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27 Cards in this Set

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Why is a strictly economicdefinition of development inadequate? What do you understand economicdevelopment to mean?

Development:the process of improving the quality of all human livesand capabilities by raising people’s levels of living, self-esteem, andfreedom.

What do you understand economic development to mean?

Developmenteconomics has an even greater scope. In addition to being concerned with theefficient allocation of existing scarce (or idle) productive resources and withtheir sustained growth over time, it must also deal with the economic, social,political, and institutional mechanisms, both public and private, necessary tobring about rapid (at least by historical standards) and large-scaleimprovements in levels of living.

Can you give hypothetical or real examples of situations in which a country may be developing economically but still be underdeveloped?

Thusdevelopment economics, to a greater extent than traditional neoclassicaleconomics or even political economy, must be concerned with the economic,cultural, and political requirements for effecting rapid structural andinstitutional transformations of entire societies in a manner that will mostefficiently bring the fruits of economic progress to the broadest segments oftheir populations.. Consequently, a larger government role and some degree ofcoordinated economic decision making directed toward transforming the economyare usually viewed as essential components of development economics. Yet thismust somehow be achieved despite the fact that both governments and marketstypically function less well in the developing world. In recent years,activities of nongovernmental organizations, both national and international,have grown rapidly and are also receiving increasing attention.In strictly economic terms, development hastraditionally meant achieving sustained rates of growth of income per capitato enable a nation to expand its output at a rate faster than the growthrate of its population. Economic development in the past has also beentypically seen in terms of the planned alteration of the structure ofproduction and employment so that agriculture’s share of both declines and thatof the manufacturing and service industries increases. Development strategieshave therefore usually focused on rapid industrialization, often at the expenseof agriculture and rural development. Problems of poverty, discrimination,unemployment, and income distribution were of secondary importance to “gettingthe growth job done.” Indeed, the emphasis is often on increased output,measured by gross domestic product(GDP).

How does the concept of“capabilities to function” help us gain insight into development goals andachievements? Is money enough? Why or why not?

Capabilities: the freedoms that peoplehave, given their personal features and their command over commodities.Amartya Sen, the 1998 Nobel laureate in economics,argues that the “capability to function” is what really matters for status as apoor or non-poor person. As Sen put it, “Economic growth cannot be sensiblytreated as an end in itself. Development has to be more concerned withenhancing the lives we lead and the freedoms we enjoy.” In effect, Sen arguesthat poverty cannot be properly measured by income or even by utility asconventionally understood; what matters fundamentally is not the things aperson has—or the feelings these provide—but what a person is, or can be, anddoes, or can do. What matters for well-being is not just the characteristics ofcommodities consumed, as in the utility approach, but what use the consumer canand does make of commodities. To make any sense of the concept of humanwell-being in general, and poverty in particular, we need to think beyond theavailability of commodities and consider their use: to address what Sen calls functioning,that is, what a person does (or can do) with the commodities of givencharacteristics that they come to possess or control. Freedom of choice, orcontrol of one’s own life, is itself a central aspect of most understandings ofwell-being. Sen identifies five sources of disparity between (measured) realincomes and actual advantages: first, personal heterogeneities, such as thoseconnected with disability, illness, age, or gender; second, environmentaldiversities, such as heating and clothing requirements in the cold, infectiousdiseases in the tropics, or the impact of pollution; third, variations insocial climate, such as the prevalence of crime and violence, and “socialcapital”; fourth, distribution within the family: Economic statistics measureincomes received in a family because it is the basic unit of sharedconsumption, but family resources may be distributed unevenly, as when girlsget less medical attention or education than boys do.Fifth, differences inrelational perspectives. Thus looking at real income levels or even the levelsof consumption of specific commodities cannot suffice as a measure ofwell-being. One may have a lot of commodities, but these are of little value ifthey are not what consumers desire. One may have income, but certaincommodities essential for well-being, such as nutritious foods, may beunavailable. Finally, even when comparing absolutely identical commodities, onehas to frame their consumption in a personal and social context. In the case ofnutrition, the end is health and what one can do with good health, as well aspersonal enjoyment and social functioning. But measuring well-being using theconcept of utility, in any of its standard definitions, does not offer enoughof an improvement over measuring consumption to capture the meaning ofdevelopment. As Sen stresses, a person’s own valuation of what kind of lifewould be worthwhile is not necessarily the same as what gives pleasure to thatperson. If we identify utility with happiness in a particular way, then verypoor people can have very high utility. Sometimes even malnourished peopleeither have a disposition that keeps them feeling rather blissful or havelearned to appreciate greatly any small comforts they can find in life, such asa breeze on a very hot day, and to avoid disappointment by striving only forwhat seems attainable. Indeed, it is only too human to tell yourself that youdo not want the things you cannot have. If there is really nothing to be doneabout a person’s deprivation, this attitude of subjective bliss would haveundoubted advantages in a spiritual sense, but it does not change the objectivereality of deprivation. In particular, such an attitude would not prevent thecontented but homeless poor person from greatly valuing an opportunity tobecome freed of parasites or provided with basic shelter To clarify this point.Sen then defines capabilities as the freedom that a person has in terms of thechoice of functioning, given his personal features and his command overcommodities. Sen’s perspective helps explain why development economists haveplaced so much emphasis on health and education and more recently on socialinclusion and empowerment, and have referred to countries with high levels ofincome but poor health and education standards as cases of “growth withoutdevelopment.” Real income is essential, but to convert the characteristics ofcommodities into functioning, in most important cases, surely requires healthand education as well as income. The role of health and education ranges fromsomething so basic as the nutritional advantages and greater personal energy thatare possible when one lives free of certain parasites to the expanded abilityto appreciate the richness of human life that comes with a broad and deepeducation. People living in poverty are often deprived—at times deliberately—ofcapabilities to make substantive choices and to take valuable actions, andoften the behavior of the poor can be understood in that light. For Sen, human“well-being” means being well, in the basic sense of being healthy, wellnourished, well clothed, literate, and long-lived and more broadly, being ableto take part in the life of the community, being mobile, and having freedom ofchoice in what one can become and can do.

