Debt and development: the role of foreign capital in economic growth

{ ,

UNITED NATIONS

AFRICAN INSTITUTE FOR ECONOMIC DEVELOPMENT

JJ{D PLft~ING

DA R AR

DEBT AND DEVELOPMENT

REPRODUCT.ION/16-82

THE ROtE OF FOREIGN CAPITAL IN ECONOMIC G R OWTH

HELEN HUGHES*

The World Bank, Washington9 D.C.

MAY

1982

*

1 am grateful to Jeff Katz, Jo Saxe₉ Cathy Slappery and the other members of the Economie Analysis and Projections Dapartment from whom I learnt about developing country debt problems, and to Goran Ohlin and Karsten Laursen who worked on the analysis of these problems with us. The views expressed are, however9 mine. They are not necessarily those of the World Bank.

REPRODUCTION/16-82 Page 1.

Debt and D~velopment~ ·

.The Role of For.eign Capital in Economiç Growth

. ^/•

.The World Bank, Washing,t onx D.C •

. ... .. ·- ·-··

·-

... ^~ .... ^-~~. . . . .

. f)umm~ry., - Çapi tal flows, wh ether between ind.iy,iq.ual s or .. nat i ons 9

... · · "ifl"'"ê··-do'tltin'ate-d ·by a two· ... f·<rl·d·--para<lti-;r-~-~:'.Ilorràw·e·r·~,.'->ffi.e···±nîtia:lly primarily interested in obtaining sufficient~ f@_!;.ls,._f_or -~heir need::;, but once they have obtained a loan, their indebtedness becomes their principal concern. While a loan is being negotiated the 1 end ers u·suàlly· have .the. <u.p.p,e.r. .. h@.d,_ .... l:),u.t: 9-.Il,.çe .. i.t

i

s made, they become dependent on the borrowers for repayment with inte~est.

Their power t o wi thhold future loans becomes .. A~h~i;J.:.'.~Q-~ly: real

measur e of control. Borrowlng and lending bas. costs and benefit !, and these balance out only in exceptional cases for both the

borrowing and lending countries and t he principal~'' 'ioCial ·groUJ?s

·_ wi thir1 them. The debate about the. impaçt o:L. internati,mal capital flows accordingly has a long hïS·t=o·ry. This paper begins ,_,.-ith a historicà.l perspective, · and then reviews the p·rincipal characteris- tics of· cap~tal flows to devel,oping _çountries s~p;~e the 1950s • . k discussion ~f the impact of capi tal ~lows on de~elopment, with a - particul~r emphasis on trends· in d~~elopirig countit· indebtedness,

fol lows.

A

brief examinat~on of borrowing and ~ebt management issu es for borrowers; lendèrs and the internat:Î.onal communi ty

coneludes the Jjlaper. · .,· ·

1. A TIISTOR:ICAL PERSPECTIVE

. '· . . '

The internatiQnal flow of cà.pit~l - borrowing and lending across political borders - dates back at le~st ~o the ancient

~ivilj,_2;~tions'"of the MeM .. ta,.rran~a,._J;li _.;met .Itro~~bJy_ 'lt),Uçh further into the past to tribal societies. In any-~~s~

...

^{Eiuc;t .. .!l.~ws .~er~ wel l}

established in medieval l'.urope, and' grew in the 16th and 17th

centuries wi th a concoiui tant development of f·inancüü institutions . capable

of

handling international capi tal transactions~·.: The greatly

.. jJ1crea,.sed pro.ductivi ty that followed the industl'ial r evolution? fi rst

. . .

in the Bri f;ish Isles and th en in coritinential western Euro_pe, led to

].EPHODUCTION/ 16-82

·\Pa~~-

2. · ·

an unprecedented ra~e _of ca.p"i té3:1.'·-~_C.C.,U~lation. By the last quarter of the 19th century. Europe?· led by Great Britain? had become the world t s-··:suppÙ-èr .ef· -.eapi

tal~ ·· · But

'-the:.'industr·ial .. revolution had al so crossed the Atlantic? and at the beginning of the 20th century the United States'?··although still .a substantiel capital importer? h.ad become a net capital exporter. Between the end of World Wa.r I and

1the b~ginn~a. b~ Worid War TI i t ~i~placed Gr~èt Biitain as the world's

. ' (··

. '·

(a) International .capital flows, 1870-1950

' :; ( i ), 1870~1913

.. · .. : .. -:·Tli'e .. ,.half ·. cen'tul!y .. bef:.o.re. WO'.r.ld. .. V/ar· I saw a li beralization of

···· · ·· ·. :o~-:;~i~~~::;:~1~::~n1~;b!:~~I~r;;;~nlr:,r~::î~~::r:Jt::

^{i t}

has not been equalleà. siiïé·e;-:··~The. cô·mbü.ïat.·~·ôn~·:orthe ~inàttstrializa­

'tioh ·of EUrope ·and the Un;i ted States 'Wi th the 'opening up :of new,

. ^~ . ^~ . . . .

·eJdensive temper!l:.i;.e agricultural J,ands, _the cQ.mmercial:iz~tion of tr.ofiical agricu~tur·e~ and the discovery of ri'ew mineral resour ces

···.-· ... , .. ·i

stimulated trade 9 provided opportuni

ti

es .. ior major p-opulation shifts from Europe9 China and the Indian sub-continent9 and led to new levels of capital accumulation and international capital transfer.

. ,. :

The bulk -of-the -flow·washfr'oni-p:dva:te sources, with outstanding

long-term debt growing from about $100 million in 1820 to $~ bi llion in 1870 and

j~4

^{billion in 1913.1}

Ailmosif. all lending was by private. lenders throug;h. stock or bo:J:~.j.

issues to the public. Sorne two-thirds_ of British lending went t o private borrowers. A third of ·:the i(otEü .went to. North AJüerice.₉ some- wbat less than a fifth t o South .Ameri.ca and about 10% to Australasie, . ft..trica ·and Asia took apout

:a

:quarter;. and Europe about 13%.2

The

bulk of United States investment al s_o .went to priva te borrowers, mainly in adjacent Canada and in Latin America. French and German e;ove::rnments

P EP00LUCTION/ 16- 82

Page

3.

h

eavily biased t

h

eir citi z ens' loans towards issues

by

eas t

E'ù.

r

op

ean

governments~

The Net4erlands

9 Belgian

and Swiss capital mark

ets

were a lso

.

open t o foreign bo rro. w ers i

n

t

h

is

per

iod 9 the Scandinavia

n

' • ..... -. . -.. , ·-~·-..... :· .....

c~untries

were borrowers.

