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TRADE AND INVESTMENT Trade Free trade – implies free cross-border direct and indirect investment and technology Advantages 1. Access to a. physical capital – increase K/L b. money – increase ability to buy K and raise K/L c. new technology – increase ability to lower L and increase K/L d. An actively trading country benefits from the new technologies that “spill over” to it from its trading partners, such as through the knowledge embedded in imported production equipment. e. Access to human capital 2. some may argue that the cause-and-effect connection can also work in the opposite direction: those countries that are most successful in economic development and growth can afford to be more open to foreign trade (and thus to foreign competition) and also tend to be more attractive for foreign investors. Disadvantages 1. Competition a. May be good, if it forces developing country to lower costs. b. May be bad, if it forces companies in developing countries to close c. Generally, companies in developing countries have not achieved the same lowcost economies of scale as companies in more developed countries have attained d. Company closings more unemployment lower effective demand 2. Developed countries also impose trade barriers 3. To help developing countries, developed countries should set low or no trade barriers on agricultural and textile imports Managed trade Tariffs Quotas Export restraints Legal prohibitions Currency manipulation Subsidies - developed countries provide subsidies to farmers – mostly Europe Advantages 1. Employment 2. Short-term – protect industry until it achieves economies of scale Disadvantages 1. Long-term – protects inefficiency 2. Retaliation 3. Trade wars International Organizations International Monetary Fund (IMF) – short-term financing for BOP imbalances World Bank – long-term loans for social (overhead) capital projects World Trade Organization (WTO, preceded by the GATT until 1995) – trade agreements Trade Theories Absolute advantage Comparative advantage – specialization and division of resources among countries Heckscher-Ohlin Factor Proportions Model Differential growth experience BRICS Sub-Saharan Africa Some may argue that the cause-and-effect connection can also work in the opposite direction: those countries that are most successful in economic development and growth can afford to be more open to foreign trade (and thus to foreign competition) and also tend to be more attractive for foreign investors. Costs and benefits of participating in international trade also depend on such country-specific factors as 1. the size of a country’s domestic market (bigger, trade less; smaller, trade more) 2. its natural resource endowment (1-2 major natural resources, trade more; more natural resources, trade less) 3. its geographic location (transportation costs). Measurement – the ratio of a country’s trade (exports plus imports) to its GDP or GNP (exports plus imports)/GDP or (exports plus imports)/GNP Fig. 12.1 Growth in GDP and Exports North – synonymous with developed South – synonymous with developing Trade patterns North-North Trade Developed countries still trade mostly among themselves. North-South Trade In 1999 only 23 percent of world imports went to low- and middle-income countries, of which 9 percent went to East Asia and the Pacific and only 1 percent to SubSaharan Africa and 1 percent to South Asia. The Middle East and North Africa received about 2 percent of world imports, while Europe and Central Asia and Latin America and the Caribbean received 5 percent each. South-South Trade Even though developing countries have increased trade among themselves, developed countries still remain their main trading partners, the best markets for their exports, and the main source of their imports. Terms of Trade – pH/pROW or pA/pM TOT for most developing countries deteriorated in the 1980s and 1990s, because prices of primary goods—which used to make up the largest share of developing country exports—fell relative to prices of manufactured goods. Developing countries that depend on primary products (agriculture and natural resources) lost purchasing power as the prices of primary products, including oil, fell 1980-2000. Developing countries have diversified and now export more manufactured goods, e.g., labor-intensive, low-knowledge products (clothes, carpets, some manually assembled products) that allow these countries to create more jobs and make better use of their abundant labor resources. By contrast, developing country imports from developed countries are mostly capitaland knowledge-intensive manufactured goods—primarily machinery and transport equipment—in which developed countries retain their comparative advantage. Figure 12.2 Direction of trade in tradables Impact on employment and wages Does the growing competitive pressure of low-cost, labor-intensive imports from developing countries push down the wages of unskilled workers in developed countries (thus increasing the wage gap between skilled and unskilled workers, as in the United Kingdom and United States) and push up unemployment, especially among low-skill workers (as in Western Europe)? Empirical studies appear to suggest that although trade with developing countries affects the structure of industry and the demand for industrial labor in developed countries, the main reasons for the wage and unemployment problems are internal and stem from labor-saving technological progress and postindustrial economic restructuring. Immigration – international mobility of labor Types of migration Employment-related – alternative to trade-influenced wages o rapid rise in migration of qualified and highly qualified workers, most notably in response to labor shortages in the information and communications sectors