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Chapter 14
Foreign Finance,
Investment, and
Aid: Controversies
and Opportunities
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Multinational Corporations (MNCs)
• Corporations that conduct and control
productive activities in more than one
country
• Large firms mostly from the U.S., Europe,
and Japan
• 350 MNCs control 40% of international
trade in primary and secondary products
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Foreign Direct Investment (FDI)
• FDI is investment by MNCs
• FDI in LDCs rose from an annual rate of
$11 billion in 1980 to $1,100 billion in 2000,
but fell to $600 in 2005
• Major recipients of FDI are China, Brazil,
Argentina, and Mexico
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FDI Inflows, 1980–2005
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FDI Inflows to LDCs in Relation to
Domestic Investment,1990–2003
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FDI Debate: Pros
FDI fills the
• Saving gap: causing economic growth
• Foreign-exchange gap: improving the BOP
• Tax revenue gap: raising funds for public
spending
• Management gap: improving entrepreneurship
• Technology gap: facilitating industrialization
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FDI Debate: Cons
MNCs
• Don’t reinvest their profit
• Return profits to their headquarters through
transfer pricing
• Create income for semi-skilled labor with low
saving propensities
• Deteriorate current account through
importation of capital goods and intermediate
products
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FDI Debate: Cons
MNCs
• Deteriorate capital account through outflow of profits
• Receive investment tax credits and are exempt from tariffs
• Hinder development of domestic managerial skills
• Gain monopoly power
• Reinforce dualism, increase income inequality, and induce RU migration
• Influence local politics and support “friendly” governments
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Seven Key Disputed Issues about the Role
and Impact of MNCs in LDCs
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Seven Key Disputed Issues about the Role
and Impact of MNCs in LDCs
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FDI Debate: Pros & Cons
Yes, MNCs
– Create jobs and income
– Transfer managerial skills and technology
But, MNCs
– Invest in most profitable business venture
– Transfer their profits out
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Private Portfolio Investment
• Foreign investment in the LDCs’ financial
markets: i.e., stocks, bonds, certificates of
deposit, commercial papers
• Investment in bonds and CDs increased
from $4 billion in 1989 to $54 billion in 1997
• Investment is stocks rose from $2.2 billion in
1989 to $33 billion in 1997
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Private Portfolio Investment
The “emerging-country” financial markets of
the NICs offered
• High rates of return (e.g., 39% in Latin
American stock markets in 1988-93)
• High risks due to frequent volatility
• Mexican currency crisis in 1994-95
• Asian financial crisis: a net outflow of $12 billion
in 1997 in contrast to a net capital inflow of $93
billion in 1996
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The Role and Growth of Remittances
• Wages and salaries made in a host country,
but sent back to the home country
• Wage differences
• “Brain Drain”
• Uneven flow of remittances
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Resource Flows to Developing
Countries, 1990–2005
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Top 20 Remittance Recipient Countries,
2004
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Foreign Aid
All governmental resource transfers from one
country to another
• Expressed in real terms
• Exclude military aid
• Exclude transfers from private foreign
investors
• Must be allocated to economic development
projects and programs
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Kinds of Foreign Aid
• Official Development Assistance: grants and
loans
• Tide aid: the donor requires the recipient to
use the funds to import products from
companies in the donor country
• Untied aid: the donor provides assistance for
developmental projects and plans
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Donation of Foreign Aid
• In monetary value, the U.S. and Japan are the
largest donor
• In percentage of GDP, Sweden and Netherlands are
the largest donor
• In monetary value, FA increased from 1985 to 2005
• In percentage of GDP, FA fell from 0.35 in 1985 to
0.23 in 2002, but rose to 0.33 in 2005
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Table 14.2 Official Development Assistance
Disbursements from Major Donor Countries,
1985, 2002, and 2005
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Allocation of Foreign Aid
• In U.S. $ per capita, the largest
recipients are countries in the Middle
East & North Africa and Sub-Saharan
Africa
• In percentage of GNI, the largest
recipients are countries in Sub-Saharan
Africa and the Middle East & North
Africa and
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Table 14.3 Official Development
Assistance (ODA) by Region, 2005
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Allocation of Foreign Aid
• In monetary value some of the largest
recipient are China, Israel, Egypt, India,
Bangladesh, and Indonesia
• In percentage of GNI, some of the
largest recipient are Mozambique,
Nicaragua, Uganda, Ethiopia, and
Bolivia
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Reasons for FA Donation
Economic
• Assist with economic development and
technology transfer
• Help in case of emergency (e.g., natural
disasters)
• Assist with economic transition (e.g.,
former Soviet republics)
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Reasons for FA Donation
• Economics: FA fills the
• Saving gap: causing economic growth
• Foreign-exchange gap: improving the BOP
• Technology gap: facilitating industrialization
given absorptive capacity limitation
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Reasons for FA Donation
Political
• Assist “friendly” government to succeed
• Promote “national security” by shifting FA
from one country or region to another
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Criticism of the Donor Countries
• FA won’t necessarily assist the poor people
of the LDCs
• FA assists non-democratic and corrupt LDC
governments
• FA is just a small percentage of GDP of
donor countries
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Criticism of the Donor Countries
• FA is mostly in the form of loans rather than
grants; FA is mostly tied
• FA discourages production, competition, and
self-reliance of the recipient nations
• FA is abused as an election propaganda in
both donor and recipient countries
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Nongovernmental
Organizations
• Voluntary organizations that work with and on
behalf of mostly grassroots and religious
groups
• Provide emergency relief, food, and medical
supplies for humanitarian reasons
• Work directly with people, not governments
• Save the Children, CARE, World Vision, etc.
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New View of FA
• Make aid need-based to reduce poverty and
overpopulation
• Provide more grants and less loans and
more untied aid
• Promote self-reliant development
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New View of FA
• Provide economic rather than political aid
• Help expand and strengthen the NGOs
• Understand that in the long-term, there can’t
be a dual future for the mankind, one for the
very rich and one for the very poor, without
the proliferation of global or regional conflict
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