What forces may be at workin giving the Millennium Development Goals such a high profile in internationaleconomic relations?

The MDGs are the strongest statement yet ofthe international commitment to ending global poverty. They acknowledge themultidimensional nature of development and poverty alleviation; an end topoverty requires more than just increasing incomes of the poor. The MDGs haveprovided a unified focus in the development community unlike anything thatpreceded them.

What critical issues areraised from the examination of development problems and prospects facingBrazil?

It might be most accurate to say thatBrazil has experienced some economic growth without as much social development,rather than the more blanketing “growth without development,” which appliesbetter to a few Middle Eastern countries and some lower-income countries suchas Pakistan, Gabon, and Equatorial Guinea. But continuing racial disparities,unjust treatment of indigenous peoples, lack of access of the poor to fertileland, extremely high inequality and surprisingly high poverty for its incomelevel, and the danger that growth will prove ecologically unsustainable allmean that Brazil will have to continue its recent efforts to make socialinclusion and human development, as well as environmental sustainability, toppriorities if it is to resume rapid economic growth, let alone achieve truemultidimensional development.

”Socialand institutional innovations are as important for economic growth astechnological and scientific inventions and innovations.” What is meant by thisstatement? Explain your answer.

The first reason is due to technology transfer.As a result, they should be able to grow much faster in the past, whenthey has to invent the technology as they went along and proceed step by stepthrough the historical stages of innovation.The second reason to expect convergence if conditions are similar isbased on factor accumulation. That is, the impact ofadditional capital on output would be expected to be smaller in a developedcountry that already has a lot of capital in relation to the size of itsworkforce than in a developing country where capital is scarceAs such, institutions provide the underpinning of a market economy byestablishing the rules of property rights and contract enforcement; improvingcoordination, restricting coercive, fraudulent, and anti competitive behavior –providing access to opportunities for the broad population; constraining thepower of elites; and managing conflicts more generally. Moreover, institutionsinclude social insurance and the provision of predictable macroeconomic stability.Nevertheless, in most countries with poor institutions, there is stillmuch than can be done to improve human welfare and to encourage the developmentof better institutions. Indeed, economic institutions do change over time, eventhough political institutions such as voting rules sometimes change withoutaltering the real distribution of power or without leading to genuine reform ofeconomic institutions.

Whydo many economists expect income convergence between developed anddevelopingcountries, and what factors would you look to for an explanation ofwhy this has occurred for only alimited number of countries and in such alimited degree so far?

