Foreign Finance, Investment, and

Aid: Controversies and Opportunities

Quantitative change or expansion in a country's economy. Economic growth is conventionally measured as the percentage increase in gross domestic product (GDP) or gross national product (GNP) during one year. Economic growth comes in two forms: an economy can either grow "extensively" by using more resources (such as physical, human, or natural capital) or "intensively" by using the same amount of resources more efficiently (productively). When economic growth is achieved by using more labor, it does not result in per capita income growth . But when economic growth is achieved through more productive use of all resources, including labor, it results in higher per capita income and improvement in people's average standard of living. Intensive economic growth requires economic development.

Three sources:◦ Private direct and portfolio investment◦ Remittances of earnings by international migrants◦ Public and private development assistance

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Foreign Direct Investment – when a firm invests directly in production or other facilities, over which it has effective control, in a foreign country.

International Monetary Fund (IMF) guidelines consider an investment to be a foreign direct investment if it accounts for at least 10 percent of the foreign firm's voting stock of shares..

Foreign subsidiaries – overseas units or entities.

Host country – the country in which a foreign subsidiary operates.

Flow of FDI – the amount of FDI undertaken over a given time.

Stock of FDI – total accumulated value of foreign-owned assets.

Outflows/Inflows of FDI – the flow of FDI out of or into a country.

Horizontal FDI – the MNE enters a foreign country to produce the same products product at home.

Conglomerate FDI – the MNE produces products not manufactured at home.

Vertical FDI – the MNE produces intermediate goods either forward or backward in the supply stream.

Liability of foreignness – the costs of doing business abroad resulting in a competitive disadvantage.

Flow and stock increased in the last 20 years In spite of decline of trade barriers, FDI has grown more rapidly than world trade because

◦FDI is seen a a way of circumventing trade barriers

◦Dramatic political and economic changes in many parts of the world

◦Globalization of the world economy has raised the vision of firms who now see the entire world as their market

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Traditional arguments in support of private investment:

Filling savings, foreign exchange, revenue, management gaps

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Traditional arguments against private foreign investment: Widening gaps

Lower Domestic saving Reduce Foreign exchange earnings Lesser contribution to taxes Lesser development of Management skills Wage Differentials Influence govt. policies

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3.6 4.18.1

13.6 16.6

52.7

0

10

20

30

40

50

60

$Billions

India Poland CzechRepublic

Mexico Brazil China

Country

FDI 2002InwardForeignDirectInvestment

What is portfolio investment?

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Conceptual problems Amounts and allocations: public aid

◦ Official development assistance (ODA)◦ Foreign Aid

Grants, which do not have to be repaid. Concessional loans, which have to be repaid but

at lower interest rates and over longer periods than commercial bank loans.

Contributions to multilateral institutions promoting development, such as the United Nations, International Monetary Fund, World Bank, and regional development banks.

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Public services (Education, Health, Population, Water& Sanitation, Government, Environmental)

Production (Transport & Storage, Energy, Agriculture, Forestry, Fisheries, Industry, Mining)

Business services (Communications, Banking, Financial, Business, Trade, Tourism)

Macroeconomic adjustment (Structural adjustment, Debt relief)

Commodities (Food aid, other commodities)

Relief (relief food, Emergency Distress Relief)

Other multisectoral and unallocated

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Why donors give aid◦ political motivations◦ economic motivations:

Foreign exchange constraints Growth and savings Technical assistance Absorptive capacity

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Why LDC recipients accept aid The role of nongovernmental organizations

(NGOs) The effects of aid

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