past few decades fast growth of multi-national corporations (MNC) rms that conduct and control productive activities in more than one country

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1 Ch. 14 Foreign nance, investment and aid International ow of nancial resources to developing countries 1. Foreign direct and portfolio investment 2. remittances of earnings by international migrants 3. public and private (NGO) foreign aid 1a. Private foreign direct investment (FDI) past few decades fast growth of multi-national corporations (MNC) rms that conduct and control productive activities in more than one country accompanied with growth of private FDI to developing countries annual FDI rate of $2.4 bln in 1962 to $35 bln in 1990 to $147 bln in 2002, $335 bln in 2005 reasons: globalization MNCs but also developing countries opening up high variance of ows over di erent regions and times e.g. out of $335 bln in 2005; $118 went to China (incl. Hong Kong) Africa receives only about 3% of global FDI (remember, this is problematic for the Solow model) total world FDIs peaked in 2000, still not recovered Fig FDI in ows to developing countries remain small fraction of their total investment note, however, FDI may be qualitatively di erent investment (e.g. hi-tech, management knowhow, etc.) FDI have become the largest source of foreign funds to LDCs (72% of all ows in 2003) sharp contrast with the late 1980s- early 1990s when o cial ows were as prominent (see Easterly s ch. 6 for more detail on those times) Multinational corporations two de ning characteristics: large size and high fraction of foreign trade 350 largest rms account for more than 40% of world trade size: 100 largest non- nancial MNCs ranked by assets account for $8 trillion in assets. The top 6 have sales in total larger than the combined GDP of Sub-Saharan Africa and South Asia. most are global brands, immediately recognizable (Ford, BP, Honda, Nestle, Siemens, etc.) their great size often yields high negotiating power with many governments of small LDCs still, remember from g that most FDIs are directed from developed to developed countries, and (some) competition in virtually all sectors exists 1

2 Historically, in LDCs these rms were into extracting resources, but more recently into manufacturing and services to use cheaper labor MNC controversy mostly not about the economic impact but other (social, equity, etc. reasons) Economic arguments in favor of FDI: 1. supplementing domestic savings to create higher investment which may then lead to higher growth (remember the Solow, Harrod-Domar models) 2. alleviate current account de cit (goods imports > exports); generate future exports 3. source of tax revenue 4. perhaps most important in the long-run MNCs can help spread new technologies and management techniques (eventually these leak out ) Arguments against private FDI 1. inhibiting domestic rms, crowding out other investment; suppressing local entrepreneurship (but why it didn t develop there before?) 2. pro ts repatriation, royalties, etc. may not bene t the host nation 3. tax contributions are low due to concessions from government; tari protection, public subsidies (but whose fault is that?); MNCs use their large bargaining and nancial power to in uence government policies (tax rebates, transfer pricing; tax competition) 4. uneven impact on development mostly urban focus, possible increase in inequality Reconciling the debate markets vs. governments as driver of the development process growth vs. inequality hard to generalize but overall facts speak for themselves countries that opened up to MNCs and trade have growth at higher rates to those who did not and have reduced poverty due to the bene cial e ect of income growth 1b. Portfolio investments (see g again) a rising factor (at least up till 2008) in nancial ows to LDCs consists of investment in stocks, bonds, commercial papers of LDCs rms and governments very high returns on investment possible in so-called emerging stock markets (e.g. 39% in L. America ) but also high risk and volatility frequent crises: Mexico ( ); East Asia ( ) and Russia (1998); Argentina ( ) 2

3 for investors: capital ows to productive uses; diversi cation possible instability in economies with structural weaknesses (e.g. xed/controlled exchange rates) Lesson: MNCs and portfolio investors often follow growth so put the right pre-requisites for it and the ows will come 2. Remittances in 2007 there were 200 mln migrants worldwide huge di erences in incomes between HICs and LDCs g steep growth in remittances after 1990 (currently higher than aid and portfolio ows); some of this due to improved accounting and recording of nancial transactions uneven distribution g Foreign aid in theory, all government and resource transfers from one country to another measurement issues: e.g. how to value preferential trade tari s private ows should be excluded (not aid) so, in practice, foreign aid de ned by 2 criteria 1. should have non-commercial objective from the donor s point of view 2. should have concessional terms ( below market rates) above de nition still controversial e.g. military aid can be both commercial and non-concessional (thus, often excluded) basically, foreign aid = o cial grants + concessionary loans (in currency or in kind) Further measurement problems: how to aggregate together (value) di erent loans and grants with di erent signi cance to donor and recipient countries tied-aid: either by source (the country must buy products/services from the donor) or project (funds can only be used for speci c purpose) nominal vs. real values Data on public aid (Tables 14.2 and 14.3) the o cial name of foreign aid is o cial development assistance (ODA) = bilateral grants + loans + technical assistance + multilateral ows (e.g. IMF, WB) grew from $5 bln in 1990 to $100 bln in 2005 (nominal values) 3

4 as % of developed countries GDP, fell from 0.5% in 1960 to 0.33% in 2005 ODA is allocated in some strange and arbitrary ways (not really) S. Asia where more than 50% of the world s poorest people live receives $6 per person in aid Middle East and N. Africa with well over triple S. Asia s GDP per capita receive 14 times the per capita aid (Table 14.3) Iraq ($750 per capita) and Afghanistan ($93 per capita) are the largest recipients in 2005; vs. India ($2 per capita) Israel (not an LDC) and Egypt were the two countries receiving the most of US foreign aid; now Iraq obviously the allocation of aid is mostly politically (militarily) determined, not by need Why donors give aid? primarily because of political, strategic, or economic self-interest very little humanitarian reasoning (mostly disaster relief) Political motives: the Marshall Plan (restart the economies of Western Europe to contain spread of communism) special interests: over the period US aid patterns switched from S. Asia, S-E. Asia, L. America, Middle East, Central America, Eastern Europe, Middle East again similar patterns in the aid by other major donor countries like Japan, Britain, France mostly propping up friendly regimes, former colonies, etc. Economic motives for aid (discussed earlier in the course) based on the nancing gap model; aid as supplement to domestic savings in investment zero empirical support for this theoretical model aid uncorrelated with subsequent investment and investment uncorrelated with subsequent growth (remember Easterly, ch. 3) Why developing countries accept/ ask for aid? LDCs willing to accept aid even under seemingly stringent terms the economic rationale aid as supplement to domestic resources... LDCs would like less tied-aid or strings attached and longer-term loans a moral hazard problem if no conditions attached, would this money be used for what is promised? but a moral hazard problem often exists on the donor s side (especially IMF, World Bank) they need to spend the aid budget no matter what otherwise it may get cut next year hard to impose conditionality many times LDCs take aid because it is readily given and no one is held accountable in fact, by remaining poor you can secure more foreign funds than if you grow (see more in Easterly ch. 6 and below) 4

5 military aid accepted/given for security/strategic reasons role of NGOs growing but small-scale relative to bilateral and multilateral assistance ows ($1 bln in 1970 to $14 bln in 2005) randomized trials and eld experiments new promising methods of policy evaluation (but can these small-scale results be scaled up?) Please also review Easterly ch.6 for his views on foreign aid as implemented in the past. 5