International issues 2
(Chapters 14 and 15)
Introduction of definitions
for Balance of Payments
Current
Account Balance, Capital Account Balance, Cash Reserve Account (then errors and
omissions).
Current Account: The portion of a country’s balance of payments
that portrays the market value of a country’s visible and invisible exports and
imports with the world.
The value of exports of goods
and services
+ Investment income received
from abroad
+Net remittances and
transfers
–the value of imports of goods and services
–Debt service payments.
Capital
account. A portion of a country’s balance of payments
that shows the volume of private foreign investments and public grants and
loans that flow into and out of a country over a given period.
Direct private investment
+Foreign loans (public and
private)
–Resident capital outflow
–Increase of foreign assets
of domestic banking system.
Cash reserve account. The balancing portion of a country’s balance
of payments, showing how cash balances (foreign reserves) and short term
financial claims have changed in response to current account and capital
account transactions.
Change in cash reserve
account:
Change in holdings of foreign
hard currency
+Change in gold holdings
+Change in deposits at the
IMF.
Special Drawing Rights: Claims on the IMF. Can be used as a type of
international reserve.
Errors and Omissions =
Change in cash reserve
account
–
current account
balance
– capital account balance.
Note there is also a measure
of the trade balance you may see reported.
Net value of exports minus imports of goods. (services left out).
Developing countries tend to
have negative current accounts. Net importers.
Historically, balanced by inflows of capital, both foreign investment
and lending for a positive capital account.
The current account balance
is expressed in value, and that value is in USD.
Devaluation can help address
a persistent negative current account (although also impacts capital account). We don’t worry as much about the capital
account since it is seen as less under the control of the national decision
makers than the current account.
If currency is overvalued,
increasing the local cost of imports / increasing the competitiveness of
exports could happen by adjusting the exchange rate.
Reduce the value of the
domestic currency (as in declare that the official rate of exchange is no
longer 2 kwacha per dollar, it is 5 kwacha per dollar; a kwacha that was worth
$0.50 is now worth $0.20).
The wine that you import for
$10 per bottle goes from 20 kwacha to 50 kwacha.
The farmers who sell a kilo
of rice for 5 kwacha locally have the international price of their rice go from
$2.50 to $1.00.
Depreciation is similar, but
more gradual.
Freely fluctuating currency
rates, where market forces determine exchange rate. Can lead to unpredictable
movements and uncertainty. “Floating” a currency.
Managed
float. Major currencies fluctuate freely, but are
managed through monetary policy. (shift supply curve of currency buy increasing supply of
money in the economy through lowered interest rates or decreasing supply of
money by raising interest rates)
Ambiguous
impact on current account balance due to inflationary aspect.
High inflation will mean the
currency will need to be continually devalued against the world currencies.
Devaluation will also impact
different segments of society differently.
Domestic producers who do not
export, importers will be harmed.
Exporters will be helped. Who are
the exporters and who are the importers?
Balance of payments
in action – Understanding the Debt crisis.
What happened in the 1980’s?
Late 60’s,
early 70’s rapid growth in developing countries. Many countries
ran current account deficits, balanced with inflows of capital.
Then in the mid 70’s, the oil
crisis came along. Three
main impacts.
1) Price of oil went up, leading to inflation.
2) World economy slowed down, decreasing market outlets
for goods produced in developing countries.
3) Savings of OPEC countries put into banks, and banks
wanted to lend this money out.
For the second half of the
70’s, private banks made loans to developing countries to balance the current
account deficit.
Faced with inflation and
slowed growth, developing countries decided to borrow money to address these
issues.
Many of these loans were on nonconcessional terms (more than tripling the lending of
private capital markets over this period) compared to the previous loans which
were from international institutions or developed country governments.
Second oil shock and macroeconomic
adjustment in developed countries in late 70’s / early 1980’s. Interest rates went up rapidly as polices
such as Volker’s Fed (tight money supply to break inflation) were implemented
in the developed countries. Particularly damaging if loans were flexible rate loans.
In addition, there was a huge
outflow of capital from developing countries from the mid 70’s to the mid
80’s. “capital
flight”. Individuals were putting a lot
of their savings into investments outside of the national economy.
