Download Sources-of-External-Finance

Sources of External Finance
• Foreign Direct Investment by MNC’s
– eg. Nike building a factory in Nigeria
• Aid (gov’t and non-gov’t)
– eg. direct payment from the UK gov’t to
Ethiopia; Red Cross sending funding and
resources to vulnerable areas
• Bretton Woods Institutions
– World Bank or IMF giving or lending money to
developing countries
• Debt Relief
– developed countries write off debts owed to
them by very poor countries
FDI – Why do MNC’s do it?
• Access to cheap labour & natural resources
• Cheaper taxes, infrastructure, planning
constraints, etc
• Grants by gov’ts
• Get inside a customs union – avoid tariffs
• Expand into new markets – regional focus
Foreign Direct Investment – Good?
• Represents > 3x the amount of aid
• A crucial source of investment funds where
savings is hard to encourage
• Brings access to world class technology &
management
• Labour productivity tends to be higher –
workers tend to be paid more
• Has a regional multiplier effect
Foreign Direct Investment – Bad?
• Exploitation of job-hungry workers (incl. children)
• May reduce labour market flexibility
• Environmental risks may seem threatening to
local population
• Firms may “ring fence” – not including the local
community, paying off influencial people, etc
• Local firms may be put out of business
• May deal with (support) repressive regimes
Government Aid
• May be a loan or gift
• May be for short term crisis or long term growth
• May have conditions attached
• May serve the aider’s interests more than the
aided
• Has fallen 20% globally in real terms since 1990
UK Gov’t Aid
• represents approx. 0.56% of GDP – target 0.7%
• targets for poverty reduction, access to primary
education, gender equality (difficult to assess
success in reaching targets)
• Bilateral aid may be used as incentive in securing
commercial contracts – poorest countries may
have none to offer
• Liberalised trade may have more benefits
• Very little given to Bretton Woods institutions –
most is bilateral or through EU aid funds
Bretton Woods Institutions
• After WWII, allies met in Bretton Woods, New
Hampshire, to set up systems to avoid the
collapse in international payments and exchange
rates that had occurred after WWI
• 3 institutions established:
- International Monetary Fund
- International Bank for Reconstruction and
Development (IBRD – now World Bank
- World Trade Organisation
• Some overlap between the institutions now
International Monetary Fund
• Function: to ease balance of payments problems
and promote exchange rate stability (primarily
concerned with monetary systems and currency)
• Loans are short-term and include
conditionalities and stabilisation policies (eg.
tighter monetary policy; devaluation of
currency)
• Paves the way for structural adjustment of the
economy
• But, measure can often lead to decreased real
output & increased unemp. in short run –
appears as pain inflicted by the developed world
World Bank
• Function: promote long-term growth by providing
loans for investment and development
• May be conditional on radical supply-side reforms
(eg. privatisation of state monopoly; trade
liberalisation) – these reforms may have made
things worse, not better, at least for some
• Since late ’90’s more focus on targeted aid for
poverty reduction – social rather than just
economic development
• Now divided into 5 separate organisations
World Bank: evaluated
• Long-term objectives may not be possible with
debt repayment
• Countries need to feel ownership of change &
must be congruent with local culture
• Structural adjustment conditions for reform too
formulaic & rigid
• Poorly run countries who don’t meet conditions
are being left behind those who get World Bank
help and subsequent MNC investment
Over-Indebtedness – Why has it happened?
Many countries have over-borrowed perhaps with
unrealistic expectations of future wealth from the
cash injection due to:
• Domestic policy failings; debt used to finance
prestige projects rather than basic infrastructure
• Keeping exchange rate high to facilitate cheap
imports – reduces export earnings
• Corruption; Civil war
• Overdependence on narrow range of exports or
in sectors with poor growth rates
Over-Indebtedness – Why has it happened?
External Factors:
• Natural disasters (disease; flooding, etc)
• High value of the $ (increasing value of debt
repayments)
• Increased oil prices
• Collapse of world commodity prices
• Increased protectionism of developed world
The Burden of Debt Servicing
• Opportunity cost: what does the country have to
give up to pay interest on loans?
• The poorest countries may spend more on
servicing their debt than on healthcare and
education
• Creates a cycle of poverty: necessary
infrastructure is never created/updated so
growth can never occur
Debt Forgiveness
• 1996: Heavily Indebted Poor Countries Initiative
(HPIC) launched – 41 countries identified as
having unsustainable levels of debt - $100B
relief agreed at G7 summit
• But, conditional (eg. no violent conflict,etc)
• Scheme criticised – countries have to prove they
are debt-relief worthy – biased toward
conditions of the creditor
Advantages of Debt Forgiveness
• Frees resources for development of
infrastructure & human capital
• Successful growth benefits the developed world
– less aid
• Wealth transfer from rich to poor countries
seems morally right
• May increase confidence of international
community & increase FDI
Disadvantages of Debt Forgiveness
• May run up huge debts again or reduce
possibility of receiving aid
• May encourage wasteful expenditure or
undemocratic governments
• Freed resources may be squandered
• Structural constraints to growth may still exist
• Consequences for lending countries who’s
balance sheets contain loans to developing
countries