ECN 115BY Final Study Guide

import substitution

make the product domestically instead of buying it abroad execution: 1. high tariffs on imports and low quotas 2. manipulate currency (overvalue exchange rate to get inputs of production) --> inputs get cheaper Results/Problem: 1. high tariffs --> inefficient for domestic firms; stick around for a long time 2. artificially overvalued exchange rate --> less demand for developing country's exports

Remittances

money sent home to a developing country from a family member or friend who has moved to a developed country Trends: - used for food, housing, and educating young people in the family - stable source of income (money keeps flowing)

capital account

net flow of financial capital Calculations: + direct private investment + net foreign loans - increases in foreign assets of domestic banks - resident capital outflow if neg. --> deficit if pos. --> surplus

current account

net flow of merchandise Calculation: + exports - imports - debt service payments (how much from the interest you need to pay back) + net remittances and transfers if neg. --> deficit if pos. --> surplus

Has the application of the Solow model to developing economies worked?

not really: - machinery not scarce enough in poor countries to explain the difference in income - diminishing returns to capital - tech (or knowledge) spillover is easy to spread

unofficial aid

private voluntary assistance; includes grants from non-gov't org., religious groups, charities, foundations and private companies advantages - avoid neg association with foreign gov't disadvantage: official aid is much bigger, they have more money to offer

official development aid

provided by donor gov't to low- and middle-income countries

How does domestication of animals earn more calories than hunting?

provides a stable amount of food rather than having to hunt for wild animals with no guarantee

Know the conditions under which export promotion will work well or will fail.

right institutions (gov't), good forecasting, self-analysis

What are the main differences in sedentary and hunter/gatherer lifestyles?

sedentary: no need to hunt for food and waste calories in hunting; start eating wild grains which could provide enough calories from early food production; food production increase birth rates and also be able to specialize --> growth

subsidies

tax relief or dollars given to promote a behavior

What is the key to long-run growth in the Solow Model?

technology

What would this model of comparative advantage advise a developing country to do, why? (Would we imagine that they would completely specialize in one good or another?)

tell countries to specialize in something with the least opportunity cost

Know the big problem that Agenor and Aizenman (2008) have with foreign aid and the implications for its efficiency?

the amount of aid promised to a developing country had no relationship with the actual aid that the developing country would get Case 1: some project managers only make a plan to do small project --> donors believe there is no need for high amounts of money and stop making promises Case 2: some projects are left half done because the promised money does not come

Know the definition of a Malthusian trap.

the health of the economy is determined by birth and death rate trap because of cycle: birth rate --> productivity increases --> more births --> living conditions decrease --> death rates increase

Managing Crisis: Structural Adjustments/Paris Club Arrangements (stabilization policies)

to stabilize currency: - import controls - devalue official exchange rates - raise interest rate and reserve requirements - cut gov't spending - increase taxes - abolish wage indexes - offer great hospitality to trade and foreign investment

Be prepared to discuss the advantage of trade in the form of shared ideas and technology.

trade --> meet other countries --> learn and innovate --> tech spillover idea

export platform

type of vertical FDI; exists when all the parts used in production are shipped to a developing country, the low wage workforce assembles the product and then ships out to the market directly

What types of aid are more valuable and why?

unofficial aid over official aid because 1. connect closer to communities, get better reception, no neg. association 2. flexible; connect at a local level more efficiently 3. recruit with fewer restrictions (experts, volunteers, and highly motivated staffs)

export promotion

use trade to access large international market Execution: 1. choose carefully goods you believe will be in demand in the world 2. subsidize domestic products 3. as export markets become too profitable, gov't not needed Result: some countries face problems with gov't being too easy with their lending to these firms, but overall very successful

Know the brief history of China that was presented in class.

- 1405-1433: Zheng He led the Chinese fleet of ocean vessels the most advanced - 1434: Ming Emporer close China to international trade - 1839: Qing Dynasty; China attacked by Great Britain in the opium wars which forced China to open trade - 1898: attempt at Capitalist Reform - 1911: Qing dynasty collapsed - 1937: Japan invaded Chinese Mainland - 1949: The People's Republic of China was established by Mao Tse-Tung

Aitken and Harrison (1999) of Venezuelan firms

- 1976-1989: Venezuelan firm level looked at how much tech spillover there was - found that joint ventures produce significant tech spillovers to the domestic market - found that domestic competitors of the multinational firm faced higher costs after the multinational firm moved in --> market stealing effect; smaller market for domestic firms

What was the process of the spread of industrialization?