.. ' .. : --' ·-.-·-:. -_

The

largest s ource of démand,

. sorne 701Jfo&

was f

.

?r ._long-term c ap ital for the construction of infrastructure.

Lon~~term

(up to

99.

years Ihaturity and even

pe~petual)

public is su eso f

st~cks and bonds

we re. t he predominant form of lending9

·the

se were

part~cularly

well sui te d to investment in rail ways and

ut

ili t ies.

Private~y

owned

rail~ay~

and utilities generally r

eceived pub

l

i

c spb sidies in

th

e f orm

of

land? and wer e frequently subj ect to public contr ol

,

s? s

o

th at w

.

he ther borrowing was by

priv

ate or

pub

li. c enti ti es of t en depended on th e accident of na ti

onal organiza

tional arrange ments.

Al tho ugh t h e bul

k

of 19 th century lendin

g

wa s through t

h

e capital mark et and _ thu. s

..

'

._

in._di:J;ect'

_- .

? .

_. th~ principa

l credi t or s

\'tere

of t en

" .... ... ... ·.. .. . ,. .

re~resented

on the

boards

of the borro wing corp

orati

ons or acted

-'

....

^{~ ... · ...}

as advis or s to the

mu~·ic-ip.ais'

state ·or

f'e·derat·-·go

vernment·s c

on

s truc - ting and runn ing rail\vays or utilities. Stockh olders' p articipation

·in

manag.ementwas .:Q suall,y maJ?.. 1. lito

:r:

y in

~ining

and a gr iculture .

Interna-tional cap ital flows offic ial

( th.

at· is from Gover

nment )

sources? whether to other

govern~ent (

t

ha

t is

pub

lic)? or to

p

riva

te

reci

p

ients ? were negli

gi

ble in the 19 t

h

cen: t

ury

?

po

st-Napo leon ic

' ···1

·and th

e

Frari.c

o-Pru ssian war reparations

be

i

ng,,th

e pr inci

pal p·ayment

s of thi s natur e.

· .A 'new

tren d in · internatiün

a

l

capi,tal.:.tra;ns:e.~rs

can

a

l so

be

disce:r:ned f..rom the

..

es.tahlishment

of the

Internati on al

Red

Cro ss

' . . . . ( . .

m ovement i

n

1863. Ini ti a lly f ounded. to

^._rel:

^ieve

^.

^{the di stress of}

soldiers tak en as prisoners of war? the m

ovement

grew with t he

a cknowled gement of the need t

o

relieve acutc

distres

s a c ro ss nati

onal borde

rs by transfers f r

om

rel

a

tively r ich peop l

e

and countries to

tho s e

p

articularly unf ortu nate.

Th

io i n t

u

rn refle cte

d

t

he

ris i

ng

ti de of rec

ognition

of n

a

tional res

ponsib

i l i ty for minimum welfare

and

equ

ity standar ds i n t

he

na ti onal distribut i

on

of inc

ome.

REPRDDUCTION/ 16 -82

Page 4..

World War I and its aftermath were a wetershed in int0xna- tional capital flows. FiJ;stly, official l ending as vell as repnra~­

tions became important. .U though. -the European countries ini tially borrowed from priva te _source.s in the United States to as si st in ti::e

. ri~~nctiig ---~-f -- -th. e~-1:' ·.;~i --- efiôî .. ~· p- --~-!lë~-- --the uii'i t~'d'.: states

eutry into the '"ar in l916·~ ··official

- un::rr;;d.-- Sta . të_ s .. ' ..

^{lo.ail_s_;.to.}

i

ts allies became importan,t. _After the war German reparations were to become a najor factQr ·in tl:\e post-:-war settlem~nt and the 20. years of uneasy peacc which followed)

Secon~ly,

^{.there were large}

' i~ter:J;la~iona,l

^capital

flows' .fro.n:t official and private sources for post-:war relief with an

acc.ompanying rationale for international .aid •.

' ..

Table 1.. Principal creditor and debtor count~ies, 1913

Gross Gross

.

$000 Credits $000 CrGdi-ts

Creditors million

%.

^{Debtors million}

...

^-~4

%

Gree.t Bri tain 18.0 41 Europe ^{12.0 <;:7}

France

9.0

²⁰ United Stàtes

Germany .

5.8 13

^{and Canada}

10. 5

^2i·,

Belgium₉· Netherlands Latin America

8. 5

^{j . ·!") ~}

and Switzerland

5.5 i3

^{A sis}

^{6.0 tt}

United Sta-faa

3.5

^{8 &fric a '-!.7 i i}

Other Countries 2.2 5 ^Oceania

2.3

5

44.0 100 4~.0

10D __

^._.,_

..

•

RBP~ODUCTION/16-82 :!?'age

5.

Thirdlyp ther e were ma,jor. chcnges . i.n pr:ivate lending. Al thou,~h Great Britain continued to be an international l ender in the 1920s? _the volume of British capital exports declin~d. Lending by other

. ^{: ;} .· ·. ·-- .

bU.ropean countries de cl ined even more. Indeed capital fl i ght fr('lm

Germa~y ~nd France to relatively more prosperons countries such as Swi tzerland and the United States became a probl em. The Uni ted States bec ame the principal source ~.î funds in the 1920s ~ , continu ir;_&~

the t rend established during Worild War I. But the borrowers condi t io::.1s

. wêr_ë_:·fa"l;·-les~· favou~·abl·e: than in the pre-~at year s.. The countries

or

^{ï;ec(::?rii-}ï:iëttl'ement and. 'ô'f

new "t' r o pïé- al

·àgfiè-ùTtu."r~T' dève'lopment haél come.

to--

^{.the-.. end of. the ir initi-al- invegtment upswing. : lrl}i th the e:\:cep·- . t:lon of the Uni ted States who se ·large national market had enabl ed

i t to industrialize· ·in. competiti-on

w i

th Europe ⁹ thei'r ecônomi es \vere in the dol drums during most o'f tl:le

19208 .

