10 - Foreign Finance, Investment And Aid Flashcards
What does a country’s financial situation depend on
Its current account and capital account balance
Non-oil exporting developing countries have historically incurred what
Deficits on their current account balance
What’s an important ingredient in a country’s long run development strategy
Continuous net inflow of foreign financial resources
3 sources of international flow of financial resources
- Private foreign direct and portfolio investment
- Remittances of earnings by international migrants
- Public and private development assistance
What have played a critical role in international trade and capital flows
MNC’s
Recent growth of foreign direct investment (FDI)
- FDI has become the largest source of foreign funds flowing to developing countries
- ## MNC employ over 100 million globally outside their home countries (but small number in developing countries mostly in the modern urban sector)
Characteristics of MNC’s
- Large In size
- Worldwide activities and operations controlled by parent companies
FDI - Arguments supporting private investment
- Filling savings
- Foreign exchange
- Revenue
- Management gaps (entrepreneurship, technology, skills)
FDI - Arguments against private foreign investment: widening gaps
- Economic and ideological or cultural
- Transfer pricing
The role and growth of remittances
Wage differences
- 5x More in developed vs developing countries for the same job
- Incentive for migration
Concerns of “Brain drain”: Can be balanced through remittances
- Improve living standards and reduces poverty
Uneven flow of remittances
- Remittances represent 12% of GDP for the top 15 recipients
- Remittances have continued to grow faster than other flows due to better accounting methods, rising number of migrants, advances in financial intermediation that reduce costs of remitting
- Migration is not always voluntary and may result in human trafficking
Conceptual problems with defining foreign aid
- Disguised transfers
- Not all transfers should be included (e.g. capital flows of foreign investors, military aid)
Measurement and conceptual problems with calculations of actual development assistance
- Loans have to be repaid: deflate or discount before adding to the value to the value of outright grants
- Aid can be tied by source or by project
- Aid May be tied to the importation of capital intensive equipment
- Projects May require the purchase of new machinery and equipment for monopolistic suppliers
- Need to distinguish between nominal and real value of foreign assistance
Criteria of foreign aid
- Its objective should be non-commercial from the point of view of the donor
- Should be characterised by concessional terms - which is, the interest rate and repayment period for borrowed capital should be softer (less stringent) than commercial terms
- Can be inappropriate as it can include military aid
Foreign aid
Foreign exchange constraints
- Most developing countries face either a shortage of do,estimates savings to match investment opportunities or a shortage of foreign exchange to finance needed imports of capital and intermediate goods
- Both gaps are unequal in magnitude and independent but one will be binding for any developing economy
- If savings gap is dominant, foreign savings may be used to supplement domestic savings
- If foreign exchange gap is binding, foreign aid can play a critical role
The two gap model: savings constraint or gap
- Capital inflows (exports - imports) add to investible resources (domestic savings), the savings restriction can be written as:
- I < F + sY
- F = Amount of capital inflows
- sY = Domestic savings
- I = Domestic Investment
- If capital inflows (F) plus do,estimates savings (sY), exceeds domestic investment (I) and the economy is at full capacity, a savings gap is said to exist