The most widely used approach is simply to examine whether poorercountries are growing faster than richer countries (relative country convergence). As long as this is happening, poorcountries would be on a path to eventually catch up to the income levels ofrich countries. That is, even when the average income of a developing country isbecoming a larger fraction of developed country average incomes, the differencein incomes can still continue to widen for some time before they finally shrink.This approach frames the question so as to weight the importance of acountry’s per capita income growth rate proportionately to the size of its population. The most important difference from population-weighted convergence isthat a world-as-one-country convergence study can take into account changes ininequality within countries as well as between them.there are many institutional and other differences between low- andhigh-income economies today, some of which may be very difficult to change. Moreover, a poor country cannot force a rich country to lower its trade barriers. Although it is true that conditions have remained stagnant or evendeteriorated in many of the least developed countries, because of their smallerpopulations sizes with the population-weighted approach the divergence effectis more than compensated for by growth in countries with large populations. ^Eٛ93h=

Statefive characteristics of the developing world. Discuss diversity within thedeveloping world on these characteristics in relation to the developed world

Lower levels of living andproductivity: there is a vast gulf in productivity between advanced economies butalso a wide range among these and other developing countries. At very low income levels, infact, a vicious circle may set in, whereby low income leads to low investmentin education and health as well as plant and equipment and infrastructure,which in turn leads to low productivity and economic stagnation. Lower levels of human capital: Humancapital—health, education, and skills—is vital to economic growth and humandevelopment. Compared with developed countries, much of the developing worldhas lagged in its average levels of nutrition, health and education.Enrollments have strongly improved in recent years, but student attendance andcompletion, along with attainment of basic skills such as functional literacy,remain problems.Higher levels of inequality andabsolute poverty: Thus the scale of global inequality is immense.But the enormous gap inper capita incomes between rich and poor nations is not the only manifestationof the huge global economic disparities. To appreciate the breadth and depth ofdeprivation in developing countries, it is also necessary to look at the gapbetween rich and poor within individual developing countries.Very high levelsof inequality—extremes in the relative incomes of higher- and lower-incomecitizens—are found in many middle income countries.Inequality is particularlyhigh in many resource-rich developing countries, Indeed, in many of these cases, inequality is substantially higher thanin most developed countries (where inequality has in many cases been rising). Extreme poverty is due in part to low human capital but also to socialand political exclusion and other deprivations. Great progress has already beenmade in reducing the fraction of the developing world’s population living onless than $1.25 per day and raising the incomes of those still below thatlevel, but much remains to be done. Higher population growth rates:But in recent decades, most population growth has been centered in thedeveloping world. Compared with the developed countries, which often have birthrates near or even below replacement (zero population growth) levels, thelow-income developing countries have very high birth rates.Higher population growth rates:But in recent decades, most population growth has been centered in thedeveloping world. Compared with the developed countries, which often have birthrates near or even below replacement (zero population growth) levels, thelow-income developing countries have very high birth rates.Greater social fractionalization: Low-incomecountries often have ethnic, linguistic, and other forms of social divisions,sometimes known as fractionalization. This is sometimes associated with civilstrife and even violent conflict, which can lead developing societies to divertconsiderable energies to working for political accommodations if not nationalconsolidation. It is one of a variety of governance challenges many developingnations face.The greater the ethnic, linguistic, and religious diversity of acountry, the more likely it is that there will be internal strife and politicalinstability. If development is about improving human lives and providing awidening range of choice to all peoples, racial, ethnic, caste, or religiousdiscrimination is pernicious. Being indigenous makes it much more likely thatan individual will be less educated, in poorer health, and in a lowersocioeconomic stratum than other citizens.

Discuss the differences between the traditional HDI incomparison to the “new” (NHDI) formulation. In what ways do you think eitherone is a better measure of human development?

*Gross national income (GNI) percapita replaces gross domestic product (GDP) per capital. *The education index has beencompletely revamped.the average actual educational attainment of the whole population andthe expected attainment of today’s children. *Expected educational attainment,the other new component, is somewhat more ambiguous. *The two previous components ofthe education index, literacy and enrollment, have been correspondingly dropped.literacy is clearly an achievement, and even enrollment is at least amodest achievement. However, literacy has always been badly and tooinfrequently measured and is inevitably defined more modestly in a lessdeveloped country. *The upper goalposts (maximumvalues) in each dimension have been increased to the observed maximum ratherthan given a predefined cutoff. *The lower goalpost for incomehas been reduced. *Another minor difference is thatrather than using the common logarithm. *computed with a geometric mean.

Traditionalfree-trade theories are based on six crucial assumptions, whichmay or may not be valid for developing nations (or for developed nations forthat matter). Whatare these crucial assumptions?

1.All productive resources arefixed in quantity and constant in quality across nations and are fullyemployed. 

2.The technology of productionis fixed (classical model) or similar and freely available to all nations(factor endowment model). Moreover, the spread of such technology works to thebenefit of all. Consumer tastes are also fixed and inde­pendent of theinfluence of producers (international consumer sovereignty prevails). 

3.Within nations, factors ofproduction are perfectly mobile between different production activities, andthe economy as a whole is characterized by the existence of perfectcompetition. There are no risks or uncertainties. 