- Britain --> Colonies (North America, Australia, New Zealand): similar climates, easy transfer of tech, and locals were pushed out or killed - Northwestern Europe to Southeastern Europe: began where climate, natural resources, disease environment, political and social condition were more favorable; spread quickly after serfdom, constitutional gov was introduced, railways facilitated transfer - Latin America, Africa, and Asia: rich, powerful European powers exploited poorer and less powerful regions; increased living standards came at a cost (war, domination or enslavement of native people to the region, loss to native language and culture in some regions)

Mishkin's 4th Stage: Twin Crisis

- countries with a history of inflation and default have loans (short term and in foreign currency) --> interest rate rise and currency falls --> firms are wiped out - bankruptcies in countries - inflation surges as currency tumbles - deep recession - spreads to neighboring countries

Why have we seen a transition from hunting and gathering to food production?

- decline in availability of wild food (Extinction of large mammals) --> end of Pleistocene - availability of domesticable wild plants with climate change - development of tech for collecting, processing, and storing wild foods - autocalytic process of increased food production and increase pop. - food producers became numerous, could kill or drive off hunter-gatherers

Mishkin's 1st stage: Financial LIberalization

- developing countries with loose banking system open their banks to foreign lending --> banks can now borrow abroad - liberalizing a rotton banking system - mounting losses --> cutbacks in lending --> bank failures

Know the dangers of having a currency that is unstable. (exchange rate fluctuations and having a lender of last resort)

- exchange rate can fluctuate - lender of last resort is central bank

IMF

- founded in 1944 - goal: stabilize currency

World Bank

- founded in 1944 - intended to finance the reconstruction of Europe after WWII - today: lends money to middle-income countries at market rates for projects

World Trade Organization (WTO)

- founded in 1949 where industrialized countries agreed to dismantle most of their trade barriers

What were the factors that set up the developing countries for disaster between 1974 and 1979?

- high import bills - commodity prices rose slower than manufactured goods --> exports low --> borrow loans to make up for the falling exports - debt was dollar denominated - increase in long term concessional borrowing - increase in short term nonconcessional/commercial borrowing

How can a country attract FDI?

- high import tariff - low taxes - labor cost low - large, untapped consumers (HFDI)

Mishkin's 2nd stage: Run Up To a Currency Crisis

- higher interest rate abroad undermine credit quality --> decrease cash flow, investment, and economic activity - borrowing more expensive now - companies begin to fail --> more panic

Case Study of Rwanda

- huge destruction from genocide --> growth was -50% - received aid from ODA to help with health and human pop (HIV, AIDS, malaria), infrastructure, and education Problems: - 40% of budget is ODA - suspension of aid in 2012 as a result of Rwanda gov't supporting rebel groups in Congo - 2013: aid resumed with restrictions - 2014: Belgium revoked aid because of media and political freedom violations (violated the aid)

What were the keys to China's successful reforms?

- low cost labor - modern tech - ample capital - safe and sound business environment

The Debt Crisis: 1979 Second Oil Shock

- oil prices increased again --> import bills increased with higher transportation costs - decrease in exports earnings as rich countries struggled - developed countries increase interest rates to support the long-run growth (r > d) --> harder for developing countries to pay back their loans

Te Debt Crisis: 1974 First Oil Shock

- oil prices led to significant loans bc cost of production increased - import bills more expensive for developing countries - borrowed from OPEC to make up for falling exports (d > r)

What was special about "Britain" that made it important for the industrial revolution?

- openness of trade and ideas - socially mobile - region of political liberty - one of the centers of scientific revolution - geographically blessed: island economy, close to European continent, navigable rivers, good climate and dirt for ag., proximity to North America, lesser risk of invasion, coal for powerful industrial revolution

Mishkin's 3rd stage: Currency Crisis

- residents and foreign speculators start to see the currency; currency dump - previous stage left to turmoil so lenders stop lending - Hobson's Choice

What rules were imposed by the British after the Opium Wars of 1839? What impact did this eventually have on the Ching Dynasty?