of developed countries, but also in the research and development, health, and education sectors. o demand is also high for low-skilled foreign labor for tasks resistant to automation, such as care of the elderly, house cleaning, agriculture, and construction. o “brain drain” from developing countries Refugees People seeking political asylum South North migration Destination countries: USA, Germany, Japan, Australia, Canada, the United Kingdom, Switzerland, and Italy. Origination countries: Mexico! Why? Increasing gap between developed and developing countries Population growth rates still higher in developing countries than developed countries Declining costs of migration (information and transportation costs) THE WALL? Investment – international mobility of capital Types Direct foreign investment – real capital (TNCs/MNCs and > 10% of shares) Indirect (bank loans and portfolio) foreign investment o borrowing and lending o shareholding (< 10% of shares Official development assistance (ODA) – foreign government aid - food aid, emergency relief, technical assistance, peacekeeping efforts, and financing for construction projects. o Post WW II – to developing countries – motivated by the desire to support their political allies and trade partners, to expand the markets for their exports, and to reduce poverty and military conflicts threatening international security. o Post-perestroika – to transition countries – Eastern Europe and Central Asia, former centrally planned economies also started to receive official assistance, aimed primarily at supporting market reforms. Table 13.1 Net capital flows Distribution of FDI among developing countries remains extremely unequal. China, Brazil, Mexico, Argentina rec’d the most – about the same amount as all other countries The bulk of FDI flows tends to go to middle income countries, so the exclusion of the poorest countries may have contributed to further widening of global income disparities. Sub-Saharan Africa as a whole receives about 5% of all FDI and most is concentrated in countries rich in petroleum and minerals. Attraction factors – favorable investment climate: Stable political regime Liberal and predictable government regulation Good prospects for economic growth – strong effective demand Infrastructure o Utilities o Communication system o Transportation system Skilled labor supply Easy convertibility of the national currency Tax considerations Advantages to developing country advanced technologies managerial and marketing skills easier access to export markets Disadvantages to developing country insensitivity of foreign companies exploitation of local workers at hint of political trouble, foreign capital flees Indirect foreign investment portfolio investment is even more dangerous than foreign direct investment, because portfolio investors—who own only a small percentage of shares in a company and have little or no influence on its management—are much more likely to try to get rid of these shares at the first sign or suspicion of falling profits. Official Development Assistance (ODA) most important source of foreign financial flows for countries that are unable to attract private capital or private borrowing Declining as % of GDP since peak in 1960s Three types: o Grants, which do not have to be repaid. o Concessional loans, which have to be repaid but at lower interest rates and over longer periods than commercial bank loans. o Contributions to multilateral institutions promoting development, such as the United Nations, International Monetary Fund, World Bank, and regional development banks (Asian Development Bank, African Development Bank, InterAmerican Development Bank). Donor countries concern: Aid may not be used efficiently enough in the countries with poor policy environments and particularly in those suffering from high levels of corruption among government officials. Large amounts of development aid can be wasted in such countries, while they could have brought considerable improvements to people’s lives in other countries. “Tied” aid: requires recipients to purchase goods and services from the donor country or from a specified group of countries. o Tying arrangements may prevent a recipient from misappropriating or mismanaging aid receipts, o but they may also reduce the value of aid if the arrangements are motivated by a desire to benefit suppliers of certain countries, and o that may prevent recipients from buying at the lowest price. “Tied up” by conditionalities or “policy-based assistance” o aid depends on the enactment of certain policy reforms that donors see as beneficial for recipient countries’ economic growth and poverty reduction, e.g., aid to transition countries is often tied to the speed of market reforms. Aid to “heavily indebted poor countries” (HIPCs) o International Monetary Fund and the World Bank program launched in 1996 o Aims to reduce the unsustainable burden of foreign debt o In order to qualify for assistance under this program, countries must be not only poor (low-income countries, by World Bank criteria), and not only severely indebted (with the sum of foreign debt exceeding 150 percent of their export returns), but they must also be able to show their ability to develop and implement their own poverty reduction strategies. o The goal is to make sure that the budget funds that will be freed up from servicing those countries’ foreign debt will indeed be used in the interests of their development rather than diverted to other uses (such as military). Further issues: 1. Would you agree that the quality of national policies aimed at economic growth and poverty reduction should as a rule govern donors’ decisions to provide aid to this or that country? 2. Which other ways of improving ODA’s effectiveness would you suggest? How does trade affect growth graph? .