AEB 4283: International Development Policy Section III: International Problems and Policies Week 12: Foreign Finance and Aid Today, Wednesday: Start Chapter 14: “Foreign Finance, Investment, Aid, and Conflict: Controversies and Opportunities” This lecture: “Foreign Finance and Remittances” Next Week: Complete Chapter 14 Wednesday: Exam #3 on Section III

Chapter 14 Foreign Finance, Investment, Aid, and Conflict: Controversies and Opportunities

So far.... In Part I and II we focused on choices within a country, and in Part III we are exploring international relationships. Remember, the highest national income usually comes from free international trade (limit tariffs, quotas, etc.), but active domestic policies (taxes, subsidies & regulations) to offset externalities and market failures So a country’s own government can help it grow …but what can one country do to help another? so far we’ve seen facilitate free trade this week: foreign finance and aid AGEC 340 - Fall 99 3

REVIEW: What are financial/capital flows? International capital flows are transactions of real estate and financial assets across international borders Capital inflows are purchases of domestic assets by foreign households and firms Capital inflows to the US include foreign purchases of stocks and bonds of US companies, US government bonds, and real assets such as land and buildings owned by US residents Capital outflows are purchases of foreign assets by domestic households and firms Capital flows are not counted as imports or exports since the funds are used to purchase assets Capital flows respond to real interest rates (allowing for inflation) Higher domestic interest rates mean greater capital inflows 4

MICROFINANCE, INVESTMENT & TRADE The International Flow of Financial Resources LDCs generally need investment to assist in the development process Where might the funds come from? 3 Sources of financial inflows: Private Foreign Direct Investment = investments from Multi-National Corporations (MNCs) or Trans-National Corporations (TNCs) Portfolio investment = financial investments in stocks and bonds (by individuals, investment banks or even governments) Can be too volatile (e.g., Asia in 1997). LDCs have nascent credit & equity markets 2. Remittances of earnings by international migrants 3. Public and private development assistance = foreign aid

Figure 14.1 FDI inflows, Global and By Group of Economies, 1980–2012 (Billions of Dollars)

Figure 14.3 Net Capital Flows to Developing Countries, 2000–2009

14.2 Private Foreign Direct Investment and the Multinational Corporation Private Foreign Investment: Pros and Cons for Development Traditional arguments in support of private investment: Filling savings, foreign exchange, revenue, and management & knowledge gaps Traditional arguments against private foreign investment: Widening gaps Two main perspectives of the arguments: Economic and ideological Economic reasons: MNCs may stifle indigenous entrepreneurship; do not pay enough taxes. Ideological: MNCs are new agents of colonialism, support corrupted regimes. Reconciling pros and cons Positive impact of MNCs can be found: China, Bangladesh, Botswana, Costa Rica

Box 14.1 Seven Key Disputed Issues about the Role and Impact of Multinational Corporations in Developing Countries AGEC 340 - Fall 99

Box 14.1 Seven Key Disputed Issues about the Role and Impact of Multinational Corporations in Developing Countries Check out the SUGGESTED READINGS for a Joe Studwell’s account of the market-access-for-technology deals between China and multinationals. AGEC 340 - Fall 99

14.3 The Role and Growth of Remittances A remittance is a transfer of money by a foreign worker to his/her home country Wage differences ~ 5 times difference between DC and LDC for similar occupations Loss of skilled workers (Brain Drain) is mitigated by remittances Pathway out of poverty Uneven flow of remittances

Figure 14.4 Sources of External Financing for Developing Countries, 1990–2008 In LDCS: Remittances have increased, exceeds 5% of GDP, outpacing FDI and foreign aid flows

Table 14.1 Major Remittance-Receiving Developing Countries, by Level and GDP Share, 2008 In LDCS remittances flows have been uneven Remittances have declined in all regions from 2008-10, except South Asia.

