Financial Flows Flashcards
What are the three main types of financial flows available for lower developed economies?
- Foreign Direct Investment (FDI) by transnational corporations (TNC).
- Official Development Assistance (ODA) (also known as foreign aid)
- Remittances
What is a transnational corporation?
A TNC is a company which operates in more than one country, and a firm which engages in international production.
Much of the trade of the TNC takes place within the corporatipn (intra-corporate trade)
What is FDI?
FDI is investment by companies from one country into another country. Typically from more developed economies (MDCs) to lesser developed economies (LDCs)
Why do TNCs enter LDCs?
- Exploitation of raw materials / agricultural goods that could not be found in other countries or cheaper in LDCs (Zambia copper)
- Exploitation of cheap labour supply for labour intensive production - low wages, no unions etc
- Avoid protectionist measures imposed by LDCs - tariffs or quotas may be used to protect an LDC’s industry from foreign competition. A TNC can access its markets by setting up production inside the nation - resulting in monopolistic power within the LDC as a result of high barriers, enabling them to charge high prices and make monopoly profits,
- Tax avoidance - corporation tax may be lower in LDCs, and to entice FDI LDCs can offer tax breaks. Transfer pricing can also occur.
How do TNCs enter LDCs?
- Joint venture arrangements - in which they are either a minority or majority equity holder.
- Licensing or franchising arrangements - here the TNC is not an equity holder, but exerts control through aspects such as supply of technology, knowledge or management.
What are the advantages of FDI?
- Injection to the circular flow of income - creating a multiplier effect for the economy and employment
- Beneficial effects on the balance of payments
- Increase in tax revenue - Those newly employed by TNC = income tax & VAT on increased expenditure. TNC pay corporation tax and purchases on local services
- Improved productivity - TNC could place pressure on local suppliers to improve efficiency and new production methods could increase quality of workforce.
- Technology transfers - TNC likely to bring in up to date technology and products
What are the disadvantages of FDI?
- Employment could only be short term - TNCs can easily pull from a country / bring their own workers
- TNC could use labour saving technology - resulting in set up could have little / no effect on unemployment, creating no multiplier.
- Tax avoidance - tax breaks or subsidies could be used to encourage TNCs to initially set up, meaning little revenue benefits for the gov
- Environmental costs - dependant on the type of FDI.
- Little production or technology gains could occur depending on the type of FDI
What is ODA?
ODA is a capital flow from one government to another on concessional terms
What criteria should ODA meet?
- Have the object of economic development (e.g not military)
- The donor country should not be motivated purely commercial considerations (e.g to make a profit)
- Concessionary terms should be granted - This could be a loan with low rates of interest, or repayment period longer, or a grant, with no repayments.
What are the types of foreign aid?
- Grants or loans
- Technical assistance
- Commodities - (food aid)
Aid can come in different forms too such as:
- Multilateral aid - joint assistance from a number of countries
- Bilateral aid - donation by one single country
Advantages of ODA for LDCs?
- Foreign aid can fill savings gap resulting in higher economic growth and development (Harrod-Domar model, multiplier effect etc)
- Alleviates natural disasters - e.g aid to Honduras & Nicaragua after Hurricane Mitch
- Multilateral aid likely is preferred as it has less conditions attached for the LDC
Disadvantages of ODA for LDCs?
- Recipient government may not use the aid for intended purposes - instead diverting expenditure for military purposes or their own luxury items for ministers
- ODA which is conditional may lead to LDC being worse off - IMF loans to Peru increased inequality
- Types of project may not be appropriate - road building projects in Uganda short term benefits but country couldn’t afford maintenance
- Food may only alleviate hunger in short term - but in long term disrupts local market and moves the country away from self sufficiency and increases dependency on foreign imports
- ODA can lead to dependency on rich donor countries rather than LDC developing own capabilites via intermediate technology.
Does foreign aid work?
1998 World Bank ‘Assessing Aid’ argued that aid can be extremely effective in promoting growth and reducing poverty, but only in the right economic climate, and the governments are aware upon how to use it. E.g no corruption etc.
What are remittances?
A remittance is a transfer of money by a foreign worker to an individual in his or her own country.
Money sent home by migrants competes with international aid as one of the largest financial flows to developing countries.
What are the benefits of remittances?
- By allowing workers to move where they are more productive, it increases their aggregate output and income.
- Remittances generally reduce the level and severity of poverty - through local multiplier effects
- Remittances support growth through productive capacity and growth via investment and financial deepening
- Fill a savings gap (Harrod-Domar model)
- Once established, they are generally a consistent and reliable source of income for families in LDCs
