15. Balance of Payments, Aid & Foreign Investment

2. 15. Balance of Payments, Aid & Foreign Investment • Globalization & Its Meaning • DC-LDC Interdependence • Capital Inflows • Balance of Payments • Sources of Financing an External Deficit

3. Globalization, Its Contented & Discontented • Globalization: expansion of economic activities across nation-states, including deepening economic integration, increasing economic openness, and growing interdependence among countries in the international economy (Nayyar). • Increasing international integration of markets for goods, services & capital (Rodrik). • Globalization took place during 1870-1913 & in the last quarter of a century. • Recent globalization: strong externalization of services, more rapid expansion of international banking.

4. Recent globalization • Strong externalization of services • More rapid expansion of international banking • High share of intra-industry trade • Increasing share of international trade that is intrafirm (between affiliates of the same multinational corporation)

5. Problems with globalization • Reduces autonomy of nation-state. • Easier to replace domestic workers with foreign workers. • Free flows of capital can undermine LDCs with poorly developed financial institutions that need to borrow in foreign currencies. • Contributes to marginalization of poorest & those in peripheral economies (such as sub-Saharan Africa). • DC middle classes may face slower income growth, contributing to antiglobalization protests).

6. North-South Interdependence • US merchandise imports/GNP increased from 6% in 1970 to 12% in 1980 to 10% in 1994 & 13% in 2001. • US exports to LDCs increased from 31% in 1970 to 38% in 1975 to 41% in 1981 to 43% in 2001. • Imports from LDCs increased from 25% in 1970 to 42% in 1975 to 46% in 1981 & 2001. • In 2002, 54% of US petroleum consumption was imported, of which 95% was from the third world. • Many other vital minerals came from LDCs.

7. Capital inflows • Y=C+I+(X-M)=C+S • I+(X-M)=S • I=S+(M-X) • M-X=F F is capital import (see Table 15-1) • I=S+F (see pp. 504-505 for meaning of symbols) • Inflow of funds enables country to spend more than it produces, import more than it exports, & invests more than it saves.

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9. Three-stage Limits • Limiting factors by stages: (1) skill limit, (2) savings gap (I-S), & (3) foreign exchange gap (M-X). • While savings gap is equal to foreign exchange gap ex post (after), stage 2 is likely to be investment limited ex ante (in terms of plans) while stage 3 is likely to be foreign exchange limited.

10. Stages in balance of payments • Newly industrializing countries borrows (young debtor) spending > output, I > S, M > X. • Mature debtor pays back loan if funds used productively, output > spending, S > I, X > M. • Mature creditor [US, the largest debtor in the world but incurring debts in its own currency, is not a creditor so does not fit the “normal” stage approach].

11. International balance on goods, services & income • Exports minus imports of goods & services equal the international balance on goods, services, & income. • Aid, remittances, loans & investment from abroad finance a LDC’s balance on goods & services deficit. • From 1981 to 1999, LDCs had a deficit every year.

12. Sources of financing the deficit • Aid • Remittances • Foreign investment • Loans (See Figure 15-1)

14. Concessional aid • Official development assistance (ODA) includes development grants or loans (with maturities of more than one year) at concessional financial terms (at least a 25% grant component). • 2001: average grant component of OECD bilateral aid to LDCs was 93.8%: $41.0 b grants; $10.4 b X .69 grant component of loans is $7.2b. 41.0 + 7.2/41.0 = 10.4 = 93.8%. • 1990s OECD contributed 98% of aid. • 2001 aid by OECD 0.22% of GNP, less than half of 0.70% target.

15. Leading aid givers • 1993-2000 Japan gave more foreign aid than any other OECD country (Figure 15-3). • U.S. led as aid giver 2001 and after. • However, U.S. ranked last among OECD countries in aid as a percentage of GNI, 0.11% (Figure 15-2).