- traded opium for tea - opening of additional ports to unrestricted foreign trade - fixed tariffs - recognition of both countries as equal in correspondence - cession of Hong Kong to Britain - social upheaving --> Taiping Rebellion

What are the various ways that economic development has been quantified?

- traditional approach: using increase in GNI at rates of 5%-7% or more annually - GNI per capita: see if income growth is keeping up with pop growth - correlated GDP: income is added/subtracted depending on people's willingness to pay for an alt. - subjective well-being - capability approach: a measure in the growth of how many choices a person has offered to them - HDI: uses a variety of indicators that give you a pic of the level of development; used today as the measure of economic growth

What are some of the social changes present in the transition to an industrialized society?

- urbanization: fewer farmers and more specialization - changing genre roles: empowering women, more jobs, delayed marriage, less births - specialization increase --> efficiency increase --> growth

What are some of the problems with aid?

- volatile and unpredictable: many countries promise aid but do not deliver which leads to projects being unfinished - tied aid often led to projects that are not of strategic importance for the developing country, but instead important for the developed country firms in charge of the project - aid can undercut domestic production (EX: food aid)

How does the early development of food production and early arrival of domesticated animals set up a region to be a powerful dominator (one with guns, germs and steel)?

vast enough production produce surpluses --> large, dense, sedentary, stratified societies --> accumulate global power w/ guns, germs, and steel to dominate other societies as well as accumulate wealth fertile land --> hunter-gatherers decide to stick around --> specialization --> inventing --> domestication --> guns, germs, and steel

Why, according to these models, is trade a good thing?

we can consume off of PPF; countries can specialize/partially specialize in producing what they are good are producing --> more products --> able to consume more

vertical FDI

when a stage of production of parent company is located in a developing country; produced then shipped back good when: - firms want to take advantage of low-cost labor in the developing country - tariffs are low enough that intermediate goods can easily flow into a country for assembly

Foreign Portfolio Investment (FPI)

where foreigners own shares or "stock" in a foreign country

Know the trends in balance of payments in the developing countries in the last 30 years

Nepal mainly relied on remittances to balance their payments; exports < imports so trade deficit; borrow foreign loans and get little foreign aid

Know the assumptions of the Heckscher-Ohlin model.

labor, tech, and capital are equally productive but each country has more or less of these factors

What makes the Fertile Crescent a unique birth place of food production?

largest zone in Mediterranean climate; greatest climatic variation (so a lots of different crops); wide range of altitudes and topographies within a short distance; less competition from hunter-gatherer lifestyle; wild grains provided enough for sedentary societies to begin before farming

What is the motivation for recipient countries to receive aid?

helps solve the problem of current account deficits, providing foreign funding to help with the buying of intermediate goods needed to start the process of rapid economic development

Know what the first, second and third world were and their attitudes toward the global community.

i. First World: capitalist world; Western Europe, US, and Japan ii. Second World: world under central planning; USSR, China, Cuba, North Korea, Eastern European States under Soviet domination iii. Third World: Autarkic countries who isolated themselves; Post Colonial Countries, not capitalist nor communist; want to industrialize on their own

tariff

import tax; focuses on prices

Be able to describe the Solow Model in words.

investing and tech change are the key to long-run growth; the rate of tech progress will determine the long-run growth rate of income per capita ii.

How did the crisis make the debt burden larger?

loans were dollar-denominated; Mexico defaulted --> US currency increased which made it harder and longer for developing countries to pay back

What is the Harrod-Domar model? Why did the concept of the "financing gap" fail to guide developing economies properly?

investment is the key to economic growth; there is a link b/w investment and growth such that if you have a target for growth, there exists a "required" investment rate to achieve that growth rate (investment/GDP = magic investment rate

How does this model of comparative advantage apply to developing countries in general?

find the good where they have comparative advantage, identify the partner, and specialize completely

What are the characteristics of an animal that make it possible to domesticate?

- Diet: require less food - Growth rate: grow quickly - Captive Breeding: can't have mating rituals requiring time and space - Temperament: not kill their breeders - Not have the tendency to panic - Social Structure: comfortable with breeder and be able to live in a herd

Why is capital unimportant in the long-run but possibly important in the short run?