The ir difficul ti

es

were

·exac.erbated by the mismanagement of the European and United Sto.tes economies. Canada2 Austl~alasia9 ^{most Latin Am~rica:n co1intries2 and.}

mo'S~'t of the tropical p colonial côuntries ~ere· siiding into a seri~~

recession by 1926-27. The failure of the iridust rialized: country markets in

1930-31

plunged them into depreetiicn.

• 1 • •

· lJ'nti) the 1920s general default on foreign l.oans was not fel t to be

a·· m ' âJo· r

Issue--~ Sorne defaults

by

po-o'rT~ niànag~d 'corpo;atï'ons

. :: c ;j

and incompetent or corrupt governments had al,vays been part of the investors' riskg lend1ng terms took ttis into account9 and when there was a fai lurep ~ockholders were expected to take their l osaes just as thëy took their profits when an enterprise succeeded~ In pract ice they often persuaded their governments to threat en or in effect even assume the defaulting country's government so that ¹gunboat diplome.cy' took over from the market.

priva

te:

capital markets in· the 1920s, but the forina.tion of the USSH seemed to be a unique pol i ti cal occurrence₉ with industriel countries swinging to the ri ght. It had beccme· cleer· that attempts t o exact

. REPRODUCTION/ t6-82 Page

6.

German reparations .and repayment of official loans

on

^{time were}

unrealistic by the end of, the l 920s 9 but such defaul ts were inter- government problems. Howe~er, in.the 1930s a large number of

private_.. . and public .borrowers abroad joined the failures and defaul

ts

'.·· . . .

at home. . In eastern Europe and Latin America the rati o of defaul ters

. . .

. t-ras high 9 up to 90 and 80% respectively of all government bonds

·~.. ' .

issued, in

. ~

the US in the 1920s. Financial markets became

: ; : ~ '

d ~pl~ië d:-~·(f~"ïn~'~t"fc • l~ndin~

^·.

~ ·e ~·o:~è 'r-~'d:.:: ;i ô wt y~ . '{:l.~ancial

:fiows among iJ?..dustrial countries'·

~·erè · ··· ~ 'Lii:i.. ted,:9 ~ · ' e:~:;J· 'i~v-e-stm-~·n:r

^{.. in èoionial}

territories and other less developed countries almost ceased~

In .the meantime a new fôrm of ·_private lending had ~vqlved.

-Sorne major British manuf.acturing corporations had already _establinhed .subsidiàri es in the Americas 9 ·in-Australa.sia and, in colt;>nial

countries in the 19th century, and this trend was açcelerated by the groi'1th of protectionism i.n thes.e countri·es in the .1920s and 1930s •

..

.. The --~:x;ploi t_ai;Jon cf differentiated mç;rk.ets by bra:q.d-name marketing,

... ^-~-· ... ^~ .. ·-... . .. ·- . . .. . . . .. ... . ' -·l· . - . . ... ... . . . . . . - . . . . .... · .. -:... .. .. . . ' ... . . . . .

... ....

le:cd~ng -t;o _aggl;'essive oligo.-r~oli$t:i.c. oompetition a.rrd ¹ defensive ¹

... • . . .•. ·--~-... . . . .. -·-., . -- ..•....•.. : . ... ,;t. .. __ . .. -···-··- -.... ----. ^J, ... _ . , ___ -• • •• • ·- -· -- --·-·-·· · ••• • •• -... • •

.investment in .new markets 9 spread beyond_ ?~~L?:~aA!._.~S!~~-ers _i_n pharma-

ceuticals9 çosm.&-ticsp soaps 9 motor .vehicl es and agl!icultural machinery~ h~avy chemicals and many otbe.r industries. Investment was product

specifie, i t was in the form of .direct equi ty holdings 9 and the

('.- .

p~rent corporation coni;rolled the subsidiary or as~_ociated company~

. ^: .

After an initial i~jection of capital, a subsidiary's growth would subsequently largely be financed by reinvested profits. The bulk of such investment was among the indust rial countries and co nt ri es of recent settlement. In Canada. and fmn.traliap for example, perhaps as mucb. as half the asse.t s of manufacturing industries were owned b_y foreign corporations by 1939.

The changing str-qcture of financial flows₉ and inherent accou:n- ting difficulties₉ make.a comparison of foreign debt outstanding 1-

1939

wi th 1913 impossible. A figure of ~~55 billion is generally

•

..

REPi.WDUCTION/16-82 Page

7.

quoted,

but

it is stressed

that

it

in

n6i co~par~ble

t

o p

r

e-Vorld

~!ar

I estimates.

5 Priva te

internatio

nal capital flo

ws

came ~ to

^an

almost

complete standstill

with Worl

d Wa

r II. The United Stà tes

. . ^' .. ^-~ .

financed

the allied war effort

anl:l

.... s:Y~$)~Q,ne.n.:t .r:ehalHl;i.t'atioïa~

predominantly through

official grants an

d concessi~riai (t~at 'is~

belo'~ market. rate). loans ~.

to a !ll1l.c:tt _

gr_~gt.e.~, .. e:~dent

than

in World

. v/ar I, ._Its efforts culmina_{.. .. .} ted_.

-

^{... ···} . in ^{·~· .... .. .} the ^{.. . ..} t1~r..sha.l1 Plan .. .f:oJ;".:the-recon-

struction of western

Europe

• .

Together

wi th

conc·es.s"

ional\ .lending

to the United

~ingdom~

po st-Har assistance to Europè amounte· d ·

to

about

$1JcO

billion.

.

About 65%

\\las i r1

gran:t'

fc)ro₉

markihg a

·new

dimension

in official

aid

flows.

There \'Jas

·

als'

o substantial assis~

ta:q: ce for

Japan' s reconstruction. Ey

1952

·

the

Hàrshall

Plan funds

had

for

_the most part

been

spent,

t

he reconstruction

of Eur

ope and

Japan

had largely

heen

completed~ · and the way was 'clear·

for

'

a

p

erio

d

. ... . . . ·~ . ···-~-· .

of rapid economie

growth.

(b)

The development impact

The

·growth in international capital flows at the turn oi

t

he

19th

century was ~apid

enough and

of sufficient political as weil

as

economie significance to lead

t

o a

considerable debate about its

impact

on both

the

borrowing and lend

ing countries.

