Chapter 7.5: North-South Capital Flows

Foreign Investment

investment in such capital goods by foreigners (most often MNCs)

has been crucial to the success of China and other developing countries in Asia

private capital flows to the global south were over $700 billion in 2014

Foreign Investors

• own the facilities and can control decisions about how many people to employ, whether to expand or shut down, what products to make, and how to market them.

• Can usually take the profits from the operation out of the country (repatriation of profits).

• However, the host government can share in the wealth by charging fees and taxes, or by leasing land or drilling rights

Joint ventures

• one way in which states have sought to soften the loss of control stemming from foreign investment by MNCs

• these are companies owned partly by a foreign MNC and partly by a local firm or the host government itself

• sometimes foreign ownership in these is limited to some percentage (49%) to ensure that ultimate control rests with the host country

• percentage of ownership is usually proportional to the amount of capital invested

Reasons MNCs Invest in Countries

1. the presence of natural resources

2. cheap labor

3. geographical location

4. some states have better absorptive capacity

5. favorable regulatory environments

6. financial stability (convertible currency)

7. Political stability

8. economic growth

9. stable local labor supply

absorptive capacity

• the ability to put investments to productive use due to a more highly developed infrastructure and a higher level of skills among workers or managers.

• often middle-income states, so the funneling of investments to states with ______ tends to sharpen disparities within the global South.

Technology transfer

• a poor state’s acquisition of technology (knowledge, skills, methods, designs, and specialized equipment) from foreign sources

  • usually in conjunction with foreign direct investment or similar business operations

• A developing country may allow an MNC to produce certain goods in the country under favorable conditions, provided the MNC shares knowledge of the technology and design behind the product.

Brain drain

the problem of losing skilled workers to richer countries

has impeded development in India, Pakistan, and the Phillippines

Borrowing money

alternative to foreign investment as a way of obtaining funds to prime a cycle of economic accumulation

if accumulation succeeds, it produces enough surplus to repay the loan and still make a profit

Advantages of Borrowing

1. keeps control int he hands of the state (or other local borrower)

2. does not impose painful sacrifices on local citizens in the short term

Disadvantages of Borrowing/Debt

1. borrowers must service the debt (making regular payments of interest and repaying the principal) according to the terms of the loan.

   1. With foreign direct investment, a money-losing venture is the problem of the foreign MNC

   2. with debt, it is the problem of the borrowing state, which must find the money elsewhere.

   3. Often, a debtor must borrow new funds to service old loans, thus slipping further into debt.

Default

Failure to make scheduled payments

considered a drastic action because it destroys lenders’ confidence and results in a cutoff of future loans

Debt renegotiation

• borrowers usually attempt to do this rather than default

• entails reworking the terms on which a loan will be repaid

• through this process, borrowers seek a mutually acceptable payment scheme to keep some money flowing to the lender

• if interest rates have fallen since a loan was taken out, the borrower can refinance

To solve the collective goods problem of debt renegotiation

state creditors meet together periodically as the Paris Club and private creditors meet as the London Club to work out their terms

Decision of G7 members

• in 2005 agreed to eliminate all debts owed by 37 very poor countries to the World Bank and the IMF

IMF Scrutiny

• analyzes developing countries’ economic plans and policies, withholding loans until it is satisfied that the right policies are in place

• sends important signals to private lenders and investors

• its approval of a state’s economic plans is a seal of approval for bankers and MNCs

IMF conditionality agreements

an agreement to loan IMF funds on the condition that certain government policies are adopted.

the IMF terms are usually painful for the citizens

• demands that inflation is controlled, which can lead to unemployment

so these agreements are usually politically unpopular in the global South

IMF Conditionality Agreements in the 2008-09 Recession

• also proved unpopular in developed countries

• After receiving a $6 billion rescue package from the IMF, Iceland was forced to make fundamental reforms to its banking sector.

• Greece, which received over $133 billion from the IMF, agreed to eliminate several paid holidays while cutting all wages of all public workers by 3 percent.

Free trade regime like WTO

• makes it harder for poor states to protect infant industries in order to build self-sufficient capital accumulation

• forces competition with more technologically advanced states

• a poor state can only be competitive in low wage/capital niches like natural resources

World Trade Deals

• often excluded economic sectors in which poor states have the comparative advantage

• concentrated on free trade in manufactured goods

• so developing countries had to open their home markets to foreign products

Trade dispute system

• another criticism leveled against WTO on system in which states may bring complaints of unfair trading practices

• these complaints can cost millions of dollars

• few states in global south can afford this legal process, so few use it to eliminate unfair barriers to trade

Winners in WTO trade disputes

• only gain the right to place tariffs on the offending country’s goods in an equal amount

• for small states, this retaliation can inflict a lot of damage on the economy

Generalized System of Preferences

• exceptions to the overall rules of trade and are intended to ensure that participation in world trade advances rather than impedes development

• does so along with the Lomé and Cotonou conventions in the EU

UN Conference on Trade and Development (UNCTAD)

• main channel through which countries in the South use to pursue proposals to restructure world trade to benefit the South

• meets periodically but lack power to implement major changes in North- South economic relations.

• efforts have done little to change the South’s reliance on the North