Domestic inflation, high
rates of interest in developed countries, low domestic growth.
Macroeconomic
instability: high inflation, government
budget and foreign payment deficits, reserves no longer adequate to balance
negative current and capital account balances.
Two choices
in such a situation.
1) Curtail imports (tariffs, quotas, reduce overvalued
exchange rate), impose restrictive fiscal and monetary measures (reduce
government spending, tighten money supply to reduce
inflation).
2) Borrow more.
Most borrowed more, leading
to huge debts and huge debt service bills.
By the 1990’s, we entered the phase of IMF stabilization programs, where
option one was arguably no longer possible to evade.
Restructuring of debt with
private institutions conditional upon adoption of an IMF sponsored
stabilization program.
1) Abolish foreign exchange and import controls.
2) Devalue overvalued currencies.
3) Anti-inflation fiscal and monetary policies (raise
interest rates and reserve requirements, cut government spending, control wage
increases, free markets and remove price controls).
4) Open up and encourage FDI.
If you follow the stabilization
steps, you get some SDR to help balance reserve account.
Did not lead to growth in the
majority of places it was implemented.
However, it did allow for
debt restructuring. Reduce interest
rates, extend payment period, cancel some of the principal due. Private banks get
guarantee from WB and IMF if they restructure that loan will not fail. Debt for equity (buy
debt at 50 cents on the dollar, use the money to buy the state owned telephone
system), debt for nature swaps (buy at a discount, use money for natural
resource conservation projects).
Worked out
well for banks and for international financial system. Crisis was
avoided, major defaults were avoided.
Did not
work out so well for developing countries. Debt service as percent of GNP
remains very high, and the burden of debt did not go away, just got spread out
over time. Need capital for growth,
need growth to pay off debt, but with outflows to service existing debt they
end up in a trap.
Low and middle income country
debt stock, current US billions:
1970, 45
1980, 339
1990, 1,034
2000, 1,357
2005, 1,361
This package of policies that go with the structural
adjustment period has been termed the “Washington Consensus”. Williamson (1990), see
Williamson in the reader (2000).
Largely
developed in response to the experience of Latin American countries in the
1980’s.
High budget
deficits, borrowing (debt crisis), high inflation.
Based on our theories that
markets work, and that market based solutions and policies would help solve
these problems that were experienced.
· Fiscal discipline, balanced budgets, control
inflation.
· Redirect public expenditure to fields with high
economic return and potential to improve income distribution.
· Tax reform (lower and broaden)
· Interest rate liberalization
· Competitive exchange rates
· Trade liberalization
· Liberalize FDI inflows
· Privatization of state owned assets.
· Deregulate to abolish barriers to entry and exit
· Secure property rights.
One main finding from
countries that adopted these policies is that liberalization without
supervision can be problematic.
The financial
crises of the late 1990’s made clear that capital market and exchange
rate liberalization could lead to instability.
Privatization did often lead
to increased efficiency, but not always increased equity.
Privatization often led to
short term benefits in the government’s budget status only.
Privatization was also found
to be of questionable benefit if there is not a competitive market to replace
the previous system.
Privatization is neither an
unambiguously good idea nor an unambiguously bad idea.
What about foreign
investment, finance, and aid? Since we
saw that the current account balance is usually negative, what can be done with
the capital account?
Part of the goal of liberalizing
according to the “
Multinational corporation – corporation or enterprise that conducts and
controls productive activities in more than one country.
Foreign direct investment
flows tend to places with highest returns and highest security. Over 90% of international FDI flows go to
other industrial countries and the fastest growing LDC’s.
[ see UNCTAD and Cgdev figures]
Huge size of MNC – often
larger than the GNP of the country they are dealing with.
GE value of assets in 2004: $750,507,000,000
SSA GNI in 2004: $503,184,615,863
LAC GNI in 2004:
$2,015,101,927,331
They may be oligopoly
producers.
Historically,
extractive industries. Increasingly, manufacturing and services (but
often aimed at manufacturing for export back to the MNC’s home country).
[see
again UNCTAD figures]
What are the arguments in
favor of MNC’s?
1) Fill savings gap.
Developing countries need capital, MNC’s have it.
