Chapter 7 International Finance Chapter 7 International Finance Lecture Notes International Financial Relations I International Finance 10 24 2011 a Every year trillions of dollars are loaned across borders b The U S is 4 5 trillion dollars in debt to other countries January 2011 c China holds about 36 of foreign owed U S debt II Factor Flows out of its economy III Types of Capital Flows a Trade in goods and factor flows across national borders are near perfect substitutes b Comparative Advantage countries should permit free flows of capital or labor into or a Portfolio Investment b Loans and bonds provide income to lender c No control over the assets of the borrower d Is simply a loan of money a student loan is a portfolio investment IV Foreign Direct Investment FDI a Investor acquires real assets facilities in a foreign country V Concessional Finance a Money lent at market rates b Why Invest Why Borrow c d Borrowers increase productivity of other factors of production especially labor e Productivity should generate enough wealth to pay back investors with interest Investors earn higher rates of return on their money VI How Should Factors of Production Flow a Factor flows determined by relative factor abundance b Capital flows from abundant rich to scarce poor countries c Labor flows from abundant poor to scarce rich countries VII VIII The Political Economy of Capital Flows How should Capital Flow If Heckscher Ohlin works all foreign investment should be in poor countries a b But only 10 of investment goes to developing countries c This is because the investment is risky IX Costs and Benefits of Investment 10 26 2011 a Debt can be used to increase development and productivity b As national output rises tax revenue increases making it easier to pay off debts c But governments often impose unpopular measures to pay off loans d Cut spending raise taxes hike interest rates which restrains wages profits and consumption e This may cause a recession or even a depression f Benefits and costs of foreign investment do not equally affect every citizen i Example bailing out Wall Street at the expense of Main Street 1 Risk and Foreign Investment 2 Without system for enforcement high risk of default on loans 3 Higher risk means less capital flows to developing countries or flows of higher rate of interest 4 To attract investment risk must be managed X How is Risk Managed a Repeated lending b Default may shut borrowing countries out of international financial markets c Force of punishment for default d e Rules and institutions also help manage risk f Makes creditors and borrowers both better off g International Monetary Fund oversees international lending Institutions of International Finance XI How Does IMF Work a Short term lending to help with balance of payments b Long term loans to help with structural weakness c Loans often come with conditions i Conditionality stabilization agreement XII IMF Controversy 1 These agreements often require governments to reduce spending a Cutting government spending can result in cuts to vital programs b These cuts affect the poorest citizens in a country c d The IMF is criticized as being biased towards lenders e But reducing risk of default permits more loans to be made at lower rates IMF stabilization agreements often lead to domestic protests XIII US and IMG a The US s current investment with IMF is 42 billion i Leads to 17 2 of the voting share ii 85 of votes needed to pass a major decision XIV MNC and Foreign Direct Investment a MNC s invest in other countries to gain access to their market and resources b Foreign managerial technological and marketing skills as well as investment capital c Yet MNCs often attract controversy d Host counties complain about MNC s e Investing countries blame MCS for not thinking locally XV International Institutions and the FDI a There isn t a global institution that regulates FSI b Most regulation occurs through bilateral investment treaties XVI International migration a People as well as money can flow cross borders i In the 1800s and early 1900s international labor migration rates were much higher than they are today XVII XVIII Inflow of unskilled labor from abroad reduces the wage of low skilled workers Benefits of immigration a Employers gain from lower wages b A larger labor force and lower cost of production 1 What is the International Monetary Fund An international organization that addresses financial crises 2 How does the Heckscher Olin theory explain increasing investment in emerging markets Loans are made to countries where capital is scarce 3 Which of the following is an example of foreign direct investment Firestone builds a plant in Liberia 4 Which company opened production in Costa Rica in 1997 Intel 5 What sparked the 1997 East Asian financial crisis The insolvency of a large bank in Thailand 6 What did the IMF advise Indonesia to do during the 1997 Asian financial crisis Cut subsidies 7 Which country had the most international migrants in 2005 The United States 8 What does it mean to default Failing to repay a loan 9 Which of the following most contributed to the 2008 financial crisis in the United States Heavy borrowing to finance the government s deficit 10 Which of the following statements regarding labor movement patterns is most accurate Unskilled workers are attracted to developed countries 11 What is the World Bank An organization that engages in concessional finance 12 Which developing countries have the most debt Brazil Mexico and Argentina 13 Which company supported attempts to overthrow President Allende of Chile International Telephone and Telegraph 14 What are portfolio investments Situations where investors do not directly manage their investment 15 What region experienced a debt crisis beginning in 1982 Latin America 16 How is most foreign direct investment regulated By bilateral treaties 17 Why do corporations become multinational To avoid trade barriers To employ labor more cheaply To take advantage of local resources 18 Where does most foreign investment occur Advanced economies 19 In 2004 approximately how many dollars were invested in emerging markets 20 Approximately what percentage of foreign investment goes to the developing world 4 trillion Ten Chapter 8 International Monetary Policy Chapter 8 Lecture Notes I Argentina example a 10 31 2011 In December 2011 Argentina experienced nationwide riots because the government had frozen private bank accounts b The argentine government
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