THE WORLD BANK GROUP

A World Free of Poverty

Development Education Program
Beyond Economic Growth
left
eee
Entry Page
About this Book
How to Use the Book
Table of Contents
Glossary
Classification of Countries
Data Tables
Feedback
Order the Book



Chapters: Introduction I II III IV V VI VII VIII IX X XI XII XIII XIV XV XVI XVII

Chapter XIII. Foreign Aid and Foreign Investment

Question for Discusion Financial flows to developing countries take two main forms- aid that comes from foreign governments, often called official development assistance, and investment from foreign private companies, known as private capital flows.

Official Development Assistance

After World War II and until the early 1990s, the main source of external finance for developing countries was official development assistance provided by the governments of high-income countries in the form of food aid, emergency relief, technical assistance, peace-keeping efforts, and financing for construction projects. Donor countries are motivated by the desire to support their political allies and trade partners, to expand the markets for their exports, and to reduce poverty and military conflicts threatening international security. After the breakup of the Soviet Union, former centrally planned economies also started to receive official assistance, aimed primarily at supporting market reforms. Table 13.1 shows the amounts of net official assistance provided to developing and transition countries by the member countries of the Organization for Economic Cooperation and Development (OECD) in 1996.

Table 13.1
Net capital flows from OECD countries, 1996
(millions of US Dollars)
Country
Official assistance
Private capital flows
Total
Foreign direct investment
Portfolio investment
Total to developing countries
Total to transition countries
Total to developing countries
Total to transition countries
Total to developing countries
Total to transition countries
Total to developing countries
Total to transition countries
Australia
1 121
10
0
0
0
0
0
0
Austria
557
226
938
355
247
355
0
0
Belgium
913
70
4 528
4 109
461
169
4 194
4 007
Canada
1 795
181
1 959
3
2 024
0
-154
0
Denmark
1 722
120
188
248
199
248
0
0
Finland
408
57
472
146
257
194
162
-64
France
7 451
709
11 115
4 860
4 657
1 192
5 352
3 886
Germany
7 601
1 329
12 336
4 671
3 456
3 648
6 980
171
Ireland
179
1
125
0
0
0
125
0
Italy
2 416
294
289
218
457
153
1 642
706
Japan
9 439
184
27 469
1 928
8 573
1 315
19 981
1 652
Luxembourg
82
2
0
0
0
0
0
0
Netherlands
3 246
13
5 858
-36
6 225
45
-912
-78
New Zealand
122
0
9
0
9
0
0
0
Norway
1 311
50
294
-193
202
-201
0
0
Portugal
218
18
593
-4
482
3
0
0
Spain
1 251
2
2 865
-102
2 865
-102
0
0
Sweden
1 999
178
-17
-107
339
-84
0
0
Switzerland
1 026
97
395
705
1 316
705
-583
0
Great Britain
3 199
362
18 196
3 952
5 852
390
12 120
3 500
USA
9 377
1 694
42 848
2 652
23 430
2 226
19 472
578
Total
55 485
5 596
130 360
23 406
61 051
10 255
68 963
14 358

Note: Negative figures in the table indicate net outflow of capital to respective OECD countries. Total private capital flows in the table can be greater or smaller than the sum of foreign direct and portfolio investments because they also include smaller flows of capital such as private export credits, grants by nongovernmental institutions, and others.

On average, the donor countries in Table 13.1 spend about one-third of 1 percent of their combined gross domestic product (GDP) on official development assistance. Use Table 13.1 and Data Table 1 to calculate which countries spend larger and smaller shares of their GDP on such assistance.

Official assistance to developing and transition countries has three main components:

  • Grants, which do not have to be repaid.
  • Concessional loans, which have to be repaid but at lower interest rates and over longer periods than commercial bank loans.
  • Contributions to multilateral institutions promoting development, such as the United Nations, International Monetary Fund, World Bank, and regional development banks (Asian Development Bank, African Development Bank, Inter-American Development Bank).

Grants account for 95-100 percent of the official assistance of most donor countries. Most official assistance, however, comes in the form of "tied" aid, which requires recipients to purchase goods and services from the donor country or from a specified group of countries. Tying arrangements may prevent a recipient from misappropriating or mismanaging aid receipts, but they may also reduce the value of aid if the arrangements are motivated by a desire to benefit suppliers of certain countries and that may prevent recipients from buying at the lowest price. Official assistance can also be "tied up" by conditionalities- as happens with aid to transition countries. Because these conditionalities are linked to the speed of market reforms, rapidly reforming economies such as the Czech Republic and Poland receive more official assistance (relative to their population and GDP) than those which are less prepared to do so (see Data Table 3).