18. Why give aid? • Purpose usually to promote giving nation’s self interest. • Strategic goals: strengthen LDC allies, shore up donor’s defense installation, improve donor access to strategic materials, & keep LDC allies from changing sides (although military aid is not included in economic aid’s scope).

19. Why give aid? • Political & ideological concerns: support a military ally, influence behavior in international forums, to strengthen cultural ties, or propagate democracy, capitalism, or Islam. • US Point Four assistance in 1949 was motivated by promoting democracy & capitalism & minimizing Soviet influence. • Humanitarian motives (for social justice): emergency relief, food aid, assistance for refugees, grants to least developed countries. Sometimes humanitarian motives overlap with self interest, e.g., in maintaining stable, global political system.

20. Tied aid • Tied aid (19.2% of OECD aid) is worth less than face value (US tied aid – where recipient country must use funds in the donor country – was 75.7% in 1996, the latest year for figures).

22. Japan’s aid • Increase economic power, export promotion, resource acquisition, overall economic security, bilateral influence, & recipient’s political stability. • Focus on Asia. • Understaffed, politically muddled & administratively complex. • Historical memory of rapid growth shapes aid programs.

23. OECD top aid recipients • Top 10 recipients of OECD foreign aid 2000 shown in Figure 15-4 (next slide).

25. Aid to enhance global public goods • Atmosphere (climate) • Biosphere • Family planning programs • Economic sustainability, peace, & security

26. How effective is aid? • May exceed capacity absorption. • Can delay self-reliance, contribute to postponing internal reform, support interests opposing income distribution. • Food aid can undercut local food producers’ prices.

27. How effective is aid?(Easterly) • Much of DC, World Bank, & IMF aid squandered on poorly designed programs. • Loans should have been based on economic reform & good governance. • Little investment in improving lot of the masses. • Debt forgiveness for highly indebted poor countries (HIPCs) “throwing good money after bad money.” - Easterly was disciplined by World Bank.

28. African aid recipients • Morss: in 1970 effectiveness of aid to sub-Saharan Africa declined: Aid programs placed more burden on scarce local management skills & put less emphasis on recipients’ learning by doing. Malawi hired donor country personnel to manage some projects.

29. African aid recipients • Tanzania kept best economic analysts at home in the late 1980s & early 1990s, but “the price of keeping top professionals at home [was] to see them absorbed into the domestic consultancy market, sustained by donor-driven programmes of [technical assistance].” (Sobhan). Diversion from teaching & domestic policy debate & initiative.

30. African aid recipients • ODA not associated with economic growth. • Low-income countries in Africa and Bangladesh are hampered by aid dependence that makes no significant contribution to self-sustained development (Riddell). • Aid needs to strengthen economic policy. • Aid has high conditionality, is volatile & unpredictable, & lacks donor coordination & coherence.

31. How to increase aid effectiveness • Select recipients with well developed institutions & polices & oriented toward economic reform. • Aid for global public goods or building indigenous skills. • Aid for food, agricultural development, debt relief, & cushioning external shocks. • Easterly: opposes aid-givers’ stinginess. Wants donors to select better quality projects.

32. US aid • Aid/GNP by US lowest among OECD (Figure 15-2). • Has reduced political influence since early 1950s reduced Congress’s interest in aid? • Do Americans lack conviction that increased LDC security reduces threats to US quality of life? • Has the end of the Cold War reduced the US’s aid competition? • Has the US achieved many of its goals through dominance in the IMF & World Bank?

33. OECD share of aid to low-income economies has fallen • From about 50% in 1972-73 & 1982-82 to 73% in 1992-93 to 30% in 2000-01. • Figure 15-5: on aid to least developed countries and other low income countries • Low-income countries received $10 ODA per capita in 2001; middle-income countries $8.

35. Multilateral aid • OECD (2001): 36% of aid (0.08% of GNP) went to multilateral agencies. • US (1997): 20% of aid (0.02% of GNP) went to multilateral agencies. • International Development Association, World Bank’s concessional window, largest giver of concessional aid. • US Congress often objects to US loss of donor control.