4.The national governmentplays no role in international economic relations; trade is carried out amongmany anatomist and anonymous producers seeking to minimize costs and maximizeprofits. International prices are therefore set by the forces of supply anddemand. 

5.Trade is balanced for eachcountry at any point in time, and all economies are readily able to adjust tochanges in the international prices with a minimum of dislocation. 

6.The gains from trade thataccrue to any country benefit the nationals of that country.

Howmight they be violated in the real world of international trade? Fixed Resources, Full Employment, and the InternationalImmobility of Capital and Skilled Labor Trade and Resource Growth: North-South Modelsof Unequal Trade

Assumption1 This initial assumption about the static nature of international exchange—that resources arefixed, fully utilized, and internationally immobile with same product productionfunctions everywhere identical—is central to the traditional theory of trade andfinance. In reality, the world economy is characterized by rapid change, andfactors of production are fixed neither in quantity nor in quality.Criticspoint out that this is especially true with respect to resources most crucial togrowth and development, such as physical capital, entrepreneurialabilities,scientific capacities, the ability to carry out technologicalresearch and development,and the upgrading of technical skills in the laborforce.

Most less developed countries in Latin America,Africa, and Asia pursued policies of import substitution as a major componentof their development strategies. What have been some of the weaknesses of thesepolicies in practice? Why have the results often not lived up to expectations?

import substitution (IS) believe that adeveloping economy should initially substitute domestic production ofpreviously imported simple consumer goods (first-stage IS) and then substitutethrough domestic production for a wider range of more sophisticatedmanufactured items (second-stage IS)—all behind the protection of high tariffsand quotas on these imports. In the long run, IS advocates cite the benefits ofgreater domestic industrial diversification (“balanced growth”) and theultimate ability to export some previously protected manufactured goods aseconomies of scale, low labor costs, and the positive externalities of learningby doing cause domestic prices to become more competitive with world prices. -Protected industries get inefficient andcostly-Foreign firms often benefit more-subsidization of imports of capital godstilts pattern of industrialization and contriputes to balance of payments (BOP)problems-Overvalued exchange rates hurt exports-does not stimulate self-reliantintegrated industrialization.

15. What issues form thebasis of the debate between trade optimists and trade pessimists? Explain youranswer.

advocates of free-trade, outward-lookingdevelopment and export promotion policies—the trade optimists —and advocates ofgreater protection, more inward-looking strategies, and greater import substitution— the trade pessimists. Thedefinitions (trade optimists and trade pessimists) are given on page 611 (RHS).Your answer should outline the key points of the discussion on pages 611-613.rotecٛh

16.What are the basic static and dynamic arguments for economic integration inless developed countries? Briefly describe the various forms that economicintegration can take (e.g., customs union, free-trade areas). What are themajor obstacles to effective economic integration in developing regions?

The static and dynamic arguments for economic integration areresources and production reallocation and the idea that developing countrieswho are trying to establish themselves are given the opportunity to with thehelp of custom unions and free trade areas. These allow the countries withinthe trade integration agreement to trade freely while non-members countries aregiven tariffs. Also, by removing trade barriers coordinated industrial strategyis made possible. Some problems with this is that the integration of low incomecountries typically leads to divergence while high income countries lead toconvergence.ey pٛ h

3. Trace the evolution ofthe developing-country debt problem during the 1970s and 1980s. What were thekey ingredients? Explain your answer.

Trace the evolution of the developing-country debtproblem during the 1970s and 1980s.The seeds of the 1980s debt crisis weresown in the 1974-1979 period, when there was a virtual explosion ininternational lending, precipitated by the first major OPEC oil price increase.By 1974, developing countries had begun playing a larger role in the worldeconomy, having an averaged growth rate of 6.6% in 1967-1973. Followingoutward-looking development strategies, they expanded their exportsaggressively. In the face of high oil prices and a worldwide recession, inwhich the growth rates of the industrialized countries fell from an average of5.2% in 1967-1974 to an average of 2.4% for the rest of the 1970s, manydeveloping countries sought to sustain their high growth rates through increasedborrowing. Although lending from official sources, particularlynon-concessional lending, increased significantly, it was insufficient to meetgrowth rates. Furthermore, countries with an excess of imports over laggingexports were reluctant to approach official sources, which might subject themto painful policy adjustments. So the middle-income and newly industrializeddeveloping countries turned to commercial banks and other private lenders,which began issuing general-purpose loans to provide balance of paymentssupport. Commercial banks, holding the bulk of the OPEC surplus and facing alow demand for capital from the slower-growing industrialized countries,aggressively competed on comparatively permissive and favorable terms. Whatwere the key ingredients?The accumulations of external debt is acommon phenomenon of developing countries at the stage of economic developmentwhere the supply of domestic savings is low, current account deficits are high,and imports of capital are needed to augment domestic resources. The basic transfer of a country is definedas the net foreign-exchange inflow or outflow related to its internationalborrowing. It is measured as the difference between the net capital inflow andinterest payments on the existing accumulated debt. The net capital inflow issimply the difference between the gross inflow and the amortizations on pastdept. the basic transfer is an important concept because it represents theamount of foreign exchange that a particular developing country is gaining orlosing each year from international capital flows.FN = dDBT =dD – rD = (d – r)D

