Session 17
The Balance of Payments
Understanding the dynamics of balance of payments. The
political economy of balance of payments. The balance
of payments and the concepts of globalization,
dependence, dominance and comparative advantage.
Patterns of consumption and aggregate demand.
Prepare a short proposal for researching on the
following: "Comparative advantage, by prescribing that
developing nations continue to specialize in the
production of cash crops and raw materials, denies
developing nations the dynamic benefits of industry".
________________________________________________________________________
Concepts to build upon the logic of the interaction of
economic variables included in the balance of payment.
Aggregate demand, as defined by standard economic theory is an aggregate
of different types of consumption. At the most general level, it can
be described as follows:
PRIVATE CONSUMPTION: is the consumption of goods and services that
after being consumed, do not produce other goods
and services: food, housing, clothing, books,
newspapers, medicines, leisure, writing material,
are among essential goods and services.
If distribution of income in a particular society
is extremely polarized, private consumption will
be dominated by taste and needs of the wealthier
elites, probably consuming large amounts of
luxury-superflous goods and services.
INVESTMENT : that is, consumption of goods and services which
produce something else (other goods and services)
when transformed by human labour. Machinery and
raw materials are within this type of consumption.
In accordance with textbook economics, these goods
and services are called CAPITAL. By definition,
this type of consumption will be useful only if
connected to human labour.
GOVERNMENT SPENDING: Defense, law and order, institutions to collect
taxes from civil society, are the basic items of
expenditure. But, then, the government can have
an economic role, particularly if related to social
welfare. Therefore, organizing the supply of public
goods such as education, health, housing and income
for old people and deprived people, is another
economic role the government can have and can
contribute to economic growth through
subcontracting the building of schools, hospitals,
low-price houses, railroads, roads, bridges,
irrigation works, power generation units, etc.
FOREIGN TRADE : Foreign trade is composed of selling to foreigners
and buying from foreigners. Selling will provide
foreign currency to buy from foreigners. Therefore,
a general situation of equilibrium between exports
and imports will be thought as economically healthy.
Students must read also my notes on
Circular Flow of Income, and Theories of consumption
In general terms, less developed countries dedicate a very high
proportion of their domestic economies to foreign trade. Because of
historical reason -before becoming free nation-states the overwhelmingly
majority of these countries were colonies of Western European powers,
United States and Japan- less developed countries are producers of
raw materials and cash crops mainly to meet the needs of industrialized
countries. This "specialization" in accordance with the "comparative
advantage theory" is not a bad thing, actually is a very good thing,
because less developed countries can become industrialized exploiting
this relative advantage, selling raw materials and cash crops and buying
technology and modern machinery from industrialized societies.
Thus, foreign trade for third world countries is critical, and
therefore balance of payments behaviour will be at the center of any
study of the political economy of developing societies.
To make sense of the above, one can built a MODEL.
The following factors will affect the dynamics of balance of payments:
1)relative price between exports and imports. That is, relative prices
between prices of commodities (raw materials and cash crops, and
foodstuff) and manufactured goods (main imports by third world
countries.
2)net balance between foreign investments and remittance of profits,
depreciation and interest on these investments.
3)net balance between foreign investments for producing for the
domestic market and import of intermediate materials, technology and
spare parts.
4)net balance between long-term loans and payment of interest and
repayment of principal.
5)the aggregate effect of 1), 2), 3) and 4), if negative, will make
that type of foreign trade "unsustainable", and with that, the whole
process of growth for that particular society. If negative, the
theory of comparative advantage will be false.
If negative, the economy of this particular society will depend
structurally on external financing, on external markets, on external
industrial behaviour, and on external fluctuations in flows of money,
flows of capitals, and flows of goods and services.
By and large, central industrialized economies will dominate peripheral
dependent economies, and the process of "globalization" of production
in an environment of free-markets, free mobility of capital, and free
mobility of goods and services, will be in reality a process of further
dominant-dominated international relations. A further development of what
is called "economic imperialism", or, sometimes, neo-colonialism.
SOME EMPIRICAL FINDINGS.