The current wave of migration is a blast from the past… Source: Reprinted from Migration Policy Institute, Washington DC (www.migrationpolicy.org). AGEC 340 - Fall 99

…but of course today’s migrants come from different regions Source: Reprinted from Migration Policy Institute, Washington DC (www.migrationpolicy.org). AGEC 340 - Fall 99

Migrant’s remittances are huge and stable A remittance is a transfer of money by a foreign worker to his/her home country In 2004, recorded remittances were the second largest source of external financing in developing countries, after FDI, and amounted to more than twice the size of ODA : Reprinted from World Bank data, online at http://go.worldbank.org/QOWEWD6TA0 AGEC 340 - Fall 99

The Growing Significance of Remittances Remittances are one of the most concrete indicators of transnational economic links between sending and receiving countries. Economic Impacts of Remittances Most research has focused on the volume and contribution of remittances to the balance of payments in the receiving countries. The growing importance of remittances as a source of foreign exchange is reflected in the fact that remittance growth has outpaced private capital flows and ODA over the last decade Numerous studies have documented Who sends and who receives remittances How much, how, and how frequently money is transferred How the funds are used Whether they fuel further migration AGEC 340 - Fall 99 17

Top recipients of remittances, 2004 $ billion % of GDP As a share of GDP, smaller countries such as Tonga and Haiti were the largest recipients

Top sources of remittances, 2004 $ billion % of GDP Rich countries are the main sources of remittance flows. U.S. is by far the largest source, with $39 billion in outward remittance flows As a share of GDP, outward remittances were the largest in the upper middle-income developing countries

Remittances tend to rise following crisis, natural disaster, or conflict Remittances as % of private consumption In addition to bringing the direct benefit of higher wages earned abroad, migration, therefore, helps households diversify their sources of income and thus reduce their vulnerability to risks

Top Remittance Receivers in Latin America & the Caribbean, 2007 ($US Billions) During the 1990s, the money sent by migrants became the second largest source of income in Latin America and the Caribbean AGEC 340 - Fall 99 21

Remittances to Puerto Rico, the Dominican Republic, and Mexico (US$ Millions) Puerto Rico’s low level of remittances is partly due to the income generated from U.S. federal agencies operating in Puerto Rico AGEC 340 - Fall 99 22

Why Do Dominicans and Mexicans Remit More than Puerto Ricans? They have more relatives and friends back home. Their socioeconomic profile is more closely associated with remittance senders. Remittances are a more important source of income in the Dominican Republic and Mexico than in Puerto Rico. The Puerto Rican economy is better off than the Dominican and Mexican economies. Puerto Rico’s low level of remittances is related to its relatively high living standards, especially to the massive inflow of federal funds. AGEC 340 - Fall 99 23

Implications of migration and remittances Over the past decade, as private capital flows have declined, remittances have become increasingly prominent. Worldwide remittance flows are estimated to have exceeded $232 billion in 2005, of which developing countries received $167 billion. Remittances have doubled over the past ten years as a result of (a) increased scrutiny of flows since the terrorist attacks of Sept. 2001 (b) reduction in remittance costs and expanding networks in the remittance industry (c) the depreciation of the U.S. dollar (which raises the value of remittances denominated in other currencies) (d) growth in the migrant population and incomes. This amount, however, reflects only transfers through official channels that have been recorded in the balance of payments under workers’ remittances, compensation of employees, and migrant transfers.

Development implications of migration and remittances Migration and remittances continue to increase Migration generates substantial welfare gains and reduces poverty for migrants, as well as countries of origin and destination The development gains from low-skilled emigration are clear cut, while high-skilled emigration has more complex effects Benefits to countries of origin are mostly through remittances There is considerable scope for reducing remittance costs faced by poor migrants, which would further increase the benefits of remittances Costs of migration → relocating costs, social costs for destination countries and for those left behind in origin countries, and psychological costs for migrants spending lengthy periods away from their families

Downside Large remittance flows may lead to currency appreciation (increase in value) and adverse effects on exports (expensive) Remittances may create dependency Some authors have argued that such outcomes may dampen economic growth On the other hand, to the extent that they finance education and health, and alleviate credit constraints for small entrepreneurs, remittances may even increase growth Remittance channels may be misused for money laundering and financing of terror

Policy priorities Governments can provide information and regulate intermediaries to reduce risks, costs of migration Investments in infrastructure and R&D, along with improved working conditions, would limit brain drain High remittance costs faced by poor migrants can be reduced by increasing access to banking and strengthening competition in the remittance industry Governments should not tax remittances or direct the allocation of expenditures financed by remittances

3) Public and Private Development Assistance = Foreign Aid Foreign Aid → any flow of capital to LDCs that meets two criteria: Its objective should be non-commercial from the perspective of the donor It should be characterized by concessional terms → interest rate and/or repayment period should be less stringent than normal commercial terms AGEC 340 - Fall 99