(i)

Bor~owing countrie~

The inte;rriatio:riat flow

of

c;a.p

ital was assumed by

liberal

eco

noi!l

i

sts to f

oll

ow economie opportuni ti es. If the bo

nd

marlŒt

channelle

d :hmds

to

infrastructure

projects

in

the

Unit

ed States

9 mines

i

n

La tin

l.mer

ic

n

o:F

plantations in Malaya~ this

w

a

s evi

denc

e that

the productivity

of cap

ital was

higher

in

the

se arEH~S "'th·ari

in

"the

lendfng

country.

Migration - the flow· of labour· ~ had a

sim

i l

ar ^ra

^tioïia1'e 9 ·and. trQde

equilibrated the

resulting speciolized production

structures.

And in a

very broad sense

this

was of

cou

rse true.

Ho

vrever, while

in

s

on

e

"e-.ases

the

assumptions that

underlay

the

mar

ginal productivi

ty

thetrrcm.s

hel

d₉ in others

they did not

₉

and the

flow of capital

turned

out to have costs as well as benefits for bo

t

h

t

h

e

bo

rrowing and. the lendin

g

countries •

REPROPUCTION

/

16-82 Page 8.

•

For the borrowint

c

ountries th

e

greatest benefits were essociated

wi th t

h

e flows

o~

cap ital, mainly

for

infrastructu re

9

that accom··

panied the f

l

ow

of mi

gration

to the countries

of

new settlement in

North .Ame

rica and

Au

stralasie.

Wh

ile

the

ext

ent·of

the '

push

'

and

'

pull

' factors particularly ecross

th

e

Atiantic,

O

annot be determ

i

ned p

recisely, 6 i ^t

.is clear

thet overell the

capi

tai' movernents

. .from

p.E'~

supported the l

on@i

investinent

a~~ migration booms

in the. 19th.

centu~z

•

..

Fortilign

capital

p

laye

d

a significent

role

in the

gross dooestic invest

- ment

of

a number

of

repidly devel

opïng côuntrie

s,

notably the 'United

'f ..

States, Canada,

_{. .}

Australie,

_{. . .} New

Zea

land₉ Denmark

and Sweden, in

the half cen~ury

before World

W

ar I.

Cons

i

derable f

l

uctuations from year

to year ma,ke

-it

difficult to evaluate its

quent

itative c

on

tJ;ibuti

on

,

but

i.t is reasonably clear t

ha

t

.in the United

States, which

vas tne

large. st single destination

of·

foreign cap i

ü~l

flo

ws

, foreign

.

capita

l

never exceeded

10~ of gros

s domestic inve

itment? ·

and in most year

s

the proportion was considerably lO\'Ter.

7 _In Austra

l

ia

, at

the oth

er end

of

the spectrump the share

of fore

i

gn

cap ita l in

gross domestic

ca

p

i talc

formation

averaged

50%-in thê ---1880s-.-and

rosa to

nearly ?fJ-'}

in

s

orne

years in the

1860s

and 1880s 8

and

it may

have been

equally

high

in Canada in the 1900s.

Even wh

ere

·tqe

sh ar

e of f

oreign caf

ital

i

n

total

gro

ss dornes tic i

nvestment wa

s

relatively

lowp

i t

fr. equent

ly p

laye

d an

important, and some

t

i

mes a

ca

talytic

role,

by being

availnbl

e7

b. t!.lo

ri,t.

"·ht ses.i9.!' at

t

h0

ri

r.-h

t ti

uç, t8 '?.JL"_?~k bo

ttlene

cl::s ~:::.·~ ·.-.y t~~.e

technical and managerial skills

that oft

en accomnan ied it.

But

conversely,

foreign

capital fl

ows ~ould be wasted

.

Th

e evidence

of

t

he

impact

of foreien

cap ital f

lows on Latin American

and east

European economie development is les.s clear. In

spi te of consider

able

capital inflO't'lS these c

ountrie

s

had s1._<2.y an~

uneven deve

lopment in the 19th an

d first ha

lt of the

20th centuri~.

Th etr uneverr economie growth cl

early bad little to

do

w

i

th

t

h

e

share

of

fo

réi

gri

cap ital in total in

vestment

.

In endowme

n

t of resources and popu

lation soine of these countrie

^S 1~ere not

dissimilar

to ^lt()Oe

•

ftEEi.ODUCTION/ i6-82 Page

9.

of the more successful ones. Argentina~ for example9 closely paralleled

..

Auatrnlia at the end of the 19th century ~ wi th both countri cs beinz well among the top per ~apita income earners. Sorne of the Balkan countries appeared

to

^{have better natural endowment} tban say the

Scandinavian countries₉ and received greater amo~nts of for~ien capital. But capital flows were often politically motivated and conflicting

interests up;to the point of armed ·conflict led to pooi econ6mic performance in the countrie s which recE:i ved them. The wast'e · an~~

corruption .. freguently associated wi th foreign investment in the se circumstances was part of-a broader social and poli ti cal lv-eakness.

The recipient economies were particularly weal~ in balance-of-payments terms₉ and large-scale borrowing tended to increase this weakness by l.'l.?~ele~a~ing urbanization BI.J:<}, pr.qt:Hm.si.ty

:to. ü.n.po.z:. :t

9 • usua;I.ly wi tho1rt a comp~nsa~in~ growth of expo.!t!?• .... rh.e coni..ras.t _.wi:th, the, English-

speeking countries of recent settlement ~..s •. .striking.,o'.; .Tkrp.s ^a;!.:thoug~:-:.

aebt service rose to nearly ~O% of exports in Australia in the 180Ds

lt!Ï th ensuing strains on the balance of payments,

9

the economy was

essentially sound and even in recession hears losses on fcreign - as on domestic - borrowing reflected poor judgment by lenders in speci~ic

cases. In eastern Europe and in many Latin American countries considerably lower ratios of forei~n capital inflows to

GDP

were

associated with much greater servicing difficulties and with àefaults.