Private Capital Flows

While official assistance to developing countries hardly changed in the 1990s, net private capital flows to these countries roughly quadrupled between 1990 and 1994, far surpassing official flows (Figure 13.1). The structure of private flows also changed notably, shifting from a predominance of bank loans to foreign direct investment and portfolio investment (see Table 13.1). The share of foreign direct investment going to developing countries has risen to more than one-third of global foreign direct investment, driven by rapid growth of multinational corporations and encouraged by liberalization of markets and better prospects for economic growth in a number of developing countries.

Question for Discusion The developing world is becoming more integrated with global capital markets, but the level of integration varies widely from country to country. In 1990-94 about 90 percent of private capital flows to developing countries were concentrated in just 12 countries (Figure 13.2). For the distribution of foreign direct investment in 1996, see Data Table 3. At least half of all developing countries receive little or no foreign direct investment.

Because poor African countries tend to be the least attractive for foreign investors, the growth opportunities fed by foreign capital flows continue to pass them by. The effective exclusion of such countries from the globalization process may widen international disparities even further.

Question for Discusion The developing countries that attract the most private capital flows do so thanks to their favorable investment climate (business environment), which includes such elements as a stable political regime, good prospects for economic growth, easy convertibility of the national currency, and liberal government regulation. Higher foreign investment in these countries helps them break the vicious circle of poverty (see Chapter 6) without adding to their foreign debt. In addition, foreign direct investment usually brings with it advanced technologies, managerial and marketing skills, and easier access to export markets. The added competition between foreign and domestic companies also makes national markets more competitive and national economies more efficient.

The increased international mobility of capital has its risks, however. If private investors (foreign and domestic alike) suddenly lose confidence in a country's stability and growth prospects, they can move their capital out of the country much faster. In that respect portfolio investment is much more dangerous than foreign direct investment, because portfolio investors- who own only a small stock of shares in a company and have little or no influence on its management- are much more likely to try to get rid of these shares at the first sign or suspicion of falling profits. The East Asian financial crisis that started in 1997 is seen by some experts as an example of the negative implications of excessive capital mobility.

Private capital flows to the transition countries of Europe and Central Asia are often deterred by uncertainties about property rights, inflation, taxes, price controls, export and import regulations, and other aspects of the business environment. As a result private capital flows to these countries remain relatively small, accounting for only about 13 percent of the flows to developing countries in 1990-95. Moreover, the distribution of these flows has been highly uneven. Countries seen as more advanced in market reforms- the Czech and Slovak Republics, Hungary, and Poland-attracted almost three-quarters of foreign investment in this group of countries (see Data Table 3). The distribution of foreign direct investment among selected transition countries is also shown in Table 13.2.

Table 13.2
Foreign direct investment in selected transition countries, 1991-96
(millions of U.S. dollars)

Country
Armenia
Belarus
Kyrgyz
Republic
Uzbekistan
Albania
Bulgaria
Latvia
Slovenia
Slovak
Republic
Cumulative
flows
36
54
146
190
248
588
614
650
687
Country
Estonia
Ukraine
Romania
Kazakhstan
Poland
Russia
Czech
Republic
Hungary
China
Cumulative
flows
859
1,163
1,379
2,997
4,862
6,205
6,368
12,767
121,704

While some countries have managed to rely on foreign investment to alleviate the difficulties of the transition period, Russia- along with some other former Soviet Union countries- has suffered from significant, mostly illegal capital outflows. If the illegal outflows of the 1990s were reflected in statistics, the numbers for net capital flows to these countries would turn negative. According to some estimates, more than $110 billion in capital flowed out of Russia in 1993-97. The ongoing capital flight from Russia is the biggest obstacle to its economic development. This situation underscores the importance of creating a favorable investment climate, which is critical not only for attracting foreign investors but, even more important, for preventing and reversing domestic capital flight.






Chapters: Introduction I II III IV V VI VII VIII IX X XI XII XIII XIV XV XVI XVII







Copyright © 2000 The International Bank for Reconstruction and Development/The World Bank.
All rights Reserved.
Footer