Relationship

between countries
at different levels
of development
 • Foreign aid: assistance given to developing economies on

forms of aid favourable terms.

A number of countries have requested aid from other countries,

often called foreign aid. Aid can take a number of forms.

It may be as a grant, a loan at reduced interest rate, technical

assistance or direct provision of goods and services.
Aid can be tied or untied, bilateral or multilateral.

Tied aid is aid that comes with conditions. For example, a grant may be
given provided that it is spent on buying products from the donor country.

Untied aid is aid given without conditions.

Bilateral aid is aid given by one country to another country.

In contrast, multilateral aid is aid given by countries to international

organisations such as the World Bank or United Nations (UN) agency, which
then distributes it to other countries.
Reasons for giving aid
Tied, bilateral aid may be given to promote the industries of the
donor country. A government may seek to increase the growth of an
infant industry by requiring the recipient country that receives the aid to
spend on products from its country.

For instance, the donor government may provide money for the recipient to buy tractors.
The donor government may insist that the recipient imports tractors from firms in the
donor’s country, even if cheaper or better-quality tractors are available from firms in other
countries.
Reasons for giving aid

Tied aid directly increases demand for the donor country’s exports, but

untied aid may also be given in the hope of increasing the donor
country’s exports. If aid does promote economic growth in the recipient
country, it is likely to result in the recipient country buying more imports.
The recipient country may be more inclined to buy from the donor
country’s industries if good relationships have built up as a result of the
aid giving.
Reasons for giving aid

A motive behind some bilateral aid is to gain political influence.

A recipient government may feel obliged to support the donor government

in its disputes with another country or countries. For instance, a donor

government may be imposing trade restrictions on another country and

may put pressure on the recipient country to do the same.

Reasons for giving aid

Both bilateral and multilateral aid may be given to influence the

economic policies of the recipient government. For example, a

government may give aid to another country on condition that it ends

the use of child labour or that it reduces its budget deficit.

Reasons for giving aid

Both bilateral and multilateral aid can be given for humanitarian

motives, that is out of a desire to do good. This may be the case with

crisis aid, that is aid given to save lives during natural disasters and

famines. Governments and international organisations can also

recognise that the development of other countries can increase global

GDP and international trade and reduce the risk of negative external

shocks.
The effects and importance of aid（benefits）

Aid can help the recipient country to experience increases in its income

per head and development. Aid can provide the investment, or the

finance, for education, healthcare and new industries that the recipient

country may be lacking.

The effects and importance of aid

Investment may not be easy for some low-income and middle-income

countries to achieve. This may be because of the lack of savings and the

lack of financial institutions to channel those savings that do exist from

lenders to entrepreneurs wanting to establish new firms and to expand

the output of existing firms. There may also be a shortage of

entrepreneurs.
The effects and importance of aid

However, if investment can be encouraged, a virtuous cycle

may be created as shown in Figure 52.3.
The effects and importance of aid

A number of countries rely heavily on aid. For example, in 2019, 40%

of Burundi’s income came from aid. Heavy reliance on aid can have a

number of disadvantages. Some forms of aid can result in countries

becoming increasingly indebted. In some cases, low- and middle income

countries transfer more money to high-income countries in terms of interest
on past loans (even if given on favourable terms) than they are currently
receiving in aid.
The effects and importance of aid
Advice given and policies suggested or imposed on low- and middle-
income economies by international organisations, such as the International
Monetary Fund (IMF) and the World Bank, are not always suitable given the
conditions in the low and middle-income countries. For example, it may not
be the best advice to recommend an economy use capital intensive
methods when it has a shortage of capital but lots of labour. In addition,
requiring a government to cut spending on primary education to cut a
budget deficit may harm an economy’s development and longer-term
economic growth prospects.
 The effects and importance of aid

Disadvantages on reliance of aid:

• Aid is often tied so that the receivers have to purchase overpriced and not always
suitable goods from the donors
• Most aid do not actually go to the poorest who most need it
Evaluation
• Aid requires a transparent and accountable government that remains focused on developing internal and
sustainable ways for the country to grow and develop without inducing an aid dependency model and long term
indebtedness issues
• Unofficial aid could in certain circumstances be better than official aid avoiding corrupt governments where aid
money will not be used for development purposes
Trade and investment

The governments of low-income countries and some middle-

income countries often argue for trade rather than aid. What they
are actually arguing for is trade on fair terms. There are several
reasons why international trade can act as an engine for growth.
It can improve supply conditions and can reduce costs,
which can lead to more efficient production as:
• economies of scale become possible because of the larger market

• the increased competition encourages domestic entrepreneurs to innovate and look for
new techniques of production

• trade leads to a transfer of skills and technology from high-income to low- and middle-
income economies

• specialisation and trade increases incomes and so provides the increased savings
which can be used for investment
Trade may also stimulate demand.

The expansion of production to cater for the export market may increase
employment. The result will be an expansion of spending power in the home
market that will create demand for domestic output.
Low-income countries have tended to specialise in primary products.

Those low-income and middle-income countries that have specialised in

agricultural products have been at a disadvantage in trading relations

since the prices of agricultural products have declined relative to the

prices of manufactured goods and services over time. This is for three

main reasons:
Trade and investment

1 The income elasticity of demand for primary products is low so that, as world incomes
have risen, there has been little extra demand for agricultural products and demand has
shifted to manufactured goods and services.

2 Producers of manufactured goods in high-income economies have an element of

monopoly power, which they have used to maintain high prices.

3 Subsidies provided to farmers in the USA and Europe put downward pressure on global
agricultural prices. For instance, it is claimed that US subsidies given to its cotton farmers
have deflated the global price and have given US cotton farmers an unfair competitive
advantage.
As trading patterns have been seen by some governments as

exploitative, a number of countries, such as Venezuela, have adopted

import substitution policies and attempted to diversify their economies.