Diverging prices for commodities and manufactured goods in the
international market during the process of globalization:
UNIT VALUE INDEX
of manufactures Petroleum Agriculture Metals and Fertilizers
exported by Minerals
France, Germany,
Japan, United Kingdom,
and United States
1965 100 100 100 100 100
1970 114 83 107 111 77
1975 205 767 190 143 405
1980 327 2683 329 257 331
1985 314 1983 238 189 228
1990 455 1667 238 270 256
1996 518 1483 298 241 308
Source: "Global Economic Prospects and the Developing Countries. 1997",
A World Bank Book, 1997
______________________________________________________________________
SUMMARY FOR FREE MARKET ECONOMIES WITH NEGATIVE TOP OF PAGE
NET FACTOR INCOME FROM ABROAD ($ MILLION -1992 PRICES)
------------------------------------------------------------------
1960-1992 1960-1975 1976-199
TOTAL -3065221.19 -672230.50 -2392990.70
PER Day -254.48 -115.11 -385.66
PER HOUR -10.60 -4.80 -16.07
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AFRICA/per hour -2.21 -2.01 -2.39
LATIN AMERICA/per hour -3.26 -1.52 -4.90
ASIA/per hour -1.79 -0.72 -2.79
INDUSTR>/per hour -3.35 -0.55 -5.98
------------------------------------------------------------------
Note: Six industrialized countries received more than 95% of the
above flow (United States, Switzerland, Japan, Germany,
Luxembourg and France)
===Source: World Bank Tables 1995===processed by Robinson Rojas===
______________________________________________________________________
BACK
LATIN AMERICA AND THE CARIBBEAN: INVESTMENT FINANCING
(Coefficients as a percentage of GDP)
1975 dollars 1980 dollars
---------------- ---------------------- -----
1950 1960 1966 1973 1970 1974 1982 1990
to to to to to to to to
1959 1965 1972 1979 1973 1981 1989 1997
----------------------------------------- -----
1.Gross domestic savings 22.7 25.4 25.7 24.1 26.1 23.1 23.9 21.0
2.Net factor payments
abroad 2.1 1.7 1.9 1.9 2.1 2.4 4.7 3.2
3.Terms-of-trade effect -0.8 -0.4 -3.4 0.4 -5.9 -1.1 -4.0 0.7
4.External savings 1.5 1.2 2.0 3.0 2.6 4.0 1.6 2.9
5.Gross domestic savings:
(1-2+3) 19.8 19.7 20.4 22.6 18.1 19.6 15.2 18.5
6.Gross domestic
investment:(4+5) 21.3 20.9 22.4 25.6 20.7 23.6 16.8 21.4
7.Net transfer of
resources abroad:
(4+3-2) -1.4 -4.5 -3.3 1.5 -5.4 0.5 -7.1 0.4
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GROSS DOMESTIC PRODUCT.- GROWTH RATES
1960- 1970- 1974- 1982-
1969 1973 1981 1988
--------------------------------
Industrialized countries 4.9 4.2 2.3 3.0
Latin America and the Caribbean 5.7 6.4 4.7 1.5
CONSUMER PRICE INDEXES
Industrialized countries 2.9 5.7 10.0 4.2
Latin America and the Caribbean 17.7 18.6 45.0 117.9
BALANCE OF PAYMENT ON
CURRENT ACCOUNT (US$ billion)
United States -5.8 1.8 -8.6 -152.5
Latin America and the Caribbean -4.5 -30.3 -41.6 -9.2
------------------------------------------------------------------------
source: CEPAL, "Postwar transfer of resources abroad by Latin America",
United Nations, 1992
________________________________________________________________________
THE BALANCE OF PAYMENTS ACCOUNTANCY:
1.Exports of goods and services
2.Imports of goods and services
3.Factor services
Profits
Interest received
Interest paid
Other
4.Private unrequited transfers
-------------------------------
BALANCE ON CURRENT ACCOUNT (1-2+3+4)
-------------------------------------------------------------------
5.Private unrequited transfers
6.Long-term capital
Direct investment
Portfolio investment
Other long-term capital
Official sector
Loans received
Amortizations
Commercial banks
Loans received
Amortizations
Other sectors
Loans received
Amortizations
------------------------------------------
BASIC BALANCE (1-2+3+4+5+6)
7.Short-term capital
Official sector
Commercial banks
Other sectors
8.Errors and omissions (net)
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BALANCE ON CAPITAL ACCOUNT (5+6+7+8)
TOTAL BALANCE (balance on current account + balance on capital account)
Total net transfer of resources:
equivalent to net inflow of capital, minus
net payments of profits and interests
Another way of looking at it:
credit plus foreign investment plus unrequited official,
where
credit is equivalent to the net inflow of long-term capital
(not including investment) and the inflow of
short-term capital (official and from commercial banks)
minus net payment of interest.
foreign investment is equivalent to direct and portfolio
investment less net payments of profits.
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BOX1____________________________________________________________________
THE MIRACLE OF THE MULTIPLICATION OF PROFIT
According to figures from the US Department of Trade, the average annual
return in US capital invested in Latin America in 1978 was 16 per cent.