In

colonial and semi-colonial countries foreign investment tended to be oriented toward enclaves.which exported minerals and

..

tropical .agricultural products. The political strength that lay . behind· the investors led to the ir. appropriation of the profits anS.

rentsa generally leading to net O'!l:tfl.c,.,s of capital and .the investiD-J;;, country after the _initial .investment period. The flow of capital was small in relation. to the flow:s to. North .. America and Australie.~

and the multiplier effects tended to be limited. by the enclave nature of the projects financed. In sorne countries there was conflict

between the land requirements of export and subsistence agricultur~.

~PRODUCTION/16-82 Page ).0;

In th,e Netherlands East Indies, for e~ample, this b~come so acv..te

', ~

that i t was debated in the

Netherla~ds

¹ parliament in

th~ · 19'oos,

The fall in relative primary produët priees in the 1920s rriade debt servicing problems acute.

The distributive impact of foreign investment affected it s .economie contribution. Where the bulk of the gains went abroad

•· _or . . t? .:.~!-P.atriates, the gains to the local ec~momy were mainly i'-1 the form of wages. encouraging populati on r.ath,er . thaQ. produc,ti vi ty

• • • ·•··· · ..... . . ~-· . . . . ~ • , . .. . . . -· •• " . \ •• ' • • • ·- w . .. . .. . - . .. .. . : ; ' : • • · _ : • • • ; " ' \ . . -io. ~- ' ••.. ;._.,,__ •• -~ •• .:... . · •. · ...•• : •. ·-

&;rowth • . But the impac:t of foreign capital wao .not, simply .en .econo~ic

••• . • • . ,. •• ,,.,_,, .... . - • . • . , . . ,, . . .. . . ... . . . :-. ! ;:;.,;: • • :· ... o.: ..• .; .... · .... .. . : ... · •.... ___ ::.:-~. _·-• . ~·-

issue.. Purely poLi, tical pressures b.ad led to .capital flows .to eas.t.ern Europe a.nd to sorne colonial and .semi~col.onial countries.

Onçe pr.ivate ·lenders were involved₂ governments came under new

:pressur*E!S .from· t};}e.!J! to create .condition.e in which .. the original invest-

:ment woul4 l:>.e protected~ .

(ii}

Lending <countries

"A "

In

lending .countries i t was argued that although investment

::t :

abroad would lead tq an init ial outflow of capital ·at the cost of domestic investment~ this would be accompanied by the export of gcods

. -~ (\

and.services, and .there would be a future inflow of capital earnin~s

and cheaper iilported goods. All these hypotheses turned out to be

·tru.-e ·in-.sûme .. ·measur.e. Returna on ·ca-p.itai. in ._par . .ticular led to ver.x.

.. , ·cons-id-ei!-a-ble· inflows •. · For Great .Bri tain P.:t ^lea.st~ .... t.a.ken, py. J;ector9

investmelits were· more profitable ab.road ... than .. at ho.me • .

Bu-e

^{the si tua.tion}

was- clearly much more complex. than· .. thei.a.e:

simp~. e. ·.p.:t:é.m;i..s .es

·implied.

~-

⁰

Tbe ·circ.um&tanoe.s and pè.r iods of time. over .. -whid~ . ca,pi t.tlL-;.eXP,Orts l'rould l ead to an incr.:ease/ d-e.crea.se~

in

^{the· l..enàing· .c.:Ount~Y:'.s ·.exports 9}

or a decline/improvemerit in it~ terms of trade vis-~~vis th~ rest of the world₉ soon be'c~me an is.sue. Given èompet i ti 'Te marKets for factors of production and goods 9 the lending country would of course benefi·[;

in the.l ong.;.run9 but while the very acts of foreit;n investment sometimes

..

..

:a~PH.DDU CT I ON/1 6 -82

Page 11.

proved the. competitiveness

of ma

rkets₉

t

hey sometimcs substantially

redu

ced i t.

Capital markets were

·,

se

gmente·d. Even at the h

ei

gb.

t._..21

' . "

liberalisin trade

was

not

al

w

ais fre· e •

. The ·1900s saw

t

he

last stag e o:f t

h

e

substantial

migration in ,;rb

ich

s

orne 60

millio" ri

p

eop le

hac.'l:.

1 eft

Eur

ope for the countries

of

^'nevr

settlement

^{1 ••}

The

employment

an

d

income distri

bution

impact

of cap

ita

l cutflows~

and te:rms of

trade

shifts f

or the le::l'::".in~-; coun

try we

r

e seen

to b

e

of

consîderable

import·

ance. Unemp

loyment.

a n d

^poverty were prevalen

t

in

Europe a.nd

the

United States.

J

?orei

gn invkst~e~t· wa~ g:

ener

a

lly accomp anied

by inoreasin

g

exports; particu

larly

in

the

case

of

su

ch

infrastructure investment

as

railways₉

bu t

over time'

the· deve

l

opment of

ne'

\i

countries9

wi t

h

their own manu:fa c

tu

rin

g Ùl.dus-tries~

was seen

. . ^{. .·} .

i;o be

dangéroua to the

exporting

country un

lëss emi· g· ration

a

ccompe.ni

eè.

capital

ou

tflows.

British w

ork

ers

vwuld sh

are

ini

the

b

en. ef i ts of

Brï'tish ·investment abroad₉

niainly in

-th

e form of

cheap food~

t

o

s

orne

extent·

from employment in associate

d e

xport ind.ustr1'es

₉ and

t

h

r

ough

:J;'.:.:-,;th

e

overall boost to the

economy

given by th

e inc

ome on foreign

investment.

But the

overall impact of for

ei

gn investment was thought to

vorsen

rather. than to

improve t

h

e distri

bution of,income

in t

h

e

lending

country. In the

longer

run, t

he difference between th

e

distri- bution of costs

an

d

benefits

could b

e

eve~ great~~~~Jinvèstment abroad

•. . ·' . i ;:

had an

oppo:r~unity

cost

in investm.

ent at

home.

Future

· j

ob creation

and

future productivity

were

at s

t

ake

. Gr

eat

Britain inv

este

d

u

p

t

o

75-80% ^of

^its

capital formati

on

a'broa

d b

etw een 1893 and 1913 . L'h e

rates of

return that

motivated

capital

mark

ets

during these

perioà

s

were probably

not the 'social'

rates

f

or

wh

ich t

h

e disadvanta

ged

i

n

the

1

ending

countries

wou

ld

have

opted. '~

REPllb:DUCTION/ 16-82 Page 12

.