- In LR: diminishing returns to capital; more capital --> pop growth --> so not growth in productivity --> no growth in GDP - In SR: helps DVLG country catch up until they reach their LR growth plan; increase capital --> marginal productivity labor increases --> productivity increases --> GDP increases

The Debt Crisis: 1982 Mexico Default

- MX stopped paying debt bc paying back for interest rate meant less money for their people - amount of US loans to MX made up 40% of the money in US banks - people got scared so they ran to withdraw cash from banks --> increase demand for US currency --> hurt MX and other developing countries bc even harder to pay back (more pesos for USD)

What are the advantages of Paris Declaration on Aid Effectiveness?

- Ownership: developing countries set their own strategies, improve their institutions and tackle corruption - Alignment: donor countries bring their support in line with these strategies and use local systems - Harmonization: donor countries coordinate their actions, simplify procedures and share info to avoid duplication - Managing for results: both focuses on producing (measuring) results - Mutual accountability: both countries are accountable for results

What is the Paris Declaration on Aid Effectiveness and what is the direction that the authors would like to take aid?

- attempt to aid more effectively - focus on having developing countries choose their own goals and how aid would help them - developing countries would get good feedback as to how their money was helping

What were the problems with the various solutions to the crisis?

- austerity measures slowed growth - powerful rich countries were now telling weaker, developing countries how to run their country - many developed country resources owned by rich country firms

industrial policy

gov't strategic effort to encourage the development and growth of all or part of the economy, often focused on all or part of the manufacturing sector

Managing Crisis: Toronto Terms

1. forgiving 1/3 of concessional loans 2. reduced interest rate on loans that were left 3. extended maturity of payments (25 years)

Know that crises, both banking and currency crises have been more common since liberalization of capital markets began.

1945-1971: 38 crises 1973-1997: over 139 crises

Know the major reforms under Mao-Tse-tung and how they impacted economic growth.

Advantages: - major public health reforms - improvements in basic infrastructure - Green revolution: increase crop productivity Disadvantages: - Great Leap Forward (1956-1961): peasants told to stop planting food instead produce steel in their backyards - cultural revolution: silenced intellectuals, esp. liberals because they wanted to restore communism

Know the impact of the "Great Opening of China" starting with Teng Hsiao-p'ing. Be able to discuss agriculture, industry, trade and investment liberalization, and the liberalization of state-owned enterprises.

Agriculture- household responsibility system: - plots assigned to households - farmers worked harder - applied inputs with more care - higher yields resulted Industry- township and village enterprises (TVE): - many jobs were available in rural industry when fewer people were needed in farming Trade industrialization and investment liberalization- Special Economic Zones (SEZs): - specific locations where trade was open - manufacturing exports increased - FDI from long-distance international capital flows from US and Europe - FDI offshore Chinese communities of Asia (Taiwan, Hong Kong) Liberalizing state-owned enterprises: - partly 1980s-1990s - end of 1990s layoffs of millions of state enterprise workers, but had other jobs available to them

Foreign Direct Investment (FDI)

An investment made by a company or entity based in one country, into a company or entity based in another country (multinational firms); the accepted threshold for an FDI relationship is 10%

Be able to understand and calculate "basic transfer"

D(d-r) in which D= total debt, d= rate of growth of Debt, and r= interest rate; want d > r bc able to get more loans than being able to pay back; more money inflow

What was the advantage of having "specialists" (or specialization) in your civilization?

greater efficiency; trade with other regions/countries

not all goods are the same (some are better than others for economic growth)

Engel's Law: demand for staple foods grows more slowly than income so growth in staple foods will lag economic growth Prebish-Singer hypothesis: in the long run, prices from primary product exports in the world market tends to fall relative to the prices of manufactured goods so developing countries have to keep exporting more and more to get the same amount of imports

What are the donor motivations for providing aid?

helping another country; cathartic; develops relationships with developed countries and their firms --> trade relationship

What are some countries that tried import substitution and export promotion?

IS: Brazil, Argentina, Nigeria, Bangkok EP: Taiwan, Hong Kong, Singapore, South Korea

differences b/w import substitution and export promotion

IS: closing yourself to market EP: opening up to the market

Understand how a country could reduce the outflow of foreign reserves using export promotion and import restriction, currency devaluation, promoting investment, and structural adjustments.

