Chapter 7 outline.docx

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Department
Political Science
Course
POL SCI 20
Professor
Leslie Johns
Semester
Spring

Description
World Politics Chapter 7 – International Financial Relations – Outline I. Introduction a. Within borrowing nations, there are many actors who value access to foreign funds i. However, there are others who resent the constraints and burdens that foreign investments sometimes impose on debtors ii. Similar conflicting interests exist within lending nations b. At the international level, both lenders and borrowers, like investors and recipients of investment, have a common interest in sustaining capital flows, which benefit both sides i. Nonetheless, they may enter into conflict- especially over how the benefits from the loans or investments will be divided c. Lenders and borrowers, and investors and recipients, bargain over the investments that tie them together i. There is frequent disagreement over debt payments to foreign creditors and profit payments to foreign corporations d. An array of important and influential international institutions structure interactions in the international financial realm i. The most prominent is the IMF, which has often played a major role in managing the problems of heavily indebted countries ii. Like international finance generally, the role of the IMF is very controversial: some analysts think it contributes to the cooperative resolution of financial problems, while others think that it takes unfair advantage of struggling debtor nations II. How and Why Do People Invest Overseas? a. Portfolio investments – investment in a foreign country via the purchase of stocks (equities), bonds, or other financial instruments i. Investors do not exercise managerial control of the foreign operation ii. Loans also fall into this category iii. Sovereign lending – loans from private financial institutions in one country to sovereign governments in other countries 1. Most common portfolio investment in developing countries b. Foreign direct investment (FDI) – investment in a foreign country via the acquisition of a local facility of the establishment of a new facility i. Direct investors maintain managerial control of foreign operation c. Why Invest Abroad? Why Borrow Abroad? i. Make money ii. Move capital to receive more profits iii. To developing countries: about half as direct investment and half in loans iv. Think of interest rate being the price of attaining capital 1. In poorer countries (capital scarce) capital is expensive with higher interest rates on loans v. If all assumptions about Hecksher-Ohlin were true, all capital would flow from capital rich to capital poor countries 1. However most international investment is amongst rich countries (only 10% goes to developing nations) 2. Lower risk with rich countries vi. Specific risk: foreign government may do things that reduce investments 1. Most relevant, loans to a foreign government 2. Promise cannot be enforced by some threat 3. Concerns for devaluing investment d. What’s the Problem with Foreign Investment? i. Mutual benefits can occur, or also costs for both sides ii. Interests in cooperation (higher profit, funds that could otherwise not be received) iii. Both sides want the most possible 1. Lenders want loans paid in full, corporations want highest profits possible, poor governments want to pay less than what they owe (bargaining) iv. Domestic interest and conflicts 1. Little opposition when money is flowing in 2. When lenders have to be repaid, taking a loan becomes a less popular option 3. Making debt payments may require raising taxes, austerity measures, increasing net exports 4. People who bear these sacrifices may not even experience benefits of foreign investment v. Some oppose the idea of money going abroad as oppose to being invested at home vi. Debt crises cause lending nations to spend a lot of resources in order to resolve the issue since the consequences can be very bad e. Concessional Finance i. Money is sometimes lent to developing countries by government agencies and intergovernmental organizations 1. Rich countries lend to poor countries 2. Interest rates applied are far below those in the marketplace 3. World Bank makes loans to poor countries with no interest added (many poor countries cannot afford loans from richer nations) ii. These loans are more like a form of aid iii. World Bank – an important international institution that provides loans at below-market interest rates to developing countries, typically to enable them to carry out development projects iv. Not very controversial since amounts at stake are relatively small III. Why Is International Finance Controversial? a. Who Wants to Borrow? Who Wants to Lend? i. Makes sense to borrow if funds are used productively in ways that increase output by more than what is required to repay the debt ii. Can be used to increase output directly through use of government natural resource iii. Indirect examples include public works projects iv. Developing countries are eager to borrow 1. Use borrowed money to speed growth and increase output v. Sovereign debts can quickly become burdens 1. Can result in unpopular measures such as tax hikes and budget cuts for spending 2. Increase interest rates, which: restrains wages, profits, consumption, and reduces imports 3. Recession – a sharp slowdown in the rate of economic growth and economic activity 4. Depression – a server downturn in the business cycle, typically associated with the major decline in economic activity, production, and investment; a sever contradiction of credit; and sustained high unemployment vi. Sources of payment difficulties 1. International conditions a. Say a loan is at a floating rate pertaining to a specific currency’s interest rate b. Say the country of that currency increases its interest rate to combat domestic inflation; result, higher rate on loan 2. Default – to fail to make payments on a debt a. Contending interests within a debtor country to default b. Those who may benefit from maintaining access to loans will disagree with defaulting 3. Creditor countries tend to support their lenders if all is relatively well a. Conflict arises when loans run into trouble b. Creditor commonly steps in with more money to help debtor out before serious crisis occurs c. Some are very critical of these “bail outs” labeling it as irresponsible d. Spending money on bailing out foreign nations can bring a lot of attention to domestic issues b. Debtor-Creditor Interactions i. Historically, countries that experience rapid growth start borrowing heavily 1. This has led to the immense development of countries like the US th 2. US defaulted multiple times in the 19 century 3. History of defaults explains why loans are reserved for the more successful less developed countries ii. Severe developmental difficulties and little reliable information is not appealing to investors iii. Sovereign lending comes with a problem of commitment 1. No enforcement if a government decides to renege 2. Creditors have a reason to consider a debtor defaulting, so they will not make a loan if they do not expect to be repaid 3. Borrower must make credible signs that it will repay a loan iv. While the threat of default is strong, creditors have tools too 1. Cut off debtor government from future lending 2. Freeze accounts or take government out properties 3. Other foreign policy strategies such as military threats v. Typically a bargaining solution exists short of defaulting or creditor retaliation vi. Incomplete information plays a big role 1. Statements of being able to or not being able to pay off a loan c. Institutions of International Finathe i. Attempts made in the 20 century to regulate debtor creditor relations ii. Bank for International Settlements – one of the oldest international financial organizations, created in 1930 whose members include the world’s principal central banks, and under its auspices they attempt to cooperate in the financial realm iii. The International Monetary Fund (IMF) 1. A major international economic institution that was established in 1944 to manage international monetary relations and that has gradually reoriented itself to focus on the international financial system, especially debt and currency crises 2. Countries with debt difficulties go to the IMF to determine a program of economic policies to address difficulty sources 3. Countries can receive inexpensive loans from the IMF for adhering to an agreed upon plan 4. IMF “certified” makes country more appealing to creditors 5. Methods of facilitation a. Set of financial and macroeconomic standards used to assess behavior of debtors b. Help verify debtors compliance with commitments c. Act on behalf of creditor nations 6. IMF negotiates directly with country’s government a. Closely tied between government and private international creditors 7. Opposition a. IMF is a tool of international financiers b. Biased agency who do little to assist debtor nations in achieving growth c. Serve as debt collectors for banks d. Recent Borrowing and Debt Crises i. Self-reinforcing trend 1. Lenders start worrying about rece
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