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 R-
U 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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