Foreign currency gap

Question 1

Introduction

Answer 1

The foreign currency gap is when LEDCs struggle to afford imports of foreign produced capital because of a lack of foreign currency. This lack of foreign currency can be caused by reduced earnings for their primary products compared to capital goods produced abroad (Prebisch-Singer hypothesis), servicing foreign debts, or capital flight. Really then, the foreign currency gap is a problem associated with a lack of capital.

Question 2

Three points

Answer 2

Inhibits FDI

Forces Primary Product Dependency

Restricts competitiveness in international markets

Question 3

FDI point

Answer 3

A lack of capital caused by the foreign currency gap means that a country is less attractive for a foreign firm to invest in a country. This is because it will mean that foreign firms would have to import all the equipment needed for their operations, and the labour force would not be experienced using such equipment. This investment could take the form of building a factory, or taking over a company within the LEDC. This potential loss of FDI could prove detrimental for development because foreign firms bring finance, employment, management know-how and potential tax revenue with them.

Question 4

FDI evaluation

Answer 4

However a loss of FDI is not always problematic for the host country. Often the advantage of this investment is exaggerated. For example, whilst FDI can lead to increased employment, it is often fairly low level, low skilled jobs that are made for workers within the host country. Often management opportunities are only available to nationals from the FDI’s country of original.

Question 5

Competitiveness point

Answer 5

Restricts competitiveness in international markets: A lack of capital caused by the foreign currency gap inhibiting imports means that a country can exhibit lower productivity compared to other countries. This increased cost of production leads to reduced international competitiveness. This could lead to reduced income from exports and further widening of the foreign currency gap.

Question 6

Competitiveness evaluation

Answer 6

If LEDCs specialise in labour intensive production in which they might have a comparative advantage, a lack of capital may not inhibit them too much. For example, China, Vietnam and Bangladesh have been highly successful in exporting garment and textiles products which have been manufactured using highly labour intensive techniques with limited capital.

Question 7

PPD point

Answer 7

Forces Primary Product Dependency: Structural change models suggest that development requires movement away from production of primary products to manufacturing or the tertiary sector. Those countries that have seen significant development (such as India and Brazil for example) have achieved this through utilising an increasingly skilled workforce. However movement to these types of markets relies upon capital. Without it, it is more likely to be forced into primary product production.

Question 8

PPD evaluation

Answer 8

Is a focus on the production of primary products so problematic? LEDCs may maintain a comparative advantage in these products. Some products also exhibit higher YED (such as blueberries produced in Chile) which suggest that revenues will rise as global incomes rise. Therefore specialisation in these products may still make economic sense and allow these countries to maximise foreign currency income.