the world depend on production and export of primary commodities and are hurt by price volatility and deteriorating terms of trade. These countries cannot grow and develop by use of trade.

3. The poverty cycle. Countries trapped in the poverty cycle cannot escape from this by means of trade.

4. Countries may have little to export. Many poor countries cannot take advantage of trade opportunities because they have difficulties moving into new areas of production of goods that can be exported. Limited access to credit is a major obstacle to opening up a new business that produces for export. Aid is therefore essential to help such countries develop the necessary institutions that will help them move into production for export.

5. Exclusion of geographically isolated communities and countries. There are many poor communities, particularly in landlocked countries, which are geographically isolated and have no access to markets, to urban centres or to ports. It is very difficult for the people in these communities to be integrated into the market economy, much less to participate in the benefits of increasing exports. Geographical isolation makes countries such as these, or isolated communities within countries, unable to compete in international markets, and therefore unable to take advantage of the potential benefits of trade in the absence of major investments in communications and transportation, which can be greatly facilitated by the provision of aid.
More and more economists believe that to be able to benefit from international trade, developing countries must have the institutional capacity to increase their exports.

This perspective is an extension of the 'trade and aid' perspective; it asserts that both trade and
aid are important to growth and development, and, in addition, aid and trade should be linked together so that a portion of aid is used to support the development of institutions that improve a country's abilities to export. This view is based on the idea that many poor countries face institutional constraints that prevent them from taking advantage of growing international markets. Even if all rich country trade protection disappeared overnight, countries that do not have the institutions enabling them to increase and diversify their exports will experience limited benefits from trade.

The constraints faced by developing countries include everything from high transport costs due to poor transport networks, limited access to credit, poor power supplies adding to costs of production, high administrative costs related to complicated border procedures, and lack of institutional capacity to meet technical and sanitary standards increasingly required by importing countries.

This approach requires that aid and trade policies be integrated, so that a policy geared toward increasing exports is based on assistance aiming to strengthen the abilities of developing countries to achieve increases in exports. The 'aid for trade' would be in addition to, and not a replacement of Official Development Assistance (ODA) funds. Moreover, efforts to address institutional constraints to trade should not concentrate only
on very poor developing countries (which receive ODA funds), but also on middle-income developing countries (which do not qualify for ODA funds).
The beginnings of the debt problem date back to the oil shock of 1973-74, when the Organization of the Petroleum Exporting Countries (OPEC) suddenly increased the price of oil. Almost overnight, oil- importing developing countries were faced with larger import expenditures due to higher oil prices. In addition, they faced lower export revenues because the oil price increases created recessions (stagflation) in developed countries, resulting in a lower demand for developing country exports. These two events resulted in larger trade and current account deficits in developing countries, creating a need for increased foreign borrowing that would provide the foreign exchange needed to cover their deficits.

A related event made it easier for developing countries to borrow more. After the oil price increases the OPEC nations found themselves with much larger oil revenues, much of which they deposited in commercial banks in developed countries, mainly in the United States, Europe and Japan. The commercial banks, seeing very large increases in their supply of loanable funds, began aggressively competing with each other to lend to developing countries. The developing countries' need for new loans coincided with the international banking system's need to make new loans. This lending pattern came to be known as 'petrodollar recycling', involving commercial banks lending to oil-importing countries the same funds that came from oil exporters, to allow the developing countries to continue to import oil.