Whatis petrodollar recycling, and how did it contribute to the debt crisis of the1980s? Why were developing countries so eager to borrow money from internationalbanks? Explain your answer.Whatis petrodollar recycling, and how did it contribute to the debt crisis of the1980s?

During the late 1970s and early 1980s,states such as Saudi Arabia, Kuwait and Qatar amassedlarge surpluses of petrodollars which they could not invest in theirown countries. This was due to small populations or being at early stagesof industrialization. These petrodollar surpluses can be defined as net USdollars earned by those nations which were in excess of the internal developmentneeds of those nations.These surpluses could be profitablyinvested in other nations. Alternatively, the world economy would havecontracted if that money was withdrawn from the world economy while theexporting nations needed to be able to profitably invest to preserve theirwealth for the future.While recycling petrodollars reduced therecessionary impact of the 1973 oil crisis, it caused problems especiallyfor oil-importing countries that were paying much greater prices for oil andincurring debts. The International Monetary Fund (IMF) estimates thatthe foreign debts of 100 developing countries increased by 150% between 1973and 1977.Johan Witteveen, the Managing Director of the IMF, said in 1974,"the international monetary system is facing its most difficult periodsince the 1930s."From 1974 to the end of 1981, total currentaccount surpluses for all members of OPEC amounted to $450.5 billion. Ninetypercent of this surplus was accumulated by the Arab countries ofthe Persian Gulf and Libya, with Iran alsoaccumulating oil surpluses prior to the Iranian Revolution in 1979.The petrodollars were investedby commercial banks in the US and Europe. As the recessionarycondition of the world economy made investment in corporations less attractive,bankers lent the money to developing countries especially in Centraland South America suchas Brazil, Argentina and Mexico as well as otherdeveloping countries like Turkey. The 1973 OPEC crisis had created a vastdollar shortage in these countries, however, they still needed to finance theiroil imports. In 1977, Turkish Prime Minister SuleymanDemirel summarized this shortage as "We're even in need of 70cent." In subsequent decades, some of these nations have had difficulty inrepaying these debts, leading to chargesby anti-globalisation activists that it was a formof neocolonialism. This process also contributed to the growth ofthe Euromoney market as a rival to US monetary markets.Whywere developing countries so eager to borrow money from international banks?So the middle-income and newlyindustrialized developing countries turned to commercial banks and otherprivate lenders, which began issuing general-purpose loans to provide balanceof payments support. Commercial banks, holding the bulk of the OPEC surplus andfacing a low demand for capital from the slower-growing industrializedcountries, aggressively competed on comparatively permissive and favorableterms.3

Describethe typical IMF stabilization package for severely or heavily indebted countries.What arethe objectives of these policies, and why do you think internationalbanks are so eager for IMFnegotiations to precede their discussions with thesecountries? What are the economic and socialcosts of these programs? Explainyour answer.

Describethe typical IMF stabilization package for severely or heavily indebtedcountries.(1) abolition or liberalization offoreign-exchange and import controls, (2) devaluation of the official exchangerate, (3) a stringent domestic anti-inflation program consisting of (a) controlof bank credit to raise interest rates and reserve requirements; (b) control ofthe government deficit through curbs on spending, including in the areas ofsocial services for the poor and staple food subsidies, along with increases intaxes and in public-enterprise prices; (c) control of wage increases, inparticular abolishing wage indexing; and (d) dismantling of various forms ofprice controls and promoting freer markets, (4) greater hospitality to foreigninvestment and a general opening up of the economy to international commerceWhatare the objectives of these policies, and why do you think international banksare so eager for IMF negotiations to precede their discussions with thesecountries?A coordinated set of mostly restrictivefiscal and monetary policies aimed at reducing inflations, cutting budgetdeficits, and improving the balance of payments. Relying on the IMF to impose toughstabilization policies, a process known as conditionally, before it agreed tolend funds in excess of their legal IMF quotas, the private banks interpretedsuccessful negotiations with the IMF as a sign that borrowing countries weremaking serious efforts to reduce payments deficits and earn the foreignexchange needed to repay earlier loans. Whatare the economic and social costs of these programs?Toreceive their loans and, more important, to negotiateadditional credits fromprivate banks, all these nations were required toadopt some or all of theenumerated stabilization policies. Although suchpolicies may be successful inreducing inflation and improving the balance ofpayments situation for manydeveloping countries, they can be politicallyvery because they strike at theheart of developmentefforts by disproportionately hurting the lower- andmiddle-incomegroups. Finally, the IMF policies are being imposed by aninternational agency that is perceived bythose of the dependence school to bemerely an arm of the rich industrializednations, stabilization policies areoften viewed by this school as measuresdesigned primarily to maintain thepoverty and dependence of developingcountries while preserving the globalmarket structure for the internationalbanks and private investors (andspeculators) from the industrialized nations.