·

2. CAPITAL FLO~!S TO DEVELOPING COVNTRIES

. At

the

.

!'lnd of

the

1940s

the

flow

of capital

to

developing

coun tries

was

negligible •

.

Sorne

develup

ing countries

bad emerged

., . ··-.

-

^{. :· ... : . . . ;}

from t

he

World

War II period with h

i

gh international

reserves

result

- in

g from

relatively

h

igh

prices.for the raw

materials

they mostly

exported and a shortage of t

he manufactured goods

t

hey

wish ed to imp

or

t.

But

t

h

is situation

quickly

changed .

Official

transfera

began

to

. be

imp ortant

~s

the

flows between

colonial and metrop6litan

coun~rie~ were

reve

r

sed.

The former

colonial

pow.

ers retained

their

i

ntere

s

t in t.4e fortunes of tn

ei

r

-colonies as t h

ey

moved. toward ;indep

endance

. T~e .United States b.ad.

~ not dissimil~r

'metropolitan'

relationship to

the countries

of Latin America·

and the

Philippinesp but

it

was i:t.f'l wodd-wide politi-

cal and mili tary interests which

led

i t

to follow up

the

r1arshall

Plan

with·

a very considerable

official capital flow effort f~rstly

in

east~J\..sia and

then

throughout the developing w

orld.

Aid wes

seen as

poli tical

and economie insurance. against

the

threat

of

coomUD.ism

.

But the

dramatic chan

ge

s in

p

ercepti

on about

acceptab le

standards of welfare

that

mark ed

dom

estic

politics

in the

19l.::Os also

enter~d

into a new

approacb to

relations

between

rich

and poor

coun

tries. Unlike

Vorld War I,

World

War II

had been in many respects. a p

eopl e

'

s

\'Jar₉

and the

peop

le voted to inheri

t the peace Rap

i

d

economie

gro•.Jth9

full

employment and

high:

standards

of

social

welfare became th

e niaj

or ohjecti

ves

of

t

he poli

tic al

parti

es

th.at

were. s'"e

pt ,into power

in

Europe,

and nffected the

political clirnate

iri

other industria- lized

countries

.

Iti international

teros' the

impetu- s

for growth

was reflected in the

~esire·

to

free

cap ital

and

trade fl

ows from the

c

onstrictions of the 1930s. The

interest in

domestic

welfare

was

extended to support for colonial i

ndepende

nce

movernents

and

assistance

to

the developing countries

to

'

catc

h-up

' with

the

industrial

countries₉ particularly in terms of

livin

g

standards .

British 'colonial

ai

d and

HEPROD UCTION/16-82

D ~: ·/·

-~age L_; •

. •

welfare ¹ ·and French ¹ economie ~nd s0cial inves'tment ¹ were objectives in these couritries' expenditU:res in their possessions in Lfricap

· Asïa and the;· Pacifie ^P and the Caribbean in the 1950s. In the United States aid hegan to have an independent rationale.

A revival of the transnational coruorations' interest in extri!_t~

tive industries and tropical agriculture and. with increasing protes-

' 1

tionismp in manufacturing and ass~c:i.ated service investmenh in devGloping countries led to the revival of nrivate capital_ flows. Lending in the form of export credits follow~d in the la~e 1950&2 ~

and by the end of the 1960s when international capital market.s hed been rebuilt and sorne developing countries bad built up a considerable semi-industrial¹ base and borrowin_. g capacity₂ other indirec_. t capital flo'Ws· to devero-p-ing ë'ôüiit:des bëga~ to-.g.ro\•Ï 'in importance. TC?t::;l .. m:ëdium and

lo·:n·g-~e·rm

6api tal

flo w/~- fro~i·

·tt:ë"-beve!'opmènt Assistance

Group. la ter Development ·As si st:ancë ... C;:)mriilitë·e-~(DAc}.

\:)f ...

the O~gani­ zation for Economie Cooperation and Development (OECD) countries

thu~ grew from a negligible beginning in the early

1950s

to some

$~0 billion a year by the mid-1970s.

Members of the Organization of Petroleum Exporting Count~ies

(OPEC) added a further average ~f $8 billion a year in capital flovs to developing countries in

1975 - 76 .

About

$5

billion consisted of grants or concessional loans. The centrally planned economies' total contribution averaged

$730

million a year

in

^{1975.:.76 with} $650 million

t . . l t 12

on ^~ran or concess1ona erms. .

(a) Aid flo\vs

And· flows have come to be defined .. as flows . that are ei ther grantsp or2 if in the form of loans2 have a substantial (at leaGt 2-5%) grant

element~

¹³

REPRO~DCTION/16-82

?age i~.

Official aid flow-s from D!.C countr ies are now relatively equally divi ded between technical assistan:ce9 ot~e-r forms of grant ai d,

bilateral lending, and aid contributions .to !llUl t i lateral insti tution!J, the bulk of the latter also being passed on in grant form. Official aid flows grew rapidly in the 1950s wi th the Uni t.~à States and t:1e former cei-onial powers·-•· ·par t iëipati on·,.

but

these ·· dô..-&nt.ries ¹. contri- .butions---s-tab-il·i,z.e-d :in· ·the.· nrid-;.;.1960s and: .evim d.eclÜ:J..ed. in re-al terms •

.. '

.. Australia, and--more rec.en~tly JapaJ:i; grew in .. im.p.o.r.tanc.e.. in this

· .. c.ategory, ... :Q~:t. Çk:;_mo·re'-·.important :dëV.:.ë!opmeri':t ... w.as the .. gr.ow.in& importance

f• of less self-interestedly motivated donors such as Canada and t:l.Le 'Scandinavüm. countries. OPEC countries became major donors after

1'9T :$ .

The data are simply not available for an accurate meesure of

14 '

overall fl ows, but aid flo,~s seem to have grown at sorne ..J:J:? per annum since the 19508, or at about the same rate as pe;r- ca_pita income in industriai and developing·èôüiitries .... ·· ·

The measurement of overall trends in aid i s of course not very

useful. The, equivocal hi story_ of the developing countries' relati ons

with the former metorpol i tan countries in colon~al times~ andi the self-interested motives of most donor countries made offi ci al ca2i tal flows · su.spect from their incepti on9 and actual aid experience Las l ed to a great deal of questioning of the aid ·process by donors and recip1ents.

