AQUINO, Angela Merice P.

BSMA 2-1 CHAPTER 12

2. Compare and contrast the classical labor cost theory of comparative advantage with the neo-
classical factor endowment theory of international trade. Be sure to include an analysis of both
assumptions and conclusions.

Classical labor cost theory of comparative advantage is the production of a commodity at a lower
opportunity cost than any of the alternative commodities that could be produced. Because it is
virtually impossible for individuals or families to provide themselves with all the consumption
requirements of even the simplest life, they usually find it profitable to engage in the activities
for which they are best suited or have a comparative advantage in terms of their natural abilities
or resource endowments. On the other hand, factor endowment trade theory is the neoclassical
model of free trade, which postulates that countries will tend to specialize in the production of
the commodities that make use of their abundant factors of production and it also enables us to
describe analytically the impact of economic growth on trade patterns and the impact of trade on
the structure of national economies and on the differential returns or payments to various factors
of production.

4. Proponents of free trade, primarily developed-country economists, argue that the

liberalization of trading relationships between rich and poor countries (the removal of tariff and
nontariff barriers) would work toward the long-run benefit of all countries. Under what
conditions might the removal of all tariffs and other impediments to trade work to the best
advantage of developing countries? Explain.

It would be easier for the developing countries in grow in terms of exporting products and as
well as importing. For example, if a country has lower tariff or tax policy, or better, no tariff, it
would be appeasing to the eyes of other countries especially the developing ones to export
products to that country which will help the latter to grow their economy leading to a higher
value of their currency which will help the amount of return on capital of the developing country.
It would also be helpful in international relationship because two countries can give and take
from each other.
6. Traditional free-trade theory is basically a static theory of international exchange leading to
certain conclusions about the benefits likely to accrue to all participants. Explain the dynamic
elements that are also important.

The six basic assumptions of the traditional neoclassical trade model that must be scrutinized are
first, all productive resources are fixed in quantity and constant in quality across nations, and are
fully employed; second, the technology of production is fixed (classical model) or similar and
freely available to all nations Moreover, the spread of such technology works to the benefit of
all. Consumer tastes are also fixed and independent of the influence of producers; third, within
nations, factors of production are perfectly mobile between different production activities, and
the economy as a whole is characterized by the existence of perfect competition. There are no
risks or uncertainties; fourth, the national government plays no role in international economic
relations; trade is carried out among many atomistic and anonymous producers seeking to
minimize costs and maximize profits. International prices are therefore set by the forces of
supply and demand; fifth, trade is balanced for each country at any point in time, and all
economies are readily able to adjust to changes in the international prices with a minimum of
dislocation and lastly, the gains from trade that accrue to any country benefit the nationals of that
country.

8. Manufactures now account for a majority of exports from the developing world. What factors
have limited the benefits that developing countries receive from this progress?

While large countries are understandably less dependent on trade than small countries, at any
given size, many developing countries tend to devote a large share of their out-put as
merchandise exports. We see that some large countries which have had unusually closed
economies, tend to be less dependent on foreign trade in terms of national income than most
relatively small countries. The greater recorded share of developing-country exports in GDP is
probably due in part to the much higher relative prices of nontraded services in developed than in
developing countries. Nevertheless, the point remains that developing countries are generally
more dependent on trade in international economic relations because most trade is in
merchandise, for which price dis-parities are smaller across countries. Moreover, in general, the
exports of developing countries are much less diversified than those of the developed countries
10. Explain the distinction between primary and secondary inward- and outward-looking
development policies.

Outward-looking development policies are policies that encourage exports, often through the free
movement of capital, workers, enterprises, and students; a welcome to multinational
corporations; and open communications while Inward-looking development policies are policies
that stress economic self-reliance on the part of developing countries, including domestic
development of technology, the imposition of barriers to imports, and the discouragement of
private foreign investment. Basically, the distinction between these two traditional, trade-related
development strategies is that advocates of import substitution (IS) believe that a developing
economy should initially substitute domestic production of previously imported simple consumer
goods (first-stage IS) and then substitute through domestic production for a wider range of more
sophisticated manufactured items (second-stage IS)—all behind the protection of high tariffs and
quotas on these imports
AQUINO, Angela Merice P.