2) Fill foreign exchange gap. Developing countries need dollars, MNC’s have
them.
3) Fill government revenue gap. Coffers filled by taxing MNC’s, use money for
development projects.
4) Transfer of skills, knowledge, and technology.
Arguments
against?
1) Capital invested in MNC may stifle local competition,
may not lead to reinvestment in local economy, may not
lead to linkages in country as forward and backward linkages may be
international.
2) Can worsen foreign exchange position, as MNC’s import
products and capital goods, and repatriate profits.
3) Tax concessions may dampen any direct impact.
4) Skills may not be transferred as expat staff in
charge, and may not be all that applicable to local conditions.
Another issue of MNC management
is the practice of transfer pricing. As
MNC’s have a global production chain, you set the price of an intermediate good
sold from one branch in one country to the next branch in another country to
get the lowest tax burden.
Portfolio investment. Foreign purchases of stocks, bonds, CD’s and
commercial paper of LDC’s.
Diversification of investment portfolios of developed country investors
has led to a large jump in these funds over the past decade.
The good news is that they
provide a lot of capital for enterprise development in developing
countries.
However, this tends to be in
the fastest growing, most secure countries.
The bad news is that it is a
highly volatile source of capital.
Sudden, dramatic, outflows of capital possible. Not long run investment in all cases.
Asian currency crisis in
1997,
Russia in 1998,
Brazil in 1999,
Argentina in 2001…
Sudden flows can lead to a
sudden crisis.
Foreign aid.
Bilateral
and multilateral.
Public and
private (NGO).
Explicit (counted) and
implicit (usually not counted).
Not commercial flows, and not military aid.
As governments move out of
the way of markets, idea was that aid would flow more efficiently.
Foreign aid meets two
criteria:
1) Objective should be non-commercial from the point of
view of the donor.
2) It should be characterized by concessional terms
(interest and repayment period less stringent than commercial terms).
Issues with figuring out the
amount of aid:
1) Discounting to distinguish real from nominal
2) Accounting for the parts of aid being given as a loan,
not a gift
3) Aid can be tied by source (must buy inputs from
donors) or by project (must use aid in a specific way).
Official development
assistance (ODA): bilateral and
contributions to multilateral grants, loans, and technical assistance.
Pattern over time from OECD www.oecd.org/statistics
:
Pattern across countries
Also OECD figures
Can find country specific
information by recipient:
O
Or by donor:
Or for the whole OECD:
Historically, a large share
of US ODA went to two countries:
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|
|||||
|
1983-84 |
1993-94 |
2003-04 |
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|
|
14.1 |
|
10.9 |
|
11.8 |
|
|
13.0 |
|
7.1 |
|
4.1 |
|
|
2.5 |
|
4.1 |
|
3.9 |
|
|
2.3 |
|
3.6 |
|
3.4 |
|
|
2.2 |
|
2.7 |
|
3.3 |
|
|
2.1 |
|
1.8 |
|
3.0 |
|
|
1.9 |
|
1.4 |
|
2.8 |
|
|
1.7 |
|
1.3 |
|
2.6 |
|
|
1.6 |
|
1.3 |
|
1.4 |
|
|
1.6 |
|
1.2 |
Palestinian Adm. Areas |
1.2 |
|
|
1.3 |
|
1.2 |
|
1.1 |
|
|
1.3 |
|
1.1 |
|
1.1 |
|
|
1.2 |
|
1.0 |
|
1.0 |
|
|
1.2 |
|
0.9 |
|
1.0 |
|
|
1.1 |
|
0.9 |
|
1.0 |
|
|
|
TOTAL DAC
COUNTRIES |
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|
|
1983-84 |
1993-94 |
2003-04 |
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|
5.2 |
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5.0 |
|
3.8 |
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|
4.7 |
|
3.8 |
|
3.7 |
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|
3.3 |
|
3.6 |
|
2.7 |
|
|
2.7 |
|
2.5 |
|
2.0 |
|
|
2.2 |
|
2.2 |
|
1.8 |
|
|
1.7 |
|
2.2 |
|
1.7 |
|
|
1.4 |
Ex-Yugoslavia. Unsp. |
1.4 |
|
1.5 |
|
|
1.4 |
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