In what ways was the recent global financial crisissimilar to past crises, and in what ways did it differ?

The financial crisis caused developing countries economic growth todrop, exports fell and in the countries with banking crises imports fell notallowing the opportunity to export to the US and th EU. Also, the presence ofaid from high-income countries slows when there is a recession. This deeplyaffects the poor countries and poverty problems. Different countries around theworld experienced different outcomes from the crisis. A difference between thiscrisis and previous ones is that the world is a much smaller place now. Onceone country is affected, then the whole world is as well.mٛuh

2. Summarize thearguments for and against the role and impact of private foreign investment inless developed countries. What strategies might developing countries adopt tomake private foreign investment fit their development aspirations betterwithout destroying all incentives for foreign investors?

Foreign Direct Investment (FDI) is overseasequity investments by private multinational corporations.Pros:· The most important contributing of FDI is its role in filling the resource gap betweentargeted or desired investment and locally mobilized savings.· A second contribution is its contribution to filling the gap between targeted foreign-exchangerequirements and those derived from net export earnings plus net public foreignaid. This is the so-called foreign-exchange or trade gap.· The third gap said to be filled by foreign investment is the gap between targetedgovernmental taxrevenues and locally raised taxes.· Fourth, there is a differenttype of gap in management, entrepreneurship, technology, and skill presumed tobe partly or wholly filled by the local operations of private foreign firms.Cons:· Although MNCs provide capital, they may ultimately lower domesticsavings and investment rates by substituting for private savings, stiflingcompetition through exclusive production agreements with host governments, failing to reinvest much oftheir profits, generating domestic incomes for groups with lower savingspropensities, and inhibiting the expansion of indigenous firms that mightsupply them with intermediate products by instead importing these goods fromoverseas affiliates.· Although the initial impact of MNC investment is to improve theforeign-exchange position of the recipient nation, its long-run impact may be to reduceforeign-exchange earnings, as a result of substantial importation ofintermediate products and capital goods in addition to the overseasrepatriation of profits, interest, royalties, management fees, and other funds.· Although MNCs do contribute to public revenue in the form of corporatetaxes, their contribution is considerablyless than it might appear as a result of liberal tax concessions, the practiceof transfer pricing, excessive investment allowances, disguised publicsubsidies, and tariff protection provided by the host government.· The management, entrepreneurial skills, ideas, technology, and overseascontacts provided by MNCs mayhave little impact on developing local sources of these scarce skills andresources and may in fact inhibit their development.· The impact of MNCson development is very uneven and reinforces dualistic structures. · Multinationals typically produceinappropriate products(those demanded by a small, rich minority of the local population), stimulate inappropriate consumptionpatterns through advertising and their monopolistic market power, and do thisall with inappropriate (capital-intensive) technologies of productionthat as a result create comparatively little employment.· Local resources tend tobe allocated for socially undesirable projects.· Multinationals usetheir economic power to influence government policies in directions unfavorableto development.· MNCs may damagehost economies by suppressing domestic entrepreneurship and using theirsuperior knowledge, worldwide contacts, advertising skills, and range ofessential support services to drive out local competitors and inhibit theemergence of small-scale local enterprises.· Powerful multinational corporations can gain control over local assets and jobs and can thenexert considerable influence on political decisions at all levels.Reconciling prosand cons: Many analysts advocate a more stringent regulation offoreign investments, a tougher bargaining stance on the part of hostgovernments, a willingness on the part of developing countries to shop aroundfor better deals, the adoption of performance standards and requirements,increased domestic ownership and control, and a greater co- ordination ofdeveloping-country strategies with respect to terms and conditions of foreigninvestment.The only valid general conclusion is that private foreign investment can be an important stimulus toeconomic and social development as long as the interests of MNCs andhost-country governments coincide, and the growing acceptance of the corporatesocial responsibility movement has been championed as an opportunity to seekcommon ground.

