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Economic interactions and flows (8 hours)


Economic interactions 1

Financial flows – Examine the importance of loans, debt repayment, development aid, remittances, foreign direct investment and repatriation of profits in the transfer of capital between the developed core areas and the peripheries.

Examine the influence of governments, world trading organizations and financial institutions (such as the World Trade Organization, International Monetary Fund and World Bank) in the transfer of capital.

Labour flows – Explain the causes and effects of one major flow of labour between two countries.

Information flows – Explain the role of ICT in the growth of international outsourcing.

Financial flows

Historically, the movement of capital has been from the rich to the poor nations. However, this situation has been changing significantly over the last two decades with the advent of more globalised markets.

Transnational corporations and foreign direct investment

Major TNCs and FDI flows

Investment involves expenditure on a project in the expectation of financial (social) returns. Transnational corporations are the main source of foreign direct investment (FDI). TNCs invest to make profits and are the main driving force behind economic globalisation. They are capitalist enterprises that organise the production of goods and services in more than one country. As the rules regulating the movement of goods and investment have been relaxed in recent decades, TNCs have extended their global reach. As the growth of FDI has expanded, the source and the destination of that investment has become more and more diverse. FDI is not dominated by flows from core to periphery as it was 20 years ago. Investment flows from Newly Industrialised Countries (NIC) such as South Korea, Taiwan, China, India and Brazil have increased drastically.

TNCs have a substantial influence on the global economy and in the countries in which they choose to locate in particular.

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The impact of the recent global financial crisis is clear to see. Foreign direct investment has been the most important source of net capital flows throughout this time period.

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Repatriation of profits

Profit repatriation can be defined as ‘returning foreign earned profits back to the company’s home country’. E.g. when the Volkswagen Group earns profits anywhere in the world, it takes a share back home to Germany, after converting it into euros; this taking profit back home process is called profit repatriation.

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TNCs will want to repatriate a certain proportion of profits to justify the original reason for the investment. In addition, a host country can tax profits, but will still want to remain an attractive location for investment.

The repatriation of profits represents outflow of a host country’s limited foreign exchange resources and has a negative impact on the country’s balance of payments. The poorest countries are usually the worst hit.

Not all FDI is beneficial

It’s the quality not the quantity of FDI that brings benefits to a country. To bring benefits FDI needs to be channelled into productive rather than speculative activities. A large proportion of FDI is made up of companies:

  • Buying out state firms
  • Purchasing equity (share) in state firms
  • Financial merges or acquisitions

Over the last decade a large number of negotiated agreements have taken place which have brought about substantial gains for the companies but with little benefit for the regions or countries, these are: cross licencing of technology among corporations from different countries, joint ventures, secondary sourcing and cost cutting equity ownership.

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Members of All India Pragati Human Rights protesting against Foreign direct investment (FDI) in retail

In a memorandum submitted to the Governor’s office, they argued that small traders could hardly hope to compete with large corporations which have millions of dollars in investments. They said that despite their meagre investments, they are able to run sustainable businesses. “But the entry of mammoth corporations will destroy our businesses,” they said in the memorandum. (Taken from The Hindu)


Loan and debt repayments

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Many single out debt as the major problem for the world’s poorer nations. Many poor countries are paying back large amounts in debt repayments to banks, lending agencies and governments in developed countries while at the same time struggling to provide basic services for their populations.

Supporters of globalisation argue that economic growth through trade is the only answer, critics say that developed countries should do more to help the poorer countries through debt relief and by opening their markets to export from developing countries.

When a country has to use a high proportion of its income to service debt, this takes money away from what it could have been spent on education, health, housing, transport and other social and economic priorities.

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Loans can help countries to expand their economic activities and set up an upward spiral of development if used wisely.

Another theoretical billionaire was Mobutu Sese Seko, the former president of the Democratic Republic of Congo. Over his 30-year reign as ruler of the resource-rich Central African country, Sese Seko amassed a personal fortune estimated by various sources at $5 billion.  Experts believe virtually all of it was illicitly acquired from the nation’s coffers and stashed away in Swiss banks.

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Critics argue that banks frequently lent irresponsibly to governments know to be corrupt. Often such loans led to little tangible improvements in the quality of life for the majority of the population, but instead left them with long term debt.