They have tried to prevent imports of manufactured goods from high income
economies in order to develop their own manufacturing industries.

Others, such as the Philippines, have gone for export-led growth. Generally, the
secondary sector is becoming more important in low- and middle-income
economies and some are gaining comparative advantage in industries formerly
dominated by high-income economies.
Trade and investment

Investment flows between countries in search of profits, interest and

dividends. Many low-income and middle-income countries have a

deficit on the current account of their balance of payments. This

requires a surplus on the financial account to cover it and is a reason

why the governments of low-income and middle-income countries often

seek to attract direct and portfolio investment from other countries.

Trade and investment

Much investment initially went between high-income countries. More

recently, there has been an increase in investment in and from what are

sometimes referred to as emerging economies. These are economies

that have high rates of economic growth and are expected to have high

rates of return while, in some cases, carrying a greater risk than

investment in high-income countries.

In 2001, Jim O’Neill, an analyst working at an investment bank,
labelled four countries, Brazil, Russia, India and China as the BRICs.
He identified these countries as the ones with the greatest potential for
economic growth and the ones providing the best opportunities for
investment. The governments of the four countries now meet regularly.
In 2010, they were joined by the government of South Africa, so now
the term used is BRICS and it covers Brazil, Russia, India, China and
South Africa.
The BRICS, particularly China and India, are important investors in

other countries. For example, state-owned Chinese firms have invested

in infrastructure projects in Africa and Indian firms have invested in a

range of European countries.

 The role of multinational companies

A multinational company (MNC) is defined as a firm that operates in more

than one country. An MNC is a business with a parent company based

in one country but with production or service operations in at least one

other country. The largest MNCs are global operations, with

manufacturing and retail outlets in many countries of the world.

Examples of the largest MNCs include Apple, Huawei, Samsung, Tata,

Toyota and Unilever.

 The Role of Multinational Companies

• A multinational corporation (MNC) is defined as a firm

that operates in more than one country
• Through their activities, MNCs provide foreign direct
investment (FDI) to the economies in which they operate. This
is investment that is necessary to produce a good or service in a
foreign country.
– Foreign direct investment (FDI): the setting up of production units or the
purchase of existing production units in other countries.
Positive effects
– MNCs can bring in new technology, new ideas, can add to GDP and
exports and may generate employment
– Multinational firms may help improve infrastructure in the economy
– Multinational firms help to diversify the economy away from relying on
primary products and agriculture
The Role of Multinational Companies

– The inflows of capital help to finance a current account deficit

– The Harrod-Domar (savings and investment relationship) model of
growth suggests that this level of investment is important for
determining the level of economic growth.
Negative effects
– MNCs may not create higher employment and higher incomes if they
replace domestic firms
– they may deplete non-renewable resources and may create pollution.
– They may also send most of their profits back to their home countries
– may employ foreign rather than home labour, especially in the top-paid
jobs.
– Some of the products they sell may not improve people’s living
standards.
– MNCs put pressure on governments to pursue policies that are
beneficial to them but not the economies in which they are producing.
 MNCs may not create higher employment and higher incomes if they replace domestic firms

 they may deplete non renewable resources and may create pollution

 They may also send most of their profits back to their home countries

 may employ foreign rather than home labour, especially in the top-paid jobs

 Some of the products they sell may not improve people’s living standards.

 MNCs put pressure on governments to pursue policies that are beneficial to them but not the
economies in which they are producing.

 Their mobility and considerable economic powers mean that they often negotiate favourable tax
breaks and exemption from some environmental laws.

 A number also develop monopsony power and use this power to drive down the price they pay
to the host countries’ suppliers of raw materials.
Foreign direct investment
Through their activities, MNCs provide FDI to the countries in which
they operate. This is investment that is necessary to produce a good or
service in a foreign country. FDI, therefore, involves capital flows
between countries.
Low-income and some middle-income countries lack savings to finance
investment. Foreign direct investment can overcome this shortfall;
MNCs can purchase capital equipment and help to develop the
country’s infrastructure.
Foreign direct investment

Some countries attract large inward flows of FDI. These tend to be

countries that are expected to grow rapidly and so provide large markets

for the MNCs’ products or ones with low costs of production or

abundant supply of raw materials.

There is a range of measures that governments take to attract FDI.

These include low corporation tax, a good education system, few rules

and regulations for firms and government subsidies.

Foreign direct investment

Some countries attract large inward flows of FDI. These tend to be

countries that are expected to grow rapidly and so provide large markets

for the MNCs’ products or ones with low costs of production or

abundant supply of raw materials.

There is a range of measures that governments take to attract FDI.

These include low corporation tax, a good education system, few rules

and regulations for firms and government subsidies.

 The Causes and Consequences of
External Debt
• External debt includes loans which have not been repaid and interest payments on
loans which have not been made to foreign banks, foreign governments and
international organisations.
– For example, more than 40% of low-income countries are heavily indebted to other countries and
international organisations.
• There are four main reasons why countries get into debt. They include:
– The country has a structural current account deficit
– The country may have been overconfident in the value of loans it could repay
– The good use is not made of the funds borrowed
– A significant rise in external debt because of unexpected events can occur.
 The Causes and Consequences of
External Debt
The negative effects of external debts includes:
• External debt can be a major obstacle to future economic development repaying the
debt can divert funds away from improving the welfare of the population and
increasing the economy’s growth potential.
• A high level of external debt can make it difficult and expensive for a low-income
and middle-income countries to attract more funds for development.
• Some governments reduce their ability to borrow more in the future by defaulting
(refusing to pay) on past loans if avoiding cutting government spending is more
important.