economics Flashcards
portfolio investment
- Investment in a foreign country via the purchase of stocks [equities] bonds, or other financial instruments
- Portfolio investors do not exercise managerial control of the foreign operation
- Allow investors to further diversify their assets by moving away from a domestic-only portfolio
- Can carry increased risk due to potential economic instability stemming from emerging markets, but can also bring increased stability though investments in industrialized and more stable markets
foreign direct investment
investment in foreign country via the acquisition of a local facility or the establishment of a new facility
diff from portfolio investment because the investor maintains managerial control and bears the risk of the investment
horizontal: multinational corporations produce the same good in a diff country, more likely when many trade barriers
- same plant/good in another country
vertical: multinational corporations produce intermediate goods in foreign countries to be used in their final product, more likely when there are few trade barriers
- taking advantage of local comparative advantages
- buy your supplier - invest and build plants for parts of brakes/transmissions that will then be shipped
advantages of going multinational
- access to more resources, more direct market access, efficiency, strategic assets
- benefits from both low production costs and low taxes - should be able to make increased profits while reducing prices, benefitting consumers
- resources - constrained to comparative advantage/disadvantage of country
- market access - subject to tariffs, quotas of foreign countries; able to set up shop in country, have access to that market of billions of people
- efficiency/access to resources - take advantage of local comparative advantage - resources, skills to produce better quality products at a cheaper price
- strategic assets - directly buying foreign firms to be able to accomplish long term corporate objectives
time inconsistency problem
- incentives the host gov faces to get the FDI, though it may change once the investment arrives (decision-maker’s preferences change over time)
- risk of investing overseas, our gov is depending on foreign production to do well
- any expropriation is a time inconsistency problem
expropriation
common form of political risk where a host country gov seizes a company’s assets without fair compensation, frequently cited barrier to foreign investment in many developing countries
- ex: Venezuela oil companies: encouraged multinational companies to come in, spend billions of dollars to find areas to drill for oil
- kicked them out
- Suez crisis: nationalized canal, led to invasion by france Britain and Israel
host country conditions and FDI
- political conditions such as war, bureaucratic red tape, authoritarian regimes, corruption and property rights have an impact on FDI
- war is not good for business bc war is costly - indicative country isn’t willing to uphold agreements in one area
- bureaucracy = longer and harder the investment, the less foreign direct investment
democracy and FDI
may be favorable in some aspects:
- less likely to expropriate and more transparent
- influence of multinational corporations on democratic leaders may be easier
- protection of property rights is positive signal for investors
negatives:
- regime changes - diff host governments
- MNCs may want to influence elections or oust leaders
- inability for monopolies: harder for MNC to cozy up to government, checks and balances
- compared to autocracy - need to get dictator/elites on your side
-
sweatshops
- factory of workshop, especially in clothing industry where manual workers are employed at very low wages for long hours under poor countries
- companies use these sweatshops as cheap labor
- many argue these are good for poor as it improves standards of living
sovereign lending
- loans from private financial institutions in one country to sovereign governments in another country
- type of portfolio investment
- not huge deal for US to borrow money, but bigger deal to smaller countries
- diff from foreign aid bc this lending should be paid with interest attached onto the repayment of the loan
information, commitment problems, and sovereign lending
- lending money to countries leads to uncertainty because you may not get paid back because of anarchy
- higher the risk = usually reward is better
misinformation:
- country claims to not have money to pay back a loan when in reality they do
- lender may threaten to retaliate - but carrying out threats is costly
- King of Defaulters (King Phillip the II) nation leader with commitment problems where they continuously default on their loans
commitment problems:
- borrower incentives to uphold promises changes once it obtains the money
advantages/costs of sovereign lending
fuel economic growth:
- investment in domestic industry, infrastructure
facilitate political goals:
- consumption for citizens
- military programs
borrowing often superior to higher taxes:
- both for economic and political reasons
costs to sending countries:
- risk expropriation
- politics of outsourcing
risk-return trade-off of finance
poorer countries = higher returns due to higher interest rates, but more risk involved
richer countries = lower returns, lower interest rates, but less risk involved
china invests in the US despite its huge deficit, because they can raise their interest rates
in anarchy system = political decision, not just economic; no higher authority to enforce rules/promises