In recent years much of the debt has been ‘rescheduled’ and new loans have been issued. However, the new loans have been given to poor countries with strict conditions known as structural adjustment programmes – SAPs. These include:

  • Agreeing to free trade – these open up their markets to intense foreign competition
  • Severe cuts in spending on public services like health and education
  • Privatisation of public companies.

Organisations like Oxfam have mounted campaigns to cancel debt.

Oxfam said the Zambian case showed that the initiative was failing, not just because it was too slow but because the amount of relief on offer was inadequate, leaving most countries still spending more on interest payments than on health or education.

Zambia has one of the world’s worst health records – life expectancy is falling and child malnutrition rising – but by 2002 it will be spending twice as much paying back western creditors as it will on basic health care.

“For a country whose human development indicators are deteriorating as rapidly as Zambia’s, this is devastating,” said Kevin Watkins, senior policy adviser at Oxfam.

Oxfam’s figures show that in six African countries – Mali, Burkino Faso, Tanzania, Mozambique, Zambia and Malawi – debt payments will outstrip spending on basic education even after the countries have graduated from the debt relief programme.


The Heavily Indebted Poor Countries (HIPC) initiative

The Heavily Indebted Poor Countries (HIPC) initiative was set up in 1996 by the World Bank and the IMF, to reduce poor countries’ debts.

What do countries have to do to complete HIPC?
When countries enter HIPC, a ‘Decision Point document’ sets out what they need to do to complete HIPC. Typically, these conditions will include measures to target poverty – but it also includes compliance with all kinds of economic policy conditions which can undermine poverty-reduction efforts. For instance, countries have to cut public spending, meaning fewer teachers or doctors; they are told to privatise basic services like water or electricity, meaning worse service and higher prices for the poor; or they are made to liberalise trade, leaving poor farmers and producers unable to compete with imports from the rich world.

32 countries so far. These countries are: Afghanistan, Benin, Bolivia, Burkina Faso, Burundi, Cameroon, Central African Republic, Republic of Congo, Democratic Republic of Congo, Ethiopia, Gambia, Ghana, Guinea Bissau, Guyana, Haiti, Honduras, Liberia, Madagascar, Malawi, Mali, Mauritania, Mozambique, Nicaragua, Niger, Rwanda, São Tomé and Príncipe, Senegal, Sierra Leone, Tanzania, Togo, Uganda, Zambia.

So, what is wrong with HIPC?

  • HIPC takes too long: more than 10 years for 32 countries so far.
  • HIPC offers far too little – total cancellation of all unpayable and unjust debt is needed.
  • HIPC is too limited – many more countries need and deserve debt cancellation.
  • HIPC comes with damaging and unfair strings attached.
  • HIPC does not include all debts: debts are only partially cancelled, and some countries, banks and companies refuse or fail to take part in the HIPC process at all.
  • HIPC is entirely controlled by creditors: they do not accept responsibility for their part in creating and maintaining the debt crisis, or allow poor countries to have a say.

Development aid

Aid is assistance in the form of grants or loans at below market rates. Official Development Assistance (ODA) is the second largest capital flow into developing countries behind FDI. In 1970, the world’s rich countries agreed to give 0.7% of their GNI (Gross National Income) as official international development aid, annually. Since that time, despite billions given each year, rich nations have rarely met their actual promised targets. For example, the US is often the largest donor in dollar terms, but ranks amongst the lowest in terms of meeting the stated 0.7% target. Most ODA goes to Africa and Asia.

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  • Official government aid – this is decided by the government of an individual country
  • Voluntaury aid – run by non-government organisations (NGOs) – Oxfam, ActionAid etc. NGOs collect money from individuals and organisations.

Official government aid can be divided into:

  • Bilateral aid – which is given directly from one country to another
  • Multilateral aid – which is provided by many countries and organisations by an international body such as the United Nations.

Critics argue that:

  • Aid fails to reach the poorest people
  • Foreign aid is tied to the purchase of goods and services from the donor country
  • Aid on large capital intensive projects may worsen the condition of the poorest
  • Aid may delay the introduction of reforms
  • Aid may can create a culture of dependency


When migrants send home part of their earnings in the form of either cash or goods to support their families, these transfers are known as workers’ or migrant remittances. They have been growing rapidly in the past few years and now represent the largest source of foreign income for many developing countries.