36. Food aid • US real food aid fell from the 1960s to recent years. • US real agricultural aid also declined. • Three-fourths of food aid in 1980s and 1990s went to low-income countries, amounting to one-third of their cereal imports. • While food aid has frequently saved lives, it can increase dependence, promote waste, not reach the most needy, and dampen food production.

37. Food aid • International Food Policy Research Institute (IFPRI, 1997): donors should replace program food aid with cash assistance for commercial food import or buying locally. Cash aid is fungible, increasing the recipient’s real resources. • Need focus on long-term agricultural research & technology in LDCs. Little DC agricultural research is applicable to the ecological zones of LDCs. Green Revolution of 1960s through 1990s in India, Pakistan, the Philippines, & Mexico emphasized aid to LDC agricultural research & might be a model for future DC aid to LDCs.

38. Workers’ remittances • World migration pressure is high & rising, analogous to a pent-up flood, increasing as the tap widens from increasing wage gaps between DCs & LDCs. • 2003: 175 million people were living outside their own country; 1973: only 75 million people. • Remittances from nationals working abroad help finance many LDCs’ balance on goods, services & income deficits.

39. Workers’ remittances • Workers’ remittances/total inflows to LDCs 24.9% in 2001, a “brain gain.” • In low-income economies, remittances/GDP 26.5% Lesotho; 16.2% Nicaragua; 16.1% Yemen; 15.0% Moldova; 8.5% Honduras; 8.5% Uganda. Tajikistan migrant workers to Russia sent back $200-300 million, more than total government revenues (see Figure 15-6 for relative importance of remittances and Figure 15-7 for leading remittance recipients).

42. Private Investment & Multinational Corporations (MNCs) • While real aid to LDCs fell during the 1990s, foreign direct investment (FDI), 74% of total resource flows to LDCs, increased (Figure 15-1). • Private FDI consists of portfolio & direct investment. • MNCs, business firms with a parent company in one country & subsidiary operations in other countries, are responsible for much of direct investment.

43. MNC intrafirm trade/international trade • In 1999, 36% of US exports were intrafrim exports; in Japan 31%. • Exports of US affiliates/China’s exports 36% in 1998. • See Figure 15-8 on US affiliate export share. • DCs 71% of FDI inflows, 75% of FDI outflows, & large share of international trade. • But emerging countries (Taiwan, Korea, Singapore, China, India & Brazil) are beginning to be a factor in FDI.

45. DCs’ FDI • Figure 15-9: in 2000, 56% of FDI in LDCs is from high-income OECD countries, 9% from high-income non-OECD countries, & 35% from LDCs. • US 52% of world’s stock of outward FDI in 1971, 40% 1983, 25% 1993, & 16% 2001 (leader all these years although European Union [38%] had more than twice the US’s 2001 figure). • US largest inward and outward FDI flows in 2001. When Hong Kong is included, China ranked 2nd in inward flows in 2001 (first among LDCs).

47. Global production networks (GPNs) • World Bank (1997): participation in the global production networks established by multinational enterprises provides developing countries with new means to enhance their economic performance by accessing global know-how and expanding their integration into world markets.”

48. Private capital flows to LDCs • However, net private capital flows to LDCs, $168 billion, 2.8% of LDCs’ GNI in 2001, a fall the percentage in 1990 (percentage for low-income countries fell even more because of low credit ratings). • Private capital flows are highly volatile, especially in countries that have liberalized their financial markets (e.g., Asian crisis of 1997-98).

49. Advantages of FDI • No future debt service • Transfer of technology • Aids balance of payments • Management & entrepreneurship • Creates forward & backward linkages • Trains domestic managers & technicians • Provides contacts with overseas banks, markets, & supply sources

50. Changes LDCs need • Institutional changes to facilitate foreign & domestic investment (especially to become part of GPNs), & participate in the new international division of labor created by outsourcing by high-income OECD countries).