Let us see what this means in practice. Let us take a company investing
$100 million in a Latin American country. Let us suppose that, out of
$16 million profit that it gains from this investment in the first year,
it sends home $10 million and ireinvests locally $6m. This pattern is
then repeated for the next seven years. Let us asee what this means.
($m)
Annual Registered Accummulated
Profit Remittance Reinvestment Capital Remittance
Year 1 16 10 6 100 10
Year 2 17 10 7 106 20
Year 3 19 12 7 113 32
Year 4 21 13 8 120 45
Year 5 22 14 8 128 59
Year 6 23 15 8 136 74
Year 7 25 15 10 144 89
Year 8 26 16 10 154 105
TOTAL 169 105 64 164 105
In Just eight years, the mother company has recovered its initial
investment of $100 million, and the capital invested in the Latin
American country has increased to $164 million. Is in this way that
US investments in Latin America were able to growth from $10 billion
in 1966 to $32 billion in 1978, with only a small part of this money
being effectively sent from the US to Latin America.
(from C. Branford/B. Kucinski, "The Debt Squads. The US, the Banks, and
Latin America", Zed Books, 1988)
---------------------------------
Year 9 28 16 12 164 121
Year 10 29 17 12 176 150
In ten years, profits remitted abroad are equivalent to 1.5 times
the original investment, and registered capital will be 1.76 times
the original amount.
END OF BOX 1____________________________________________________________
BOX2____________________________________________________________________
22. The performance of TNCs and their affiliates
(from The United Nations Library on Transnational Corporations, updated
by Dr. Robinson Rojas)
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21. TNCs and the Balance of Payments: the exchange gap
21.1 introduction
why, and under what conditions, should the impact of TNCs on
the balance of payments be of concern to host and home countries?
21.2 viewed form the host country's perspective
a) identifying the external transactions associated with FDI
i) capital account:
- initial inflow of foreign equity or loans, net of
imports of real assets (+)
- subsequent capital inflows (+)
- reinvested profits (+)
ii) Current account:
- imports of intermediate products and goods
for resale (-)
- exports of affiliates (+)
- profits and interest earned (-) royalties and
management fees (-)
iii) transactions of other forms associated with TNC
affiliates (even a good which is non-tradeable may
embody inputs which are tradeable)
b) attributing balance of payments transactions to TNCs
i) alternative models of estimating effects
ii) what would happen in absence of TNCs (the counter
factual situation): making direct comparisons with
balance of payments transaction of non TNCs
iii) indirect effects of FDI on other firms
c) the relevance of host country macro-economic policies in
evaluating contribution of TNCs to balance of payments
objectives of host countries
21.3 variables affecting impact of TNCs on balance of payments
a) according to type of TNC affiliate activity, e.g. resource
based, import substituting manufacturing, export processing,
service, etc.
b) according to TNC specific characteristics (e.g. age, size,
strategy, control exercised on sourcing and export markets,
etc.)
c) according to policies pursued by host governments;
cf. Singapore with India, Mexico with Thailand, etc.
21.4 Do TNC affiliates export/import more than indigeneous firms in
developing countries?
The evidence is mixed, but, on balance, TNCs affiliates
export about the same or marginally more than their domestic
competitors; but they also import more. Clearly there are country,
industry and firm specific characteristics which are as, if not
more, important than the nationality of ownership in influencing
balance of payments effects
21.5 intra firm trade flows
a) the components of intra-firm trade e.g. foodstuffs and raw
materials, components and parts, finished goods, services,
second hand equipment, machinery etc.