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It is hard to estimate the exact size of remittance flows because many transfers take place through unofficial channels. Worldwide, officially recorded international migrant remittances were projected to exceed $483 billion in 2011, with $351 billion flowing to developing countries.

New rivers of gold: Remittances from unlikely places are helping poor countries in the downturn

Last year Mexicans received an estimated $24 billion from friends and family working abroad, mainly in the United States, with which Mexico forms the world’s busiest remittance corridor (see map).

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The value of remittances to poor countries is enormous. Since 1996 they have been worth more than all overseas-development aid, and for most of the past decade more than private debt and portfolio equity inflows. In 2011 remittances to poor countries totalled $372 billion, according to the World Bank (total remittances, including to the rich world, came to $501 billion). That is not far off the total amount of foreign direct investment that flowed to poor countries. Given that cash is ferried home stuffed into socks as well as by wire transfer, the real total could be 50% higher.

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The influence of governments and major international institutions

Along with TNCs governments are major players in the global economy. The influence the transfer of capital to developing countries in a number of ways:

  • Tariffs, quotas and regulations with regard to imports from developing countries. Most development economists argue that trade is more important than aid and that developed countries should do more to open their markets to export from poorer nations. Sub-Saharan Africa is the poorest region of the world which is strongly linked to its very small share of world trade.
  • Only a small number of countries give the 0.7% of their GDP to ODA.
  • Taxation and regulations affecting the work of NGOs abroad. E.g. in the UK gift aid means that money given to charities is exempt from taxation.
  • The number of foreign workers allowed into a country. This is the main factor in the flow of remittances.
  • Taxation and regulations affecting investment abroad by companies and individuals.
  • Advocacy – some countries like the UK have been major advocates for the cancellation of debts of the world’s poorest countries.
Tariffs and quantative restrictions (commonly known as import quotas) both serve the purpose of controlling the number of foreign products that can enter the domestic market. A tariff is a tax on trade; a quota is a restriction on trade within a certain time or date.

Advocacy is action that aims to change laws, policies, practices and attitudes.

The International Monetary Fund (IMF) and the World Bank

The World Trade Organisation (WTO)

In 1947 the General Agreement on Tariffs and Trade (GATT) was set up. The objective of GATT was to gradually lower barriers to trade, with free trade as a conceptual objective. In 1995 the GATT was replaced by the World Trade Organisation they were given greater powers to arbitrate trade disputes. Since the establishment tariffs are a tenth of what they used to be and world trade has been increasing at a greater rate. The WTO exists to promote free trade. The fundamental issue is: does free trade benefit all those concerned or is it a subtle way in which the rich nations exploit their poorer counterparts?

The most vital element in the trade of any country is the terms in which it takes place. Many poor nations are primary product dependent – they rely on one or a small number of primary products to obtain foreign currency through export. The world market price for primary products are in general very low compared to manufactured goods and services. Also, the price of primary products is subject to considerable variation from year to year, making economic and social planning very difficult.

The World Trade Organization (WTO) is an international body whose purpose is to promote free trade by persuading countries to abolish import tariffs and other barriers. As such, it has become closely associated with globalisation.

The WTO is the only international agency overseeing the rules of international trade. It polices free trade agreements, settles trade disputes between governments and organises trade negotiations.

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WTO decisions are absolute and every member must abide by its rulings. So, when the US and the European Union are in dispute over bananas or beef, it is the WTO which acts as judge and jury. WTO members are empowered by the organisation to enforce its decisions by imposing trade sanctions against countries that have breached the rules.


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The WTO has been the focal point of criticism from people who are worried about the effects of free trade and economic globalisation. Opposition to the WTO centres on four main points:

Battle for Seattle: Violent protests disrupted WTO trade talks in 1999
  • WTO is too powerful, in that it can in effect compel sovereign states to change laws and regulations by declaring these to be in violation of free trade rules.
  • WTO is run by the rich for the rich and does not give significant weight to the problems of developing countries. For example, rich countries have not fully opened their markets to products from poor countries.
  • WTO is indifferent to the impact of free trade on workers’ rights, child labour, the environment and health.

• WTO lacks democratic accountability, in that its hearings on trade disputes are closed to the public and the media. (BBC)



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