The efficiency of aid flows wes an early concern. It ~s6on

became clear that the form of ai d flows was of considerable importe.::.cc to its economie impact. For example₉ the use of agricul~1ral su~pluses

for food aid could have counter-productive effects9 feeding poor peogl e in the short-run

(if

all · went weil wi th the di stri bu ti on) but undero·

mining a country' s own long-run agricultural potential in sorne cases.

REPHODUCTION / 16- 82

Table .~. The composition of DAC capital flovs, to developing countriesv

. 1960-62, 1969-71

and

197 5-76 •.

~

. .

' 1969.;..71

(percent, annua,l average)

----~-··

A.id* '

. Othe.r official

Priva te

1!Direc

t

inve s·tment) Export credits) Portfolio and ·other)

·Total·

.:Memo :. . · .. Am.oun t .

(US$ bill_i;pg~, curr~nt}

(us$

bïllioiïs·~-- ·1976) . ·

59 7

)4:

100

nl

.. 9;- ' "17'

19 . -. - - . -.. . ... --- ·JO

^{''. .}

Source.~. ·

0E.CD, . .

nevelopment ·Coopera-tion::. (Pari.s};.·.passim. · ·

*

These figures exclude gra.nts by voluntary a.gençi·.es,_ . .

t

Include~ officia~ ex~ort. credits, debt rëlief · an.·a· "èontribu.tions to. mul t1lateral 1nst1 tu tl. ons on market. terms. · . ·.

Excludes 'Euro~urrency' flows estimated to be $1-2 billion in

1969-71

and $10~12 billion in 1915~?6.

·

Table

'3 .

Corn osition of DAC and flows includin. agencies, to de~eloping criuntrie~,

yoluntar ^r average

197 2 -]É.•

'l f-.'

... ~

- ·

"

u

J n~

:.vL

$

Billion · 7·~ of total Official Development Assistance

!

^{Bilateral technical} assistance) Other bilateral grants)

Net bilateral lending)

Contributions· to multilateral insti tu ti ons) Grants by voluntary agencies .·

Total aid flows

. (13.6) ( 2.9) ( 3 . 5) ( 3.2)

( 4.0)

1.4

15.0

(:;_9) 91

l

^2'7)

^~3

^;,;;2

₉ ^~

^t

100 Source: OECD Development Cooperation,

1977

Review, op. cit. p.

172 .

REPRODUCTI01'J/ 1.6-~82 ll'lge 16.

•

It is sometimes arg:u~d that _{. ..} from a bnlance-of-p_. ayments _' point of .view ... :technical. assistance s.houl~ .not ... b.e a :·?onponent of aid flows as there is usually little. capitaLtrensf.er .. to the recipient country. Ho,-,revel~'---~~-e __ ~r~ining and a~~ice ~-rovided under 'technical assisto.nce programmes9. whether they are ·carried out in the donor or recipient co~ntry, have 'an opp~rtunity éost9 and they are t:herefore

a '

^reel

. . .. ·• · . ... . . . . .. . . · - .·.· · . 15 .... · ··· ·· - .. ·-·-·- --···· · ·-· ·· ···· · ·· ·· . -

transfer in resources. How efficient such a trn:nsfer

of

resources may be, particularly if i t is tieà to nationals of the donor countr:'/9

is another issue.

It bad become evident by the 1960s in more general terms that tying aid. to suppliers from the donor country could be costly in terms

of

the appropriateness and cost

of

technology. In extreme cases exces.s recurrent and maintenance costs cou.ld lead to an __ p.nwA~.ra;o.ted net capitaL o1,ltflow .fr.om,..the.. re.c.ip.ï'..en.t. country. in the

medium-to long-term.

Efficiency arguments have been mede ·fo.r projêct versu.s progrrunme a id.' But in p·ractice diffe.rence's hetwee-~ ¹ récurrent ¹

~ ~~

and ¹ investment¹ expendi tures turn out to: be· i·llu:Sory. The develop- ment impact of recurrent funds spent on nutrition or teachers¹

salaries may be greater than the impact of investment in projects

\<1hich~~canip.ete-, for funds , with. S:UC·h recurrer.vt ·-exp.endi tu res 9 but i t

cas.e .•... Funds-are funŒible • . The. do:nor's .. flmds-m.a.y .. be -devoted.to

spe-cifie~ ¹ target areas 1 , but they are generally a small proportion of

t6téfl '

investment allowinii"

oth er

iü

n

d.

s'' tc:

ï 'b'é. ùs'ëd"

f or -

the. recipients ¹ preferred projects. Project oriented aid· can lead to ·an im-bala.nce bet.,vee·n capital and recurrent expendi ture's.

The ar8Ument for loan rather than erant 'aid has been made bot~:

on ~ifieiency and self-interest groundsi · d~pending on the concessiono- li

ty

o·f the · fldw. Some · do.rtërr g·overnmentfi

cori sf d àrëd that

.

tne

l oan

. . .

form imposes a greater economie discipline on the ~ecipient country,

B.E='..,JlüDUCTIDN/16-82

. ~ 'j _; . . ' ' ' -.

forci~g i t to think about using such flows for investment purposes which will give po~itive returns

to.

the economy₉ and9 incidentally

' . ' · : "

. . . .

make the :re~ayment of the original loan possible, The proportion of loans iri aid were thus increased in the 1960s. But the weakness of such economie efficiency a rguments was recognized. The ratio of grants and the concessional elements of loans were again increased in the 1970s9 and more recently sorne donors have ¹forgiven¹ service charges to small poor recipients.

. !

'!'

.A second group of questions 9 ccnceraed w;i th .the ~qui ty implica- tions of aid₉ has become increasingly important .in recent years.