Structural adjustments: - abolish import restrictions - devalue currency: currency worth less --> can't buy as much --> less money outflow Export promotion: - restrict import --> using less money - export > import --> bringing money in

quota

a limit on quantity traded; focus on quantity; limit on import

How is foreign aid defined?

financial flows, technical assistance, and commodities that are... - designed to promote economic development and welfare as their main objective (thus excluding military or other non-development purposes) - provided as either grants or loans

What are the advantages and disadvantages of a developing country encouraging FDI?

advantages: - tech spillover - more jobs - potential tax revenue - stable source disadvantages: - disappointing tax rev - profits are reinvested in another place - crowd out business for domestic investment

What was the result of the 1898 attempt at capitalist reform?

advice of Japanese capitalists who had pushed for industrialization - modern traditional exam system - eliminate sinecures - modern education system with math and science - create a constitutional monarchy - strengthen military - industrialize

tied aid

aid that requires the developing country to use the aid provided to them on specific projects with the use of a specific vendors problems: - provision of inappropriate goods, tech, and advice - favors capital-intensive industries over smaller ones - developing countries may be over-reliant

Understand how balance is achieved.

balance of payments are always equal to 0. surplus: inflows > outflows; increase cash reserves account deficit: outflows > inflows; decrease in cash reserves account

What is the Hobson's Choice and why is it so important for a developing country facing a currency crisis?

choice when we are faced with 2 bad options: 1. raise r: support currency because folks abroad want to invest in your economy again --> harder for domestic firms to borrow --> slow economy, lower export bills, higher employment 2. do not raise r: currency might collapse wiping out banks and companies with large liabilities in foreign currency; foreign-denominated loans were impossible to pay back

What are some problems that arise with import substitution?

closing yourself off to local demand; high tariffs; messing up currency of exchange rate; promoting inefficient behavior (producing things that you aren't good at-- that's why you imported)

What are the differences between the model of comparative advantage and the Heckscher-Ohlin model in terms of the impact of opening a developing country to international trade relationships?

comparative advantage: total and complete specialization; not offer partial specialization because opportunity cost is constant H-O: partial specialization; when there is a shortage --> labor gets more expensive

Know the assumptions of the Ricardo's Absolute Advantage and Comparative Advantage models.

countries only have tech and labor countries may have absolute advantage, but trade can still be good by comparing opportunity cost

Managing Crisis: Brady Plan

debt-for-equity swap and debt-for-nature swap EX: foreign institution buys up a portion of debt in a developing country and exchanging for an oil field

Debt Crisis: 1970s

developing countries doing import substitution so rapid industrialization: - require high import bills - low export bills - current account deficit so to overcome this, they borrowed loans (d > r)

How does this model apply to developing countries in general? Would we imagine that they would completely specialize in one good or another?

developing countries tend to be labor abundant and capital scarce so they should partially specialize in goods that are labor-intensive and import goods that are capital intensive

preferential fixed exchange rates

different currency exchange rate depending on the country or industry

What is the role of disease in empowering a region?

disease bring death rates up so important to have healthier pop --> productivity increase --> growth disease is also used as a weapon to other regions that are not immune

What is special about the axis of Eurasia? Why did it turn out to put Eurasia in such an advantageous place?

east/west axis meant food production of the fertile crescent spread the fastest and tech traveled more easily --> more "guns and steel"

horizontal FDI

exact replica of the parent company is established in the developing country good when: - located close to consumers - when tariffs are high b/w countries --> cannot easily import inputs that you need to use if the production process located abroad - more diverse jobs

What can help your company survive a currency crisis?

exporting to foreign markets because export revenues will give the foreign currency when your own currency is losing value; this currency will give you more power to pay back debt and/or import intermediate surplus

Why, according to this model, is trade a good thing? (Don't forget to mention that factor prices tend to equalize)

you can consume off of your PPF factor prices are equalizing because the wage and rental rate if country A is labor rich --> wage low --> prices of labor intensive goods low; if country B is capital rich --> wage high --> price of labor-intensive good high; therefore A should trade w/ B EX: apples imported from A to B: high producers in B leave market (bc can't compete w/ cheap apples) --> demand for labor increases --> wage decreases --> capital rental rate would equalize