To what extentdo private portfolio investments in developing countries benefit the recipientcountries? What are the potential costs and risks to both investors andrecipients? Explain your answer.

· From the investor’s point of view, investing in the stock markets of middle-income countrieswith relatively more developed financial markets permits them toincrease their returns while diversifying their risks.· From the perspective of recipient developing countries, private portfolio flows in are apotentially welcome vehicle for raising capital for domestic firms.· Well-functioning local stock and bond markets also help domestic investorsdiversify their assets and can act to improve the efficiency of the wholefinancial sector.· Potential Costs & Risk for recipients: Unstable speculative capital, volatility that respondsprimarily to global interest-rate; doesn’t always go to long-run economic investment.· Potential Costs & Risk for the investors: Declining interest rates, political risk.-

How importantis foreign aid for low- and middle-income developing economies in relation totheir other sources of foreign-exchange receipts? Explain the various formsthat official development assistance can take, and distinguish betweenbilateral and multilateral assistance. Which do you think is more desirable,and why?

Officialdevelopment forms can take the form of governmental resource transfer form onecountry to another; granting of preferential tariffs; loans characterized byconcessional terms (more favorable to theborrower than those available through standard financial markets).Finally, bilateral aid is from one country to another country, and is largelybased on political and military considerations. Multilateral aid is from agroup of countries or an institution representing a group of countries,for example World Bank and UN agencies, and is somewhat more economicallyrational.

What is meantby tied aid? Most nations have increasingly shifted from grants to loans andfrom untied to tied loans and grants. What are the major disadvantages of tiedaid, especially when this aid comes in the form of interest-bearing loans?

Tied Aid: Foreign aid in the form of bilateral loans or grants that require therecipient country to use the funds to purchase goods or services from the donorcountry.There is no historical evidence to suggestthat over longer periods of time, donor nations assist without expecting somecorrespondent benefits (political, economic, military, counterterrorism etc.). Whereaid is seen primarily as a means of furthering donor-country interests, theflow of funds tends to vary with the donor’s political assessment of changinginternational situations and not the relative need of potential recipients.Finally, tied-aid has saddled many countries with substantial debt repaymentsburdens. It has also increasedtheir import costs because aid tied to donor-country exports limits thereceiving nation’s freedom to shop around for low cost and suitable capital andintermediate goods.

What is meant by financial repression, financialliberalization, currency substitution, and unorganized money markets, and howdo they relate to financial policy in developing countries?

Financial repression Constraints on investment resulting from the rationing of credit.Financial liberalization Eliminating various forms of government intervention in financial marketsCurrency substitution The useof foreign currency (e.g.,U.S. dollars) as a medium of exchange in place of oralong with the local currency (e.g.,Mexican pesos).Unorganized money market The informal and often usurious credit system that exist sin most developingcountries (especially in rural areas)where low-income farms and firms withlittle collateral borrow from moneylenders at exorbitant rates of interest.Many developing countries are financiallyrepressed because their governments ability to expand their money supply isminimal. Financial institutions in LDC’s are very unorganized and in somecases, banks from developed countries are the only financial institutions theyhave.

4.List and briefly discuss the seven market failures that, Stiglitz and hiscolleagues say, justify a strong government role in developing-countryfinancial sectors. Do you agree or disagree with this assessment? Explain.

The seven market failuresThe“public good” nature of monitoring financial institutions. Investors need information about the solvency and management offinancial institutions. Like other forms of information, monitoring is a publicgood—everyone who places savings in a particular financial institution wouldbenefit from knowing that the institution was prospering or close toinsolvency.Externalizesof monitoring, selection, and lending. Benefits areoften incurred by lenders who learn about the viability of potential projectsfrom the monitoring, selection, and lending decisions of other lenders. Externalizesof financial disruption. In the absence ofgovernment insurance(whether or not an explicit policy has been issued), thefailure of one major financial institution can cause a run on the entire bankingsystem and lead to long-term disruptions of the overall financial system.Missingand incomplete markets. In most developingcountries, markets for insurance against a variety of financial or physicalrisks are missing. The basic problem is that information is imperfect and costlyto obtain, so a developing-country government has an important role in reducingthese risks.Imperfectcompetition. Competition in the banking sector ofmost developing countries is extremely limited, meaning that potential borrowersusually face only a small number of suppliers of loadable funds, many ofwhich are unwilling or unable to accommodate new and unknown customers.Inefficiencyof competitive markets in the financial sector.Theoretically, for perfectly competitive markets to function efficiently,financial markets must be complete (without uninsured risks) and informationmust be exogenous(freely available to all and not influenced by any oneparticipant’s action in the market). Uninformedinvestors. Contrary to the doctrine of consumersovereignty,with its assumption of perfect knowledge, many investors indeveloping countries lack both the information and the appropriate means toacquire it in order to make rational investment decisions. As inother areas of economic development, the critical issue for financial policy isnot about free markets versus government intervention but rather about how bothcan work together (along with the NGO sector) to meet the urgent needs of poorpeople.

