4. Two types of
investment
1. Portfolio investment
Sovereign lending
Corporate investment
2. Foreign direct investment (FDI)
5. Definitions:
Portfolio Investment:
Gives the investor a claim on income
but no role in managing the
investment
Foreign Direct Investment (FDI):
Ownership of productive assets by
foreign residents for purposes of
controlling uses of those assets.
8. • Capital: A certain amount of debt isn’t a bad thing.
You have to “spend money to earn money”
Improves productivity of other factors and increases tax revenue
Examples: rise of US, Canada, Australia, Brazil, South Korea, etc.
• But there is a downside: risk of not being able to pay
the debt
9. • Who invests?
Banks, countries, international organizations
• Why?
To earn profits. In a capital-scarce country, you can charge high
interest.
To diversify portfolio
To stabilize the international economy (IMF, World Bank)
10. Where to invest abroad?
Which types of countries do you think are the most
attractive to investors? Explain WHY.
• High income countries (UK, Canada)
• Middle income countries (Indonesia, Colombia)
• Low income countries (Somalia, Tajikistan)
11. Where to invest abroad?
• High income countries – safer investment but lower interest rate
• Middle income countries – riskier and higher interest rates
• Low income countries – very risky, but important for the global
economy
15. 1. Cross-border investment can improve welfare in both countries
2. But financial ties can also make societies mutually vulnerable
16. What if a debtor
can’t pay?
• Creditors don’t
want debtors to
default on their
loans, but they
want to be paid
• Discussion: If you
were a bank, how
would you get a
foreign country to
“pay up”?
17. Creditor
responses to a
default
1. Withhold future lending
2. Convince home government
to apply political pressure
Sanctions
Reduction in foreign aid
Military invasion/colonialism
18. What causes
countries to default?
• Domestic economic crises
• International economic crises
that spill over
• Hostile governments
19. • Sovereign debt renegotiation
• Austerity measures: “Tightening your belt”
Lower spending
Increased taxes
• International involvement (IMF)
20. The problem
with austerity
Often results in strong
domestic opposition
Distributional consequences
“Big banks got us in trouble and
now the people need to foot the bill!”
26. Latin American Debt Crisis (1982 –
1990)
• 1982 Mexico defaults on sovereign debt.
• Banks panic about other LA borrowers.
• Result: downward economic spiral.
1983: economic collapse in Latin America.
27. Asian Debt Crisis (1997-1998)
• Economic downturn in the “Asian Tiger”
countries.
• Connected to default by
Russia in 1998,
Brazil 1998-1999
Argentina in 2000.
28. The Global Financial Crisis (2008)
• Irresponsible mortgage loans.
• Led to domestic and international economic collapse.
• Result: Massive bailout, along with protests.
30. Effect of financial
integration
• All countries in the world are highly
dependent on whether OTHER
countries pay their debts.
• For example, US banks who invest in
other countries face big losses if these
countries default, which destabilizes
the US financial system.
32. The basic premise:
• International investment lifts all ships (similar to the WTO
philosophy about trade)
• But collective action problems between countries prevent
investment
• An international institution can facilitate investment abroad
33. Institutional Structure
• Each country contributes a “quota” to a joint pot of money that
can be used to stabilize the international financial system.
• Current quotas: $650 billion, (up to $1 trillion more in times of
crisis)
• The IMF includes all countries, but votes and agenda-setting
power are proportional to financial contribution
34. Actions
• Loans money in exchange for certain “conditions” that
decrease the risk of default. Certifies compliance with
conditions
• Mediates negotiations between creditors and debtors
• Traditionally focuses on developing countries, except for in
times of crisis (e.g. 2008)
35. Benefits
• An international institution with actual “teeth.” Loans directly
to countries
• Provides the “very low income” countries access to capital
• Brings stability to a very volatile system
36. Controversies
• Some argue it disproportionately
benefits the powerful countries that
contribute higher quotas
• Has not prevented crises
• “Conditions” are austerity
measures that many argue hurt the
poor while benefiting lenders
37. World Bank
• Provides “Concessional Finance” – Very
low/ Zero interest loans
Even this can create a burden of debt
• Invests in development projects
Economic infrastructure (power plants, dams,
highways)
Social infrastructure (schools, housing)
• Regional counterparts (e.g. Asian
Development Bank)
38. Two types of
investment
1. Portfolio investment
Sovereign lending
Corporate investment
2. Foreign direct investment (FDI)
39. Foreign Direct Investment
• FDI is carried out by Multi-National Corporations (MNCs)
• Multinational corporation (MNC): A firm that controls
and manages productive facilities in two or more countries.
Incorporate in one country (the “home country”) and
maintain productive operations in other countries (“host
countries”)
41. Vertical
FDI
When a MNC owns and
controls different stages
of a worldwide
production process (i.e.,
own the supply chain)
42. Why do MNCs invest
in production abroad?
• Local resources
• High access to labor
• Friendly regulatory environment
• Avoid tariffs on international trade
43. Why do countries seek it?
• Less risky than loans
• Creates Jobs
• Generates “human capital”
45. Why do some oppose it?
• People at home are opposed to “outsourcing”
• Facilitates poor environmental and human rights practices,
supports dictators
• Local companies are pushed out, prevents the generation of
high-skill labor
46. Regulation
• Virtually no regulations by international institutions
• Bilateral Investment Treaties (BITs)
47. Human Migration
• Predicted by H-O model of trade: Countries
with a high number of unskilled workers will
“export” unskilled workers.
• Creates similar patterns of employment as
MNCs
• Stolper-Samuelson prediction about support
or opposition to free trade also holds for
migration
48. Summing
Up, Part 1
•Some benefit from access to
foreign funds.
•Others resent the constraints
and burdens imposed by
foreign investors.
Within nations:
•Creditors and debtors can
conflict.
Internationally:
49. Summing
Up, Part 2
International institutions can structure
interaction but their role (e.g., IMF) can
be quite controversial.
Each party seeks a better deal.
Lenders, borrowers, investors, and
recipients all bargain over debt
repayments and over profits for MNCs.
50. Exam 2
• During class: 10:10-11:00am on Friday 10/30.
• Proctored through Honorlock- access through Honorlock tab.
• Four short answer (10 points each), 30 multiple choice (2 points each).
• Practice questions are available on Canvas.