(Casson, M.C. and Pearce, R.D., MULTINATIONALS AND ECONOMIC
DEVELOPMENT: A SURVEY, University of Reading, mimeo, 1986)
b) the significance intra-firm trade in TNC transactions
c) the propensity of TNCs to engage in intra firm trade
i) type of TNC activity; composition of final output
ii) extent of 'roundaboutness' of production and degree
of horizontal and vertical integration
iii) propensity of TNCs to engage in trade
iv) propensity of TNCs to internalise intermediate product
markets
v) country-specific variables
d) the likely effects of intra-firm trade on the host countries
balance of payments
21.6 a home country perspective
------------------------------------------------------------------------
Lall, S. and Streeten, P., FOREIGN INVESTMENTS, TRANSNATIONALS AND
DEVELOPING COUNTRIES, London: Macmillan, 1977
Helleiner, G.K., INTRA FIRM TRADE AND DEVELOPING COUNTRIES,
London: Macmillan, 1981
Nayyar, D., "Transnational corporations and manufacturing exports for
poor countries, ECONOMIC JOURNAL, 88, March 1978
Dunning, J.H., INTERNATIONAL PRODUCTION AND THE MULTINATIONAL
ENTERPRISE, London: Allen and Unwin, 1981 Ch II
UNCTC(1985b)
Kirkpatrick, C.H. and Nixson, F.I., THE INDUSTRIALISATION OF LESS
DEVELOPED COUNTRIES, Manchester University Press, 1983
------------------------------------------------------------------------
22. The performance of TNCs and their affiliates
22.1 introduction
a) the choice of which intermediate or final goods and services
to produce (allocative efficiency)
b) efficiency in use of resources (technical and scale
efficiency)
c) private and social criteria for assessing 'performance'
22.2 the performance of TNCs as a whole
a) growth and profitability of TNCs vs other firms
b) variations of performance among TNCs
c) the relevance of industry and countr-specific variables
d) data problems
i) lack of standardized accounting procedures
ii) judge performance in different ways cf. Japanese with
US firms
iii) firms differ in the calculation of costs and revenues;
and use of 'discretionary' profits
iv) profits may be affected by intra-firm transfer pricing
practices
v) difficulties associated with foreign exchange conversion
vi) difficulties associated with price distortions of both
inputs and outputs
22.3 the technical efficiency of foreign affiliates
a) measurement techniques
i) the structure-conduct-performance (SCP) paradigm
ii) optimum use of factor resources
iii) productivity, profitability and market share indices;
the 'pyramid' of performance ratios
iv) other performance indices
b) empirical evidence of performance of TNC affiliates;
problems associated with deriving a meaningful measure of
efficiency
c) private and social efficiency: what governments may do to
increase the social efficiency of TNC affiliates
22.4 the choice of sectors in which TNCs invest
a) what types of sectors do TNC invest in cf indigeneous firms;
e.g. are they more (or less) growth, (net) export,
productivity, R and D intensive etc. oriented
b) how do TNCs which promote global strategies allocate
resources among affiliates
c) individual country or industry case studies (see especially
Dunning, J.H., and Pearce, R.D. (eds.), THE WORLD'S LARGEST
INDUSTRIAL ENTERPRISES: 1962-83, Farnborough: Gower, 1985)
-----------------------------------------------------------------------
Lall, S., "Transnationals, domestic enterprises and the industrial
structure in host LDCs: a survey", OXFORD ECONOMIC PAPERS, 30,
No. 2, 1978
Sosin, K. and Fairchild, L., "Capital intensity and export propensity
in some Latin American countries", OXFORD BULLETIN OF ECONOMICS AND
STATISTICS, 49, 1987
Lecraw, D.J., "Choice of technology in low wage countries: a new
classical approach", QUARTERLY JOURNAL OF ECONOMICS, November 1979
Caves, R.E., MULTINATIONAL ENTERPRISE AND ECONOMIC ANALYSIS,
Cambridge: Cambridge University Press, 1982
Chudnovsky, D., EMPRESAS MULTINACIONALES Y GANANCIAS MONOPOLICAS EN
UNA ECONOMIA LATINOAMERICANA, Buenos Aires: Siglo XXI Editores, 1974
Stopford and Dunning(1983)
UNCTC, TOWARDS INTERNATIONAL STANDARDIZATION OF CORPORATE ACCOUNTING
AND REPORTING, New York: UN E82 II A.3, 1982
------------------------------------------------------------------------
--RRojas Research Unit/1998
---------------------------
"I'll be the judge. I'll be jury", said cunning old Fury: "I'll try
the whole cause, and condemn you to death",
Lewis Carroll, ALICE's ADVENTURES IN WONDERLAND
------------------------------------------------------------------------
END OF BOX 2____________________________________________________________
TECHNICAL NOTE:
Standard Industrial Classification (SIC) of the United Nations:
1.- Agriculture, hunting, forestry, and fishing
2.- Mining and quarrying
3.- Manufacturing
4.- Electricity, gas and water
5.- Construction
6.- Wholesale and retail trade, restaurants, and hotels
7.- Transport, storage, and communications
8.- Financing, insurance, real estate, and business services
9.- Community, social and personal services
(Sectors 1, 2 and 3 are typically the most tradable)
Standard classification of Non Tradables and Tradables:
NON TRADABLES:
Construction and public works
Residential rent
Government services
Personal Services
TRADABLES (other than raw materials and cash crops):
Textiles, clothing and leather
Paper and printing
Refined petroleum products
Chemicals and rubber
Manufactures of metals
Transport materials
Machinery and equipment
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