6. In what ways do youthink taxation and expenditure systems in developing countries could beimproved? Be specific.

Most developing countries have had to rely on fiscal policy tostabilize the economy. In many developing countries they have a more regressiveoutlook for taxes which means low income people pay a higher proportion oftheir income than high in come people. Optimal tax systems must be moreimportant than optimal taxes. Political changes need to first be enforced inorder to improve the tax and expenditure system.c

13. Consider the threerecent policy debates concerning microfinance (on subsidies, nonfinancial activities,and commercialization). What kinds of evidence would you seek to resolve theseat least in a localized context? . Poli?ٛ

Onedebate under way in the microenterprise credit community is whether subsidiesare appropriate. Known as the “microfinance schism,” the debate pits theConsultative Group to Assist the Poor (CGAP), a donor consortium headquarteredwithin the World Bank, and other mainstream donors against other NGOs andacademic economists. CGAP effectively argues that one can reach more borrowersby requiring sustainability so that available dollars go further. This argumentis reasonable as far as it goes, but there is no reason to believe that thepoorest borrowers can afford to pay the high interest rates that this wouldrequire with the business opportunities they realistically face. Put moreprecisely, the interest elasticity of the demand for credit on the part of thepoor is not close to zero. And the poor generally lack opportunities to investin high-return projects. But even subsidized credit is no guarantee of higherproductivity and incomes. Of course, it will be essential to ensure that thesesubsidized credit programs are run efficiently, that the credit is allocated toappropriate investments, and that credit actually ends up in the hands of poorhouseholds. In this regard, a second debate concerns whether to combinemicrofinance with other programs. Proponents argue that it may be useful to tiecredit to social services that are demanded only by the poor and inherentlyrequire time for participation, for at least three reasons. First, suchrequired participation can act as a kind of screening mechanism to ensure thatnon-poor borrowers are not taking advantage of a subsidy not intended for them.Second, the poor generally cannot make adequate use of credit without betterhealth and education. There is usually at least some subsidy in programs thatoffer health or educational services along with credit. Third, many of the poorappear not to recognize the importance of human capital, and the availabilityof credit may act as a “hook” to get them enrolled in health and educationprograms. But it may be less costly to keep these programs separate, inaccordance with the varying comparative advantage of different NGOs, and somelow-income borrowers do not need these services. Accordingly, there is agrowing debate in the microfinance community over whether to integrate creditwith education, health, or other programs. A study of a program combiningmicrofinance with basic business training shows it may be cost-effective. Athird ongoing debate, related to the first two debates, is whether MFIs shouldundergo commercialization, whereby a (non-profit) NGO providing microfinance isconverted into a for-profit bank. Advantages include the fact that the MFIbecomes regulated as a bank, and so can legally accept savings deposits as wellas disburse loans; and that the MFI acquires the discipline of the market andan added incentive to cut costs and expand its scale. Commercialization alsofurthers the key objective of some in the microfinance sector to make use ofMFIs as a vehicle to develop the overall financial system. Disadvantagesinclude the problem that people living in poverty become considered in somecases too expensive to serve; or, that if they are served, very high interestrates will be charged and aggressive tactics may be used to collect funds. Notethat there are some frequently overlooked alternatives, in that to be regulatedand accept deposits does not imply a requirement to be a for-profit corporationin most legal systems. Although conversion to, and entry of, for-profit MFIshas become a major trend, most likely microfinance will proceed on multipletracks, with profit-making or perhaps other commercialized institutions servingthose above or close to the poverty line; NGOs providing microcredit to thepoor who run a microenterprise with possible subsidies including externalpayment of staff time; and transitional services for the ultra-poorwho are not ready to run a microenterprise for which credit would bebeneficial, but may become so. Ultimately, all people will need financialservices, but probably only a minority will need or want a loan to expand amicroenterprise or small business. But until regular employment becomes muchmore widely available as a pathway out of poverty, credit for microenterpriseswill play a vital role.