In e;enel.:ü terms i t is assumed that tb.e r elatively rich in the high

incom~ _countries bear the cost₉ while pcor people in the low income countr ies benefit. But taxation is not equi table in all high income countries: sometimes i t is not even suffi~iently equitable to avoid

· .. ~- --· .... ·. ·:····--...... -~ ... -·-···-··. ··--•· ... - .. ---.. --

extr~me poverty in the sense ..

of

"ffialrÏutri ti

on , .

cold, lack of educatiOl.

and minimal health services. The incidence of aid sou~c~s is clearly unequal among donors, and the range - i:rom an average of about 0.~5%

of

GNP

in industrial countries to about

3. 5%

of

GNP

in

OPEC

countriec - . t f ll . d . t · f ¹ b d h . ¹

16

_{T' · t . b t . f}

l.s no a _u 1n 1ca 1on o. ur ^~n s ar1ng • · . ., ·· .ae con r1 u :ton o_ centrally pl anned economies remains below

0 . 1%

of tbeir GNP.

17 ~!h ile

aid flowo remain at so low a percenta~e of the high inçome countries¹ GNP9 the issue is in any case trivial.

A

great deal of attention h~s b~en focuse~ in recent years

on equity in terms of recipient countries₉ with an argument for a shift

fro~ - 'middle income' countries vi th incomes above $265 a year9 and particularly t o the numerous₉ small₉ !least developed¹

this ~ense of equi ty i s based on j;,h_e: p..fftional boundaries often

ir-~ c.-ti~~a Ù.y

determined by

19th. ~- ~ntury

imperial

~dventures .

The very,poor people of the world are concentrated in th~ -~~ry· large

But

countries of South Asi a, and some are in relatively high income countries. The discussion of the equity sharing of the benefits of trade ie even less conclunive than that of burden sharing.

REPRODUCTION/16-82 Page 18~

T n G

increasrng interest in equity has also led to a concern with the direct and relatively short-run effect of aid. The desire

· to

proviàe aid flows, and in sorne cases to provide them exclusively or predominantly for 'the poor and for their 'basic needs¹ has led to a confusion of the direct and indirect impact of development and, at wor~t, a paternel determinism in aid allocation. It is also being used to eut aid on the grounds that the poor are not the recipients, that pest aids flows have made the rich richer in developing conn- tries, and even more disingenuously that aid for industriali~ing,

. '

which may lead to•·adjustment problems for donors~ is no help to the -poor! Rooted in· a ~ery un~~rstandable concern that the fruits of

higher incomes in many developing countries have fâiled to be s ared by lower_ inçome groups, the 'basic needs' approach can lead to the àlleviation of poverty and development, ÈE·t i t can also unduly tin the favour of present against future consumption. Volunteer aid agencies have proved to be the most successful at actually brin; inG aid to poor people9 with a greater impact than their iess than 10%

of the aid effort suggests. They are therefore being increasingly utilized as aid vehicles by sorne donors. But the sèope of such a shift is limited.

•A

major expansion oÏ their effort could destroy .its effectiveness. In any cas~9 the ~ocial and inter~gen~rational

conflicts that equity questions pose are the proper business of the recipients and not of the givers. This is

lm

area where example serves better than exhortation~ social revolution.should begin at home.

The political implic~tions of aid ar~ inescapabie9 and to 'avoid-them donors have moved toward multilateral forms of ·aid

distribution. But mul ti1ateral ins_i!_tutions are also not f ree from -poli tics. To the-extent that a id !3rogrammes are mo t i vaté(!: by SBlf~,

interest~ countries try to impose limitations on multinational aid

organizations to which they contribute to prevent conflicts of interest with their own producers~ or to deny aid to countries whose politics

ii1~P3.0DUCTION/ 16-82 Page ~-9•

t

hey do

not l i

ke. A

nd w

h

ile

multilateral bû.reaucrac

ie

s may be

differ· ent

from national bureaucra.cies₉ ·

t

hey are bur

eau c

:.acies?

nevertheleos.

At its best b

ilater

a

l

and h~s

an i

mm

ediac

y,

conti- nui

ty of human contact

and quickness

of.

res

ponse

t

hat raul ti lateral agencies of

ten

lack.

Sorne

b

ilateral

p

ro

grammes have h

een ready to experiment,

but

others

have opted for prestige p

r

oj

ec,

;ts

t

o

demonstrate

pol

itical

support

for the

recipient~

.. ·- '1 ··

Poli ti cal

leverage

is· cl-early

· a faetor iri relations between

donors a,nd

-recipients,

often

. in· conJuction-w.i th ... -p:dvate _capital

flows and trade pclicies. At the

mar.:.gi.n .it. b.ecomes.

difficult to

identify

w

ha

t ai

d.is.

Thus a sigriifica.nt, t

hough poorly

documented

mili

tary aid effort

continues

t

o absorb

very larg e r

'

esources.

The

most

concentrated

and

largest

flows

of non-military aid have histo- riccally been

associated with militart

capital f

l

ows.

In the

1950s

such

aid

played

a

considerable role

in the rapid development of Taiwan

and

___

t

he Rer,rptllic of.

Korea,

__ b~t_ ï,n ~~~-_1960s _

it

_

con tributed t

o

the destruc.

tion. of

Vietnam,

_Çan;~_lH?g~ll.

and

Laos • .. ~h~ a~_tempts

to link aid with

human

ri

ghts illustrate th

e extreme

moral

confu sion

of

t

h

e

p

olitical m

otivation for aid.

What are human rights?

·How can lines

be

drawn beh

1

een countries

who se ci tizens

enjoy t

hem an

d

tho se whic

l-.

do

not? Does

it

~ake_

sense

to

deny aid to

people opp

ressed

by

tyrannical

governments? Do<ls

it

lm

ake sense

to

suppo rt

tyrannical governments by making

aid

availab

le

t-o

t

h

em?

_ T~e

many

conflicts,

new starts

·

and reverses in

t

rends t

het have

characteri:zed official flows

of ca-pital to deve

l

op

in

g

c

oun

tries

: :· 0 "•"• : · • ' ' • 0 ~ H... ^{ooO ' ... - 0 . 0 0 0 '}

reflect thü con

fu

sion of ai

d

lending

. A-id donors and often

even recipients turn t

h

ankfully to non-concessJ

onal market flovm.

(

b) Private

direct foreign

investment

... A

oon

j

nnction of f

actors -brought· toget.her an interest

in reviving

. ./

the flow

of direct irivestmè'ri.t' t~ ·th

é- former cololi-i.al

. and. semi-colonial

countries

in

thê

1950s. T~e large tians~ational

corporations were

emeiging from t

he

post-war reconstru

ciion ~ra and

l

ooking about th

em.