relationship between interest rates, the spread and the risk
- high risk = high interest rate
- low risk = low interest rate
- spread = difference in rate charged to most secure borrower and insecure borrower (difference in risk); reliability through experience
- compensation for risk = interest rate (yield)
- defaulters find it harder and more expensive to borrow with more strings attached (conditionality)
benefits/risks of FDI to recipient countries
- access to capital, tech, expertise at cheaper price than nationally
costs
- conflicts of interests with investors
- anarchy - do you want foreign rivals buying up your companies
- finance as a source of leverage, use this to create relationship of dependence
inflation and hyperinflation
- rises in the prices of goods and services but most agree that low levels are okay
- hyperinflation: drastic inflation in short period of time
ex: germany post WWI
- 4.2 quadrillion marks to the dollar
- inflation was so bad that money was so worthless that they had to bring in wheelbarrows of money just to buy bread
- war guilt clause and heavy reparations - gov tried to get around payments by printing more and more money
Bretton woods institutions
- political economic conference with goal to prevent another world war from happening and prevent another depression
- monetary order negotiated among WWII allies in 1944, which lasted until the 1970s and which was based on US dollar tied to gold
- other currencies were fixed to dollar but permitted to adjust their exchange rates
- creation of IMF and WTO
defining elements of money
1) medium of exchange
2) unit of account
3) stores value
monetary system: anything that is accepted as a standard of value and measure of wealth that allows exchange
exchange rate appreciation/depreciation and its basic determinants
- appreciation: in terms of currency, to increase in value in terms of other currencies
- depreciation: in terms of currency - to cease value in terms of other currencies
monetary union
involves two or more states sharing the same currency without them having any further integration
- euro
dollarization
using, officially or unofficially, a diff country’s currency as a legal tender for conducting transactions
fixed currency
an exchange rate policy under which gov commits itself to keep its currency at or around a specific value in terms of another currency or a commodity, such as the gold standard
- certainty for the value, gold standard
floating currency
- an exchange rate policy under which a government permits its currency to be traded on the open market without direct gov control of intervention
- uncertainty for value of the currency
gold standard
- monetary system that prevailed between about 1870-1914 in which other countries tied their currencies to gold at a legally fixed price
- WWII: germany was able to take over France because they left the gold standard before France, Germany was able to raise money more quickly for the war effort because of this
why leave the gold standard:
- early 70s not great for US economically
- economic growth slowed and oil depleted
- change money supply freely and on the gold standard unable to easily change the money supply
monetary policy autonomy (costs vs. benefits)
- as a tool to affect macroeconomic conditions (unemployment, inflation, economic growth)
- free reign in printing of money and value not dependent on another country’s currency
- country controls interest rates
benefits monetary autonomy
- gives more freedom to pursue its own monetary policies
- gov can step in and help in monetary policy autonomy situations
- NY banks after 9/11, federal reserve system can lend money to the banks and print money through the treasury
costs monetary autonomy
- can move around a great deal and be unstable
- money isn’t free
- if you have more of a currency, the value of each one becomes less and less and if you were to buy anything you would need more and more
significance monetary autonomy
- Germany printed too much money which led to hyperinflation cause money isn’t free
- Lower interest rates = make it easier to get money
- If you increase the supply of money, you raise the interest rate
- Print money when you want
- If you have fixed exchange rate system, you cannot do this
capital controls
keeping currency inside the country via making it illegal to spend money outside of the country, or making it very expensive
capital control vs. capital mobility
unholy trinity (trilemma) of finance
- a country cannot have all of the following at the same time: free capital mobility, a fixed exchange rate, and independent monetary policy
- can have 2 of 3 but not all
- consider benefits of each part of triangle and weight which one they’re willing to give up
currency crisis
- brought on by a decline in the value of a country’s currency
- this decline in value negatively affects an economy by creating instabilities in exchange rates, meaning that one unit of the currency no longer buys as much as it used to in another
dollar diminution
- the weakening of the dollar
- from the Kirshner article- explains how the dollar has diminished due to liberalization of finance, which caused the market to crash in 2008
1) loss of benefits associated with issuing international money
2) difficulties associated with supervising a currency experiencing a contraction in its global use
digital currencies
- not linked to a particular country’s economy
- state’s have no autonomy over currency
- lacks control compared to sovereign currency