BSMA 2-1 CHAPTER 13

2. Describe the basic-transfer mechanism. Using the list of credits and debits in Table 13.2,
identify which ones would fit into the basic-transfer equation. How does the basic transfer help
us analyze developing-world debt problems?

Basic transfer is the net foreign-exchange inflow or outflow related to a country’s international
borrowing; the quantitative difference between the net capital inflow (gross inflow minus
amortization on past debt) and interest payments on existing accumulated debt. It is measured as
the difference between the net capital inflow and interest payments on the existing accumulated
debt. The net capital inflow is simply the difference between the gross inflow and the
amortization on past debt. The basic transfer is an important concept because it represents the
amount of foreign exchange that a particular developing country is gaining or losing each year
from international capital flows. Although foreign borrowing can be highly beneficial, providing
the resources necessary to promote economic growth and development, when poorly managed,
can be very costly. In recent years, these costs have greatly outweighed the benefits for many
developing nations.

4. Why was the problem of capital flight so serious in some highly indebted countries? What
causes capital flight, and what do you think can be done about it?

Capital flight is the transfer of funds to a foreign country by a citizen or business to avoid
conditions in the source country. To put its importance in perspective, during the 1980s debt
crisis, wealthy nationals from many developing countries sent vast amounts of money into
developed-nation bank accounts, real estate ventures, and stock and bond purchases; this capital
flight is estimated to have had a value of up to half the total debt of some debtor nations at the
peak of their debt problems.1 It dwarfed the receipt of private and public loans and investments
and was a major contributor to the worsening balance of payments of many developing nations.
Capital flight is also a chronic problem where autocratic governments have a shaky hold on
power.

6. What is the significance of the debt service ratio? Can indebted countries do anything to
lower this ratio? Explain your answer.
Debt service is the sum of interest payments and repayments of principal on external public and
publicly guaranteed debt which also represents a major component of heavily indebted poor
countries current account deficits which is an excess of expenditures over revenues. Indebted
countries can lower this ratio by refinancing through issuing equity instruments inside their own
country which may help them accumulate interest to be used in paying their publicly guaranteed
debt.

8. Do you think a full-fledged developing-country debt crisis might reemerge in the future? If so,
why and under what conditions? If not, why not?

On my opinion, it is possible that the debt crisis might happen again since developing countries
are, as mentioned, still developing which means they still need funds to build their country. This
will lead them to international borrowing or international debt and due to newly emerging
economic conditions due to technological advancement, there might be fluctuations on the
currency of the country where they decided to borrow funds for development which means the
value of their debt will increase compared to their country’s value. This might be the reason why
developing countries might experience problems when it comes to paying their international debt
leading to another debt crisis.

10. In what ways was the recent global financial crisis similar to past crises, and in what ways
did it differ?

Recent global financial crisis similar to past crises is similar in the aspect that umber of heavily
indebted developing countries experiencing high inflation, weak export markets, falling terms of
trade, and large government deficits threatened to destabilize international financial markets. As
the severity of crises in developing countries intensified, private sources of funding shrank
rapidly, reducing the liquidity necessary to service debt. To avert widespread default and hence
the threat of systemic failure in international capital markets, the IMF undertook exceptional
measures to effect adjustment. It is also similar in the role of the IMF which undertook
exceptional measures to effect adjustment. Its new role was instrumental in restructuring and
financing developing-country debt during the debt crisis of the 1980s, the Asian currency crisis
of 1997–1998, and the global financial crisis that began in 2008.
AQUINO, Angela Merice P.

BSMA 2-1 CHAPTER 14

2. Summarize the arguments for and against the role and impact of private foreign investment in
less developed countries. What strategies might developing countries adopt to make private
foreign investment fit their development aspirations better without destroying all incentives for
foreign investors?

The first and most often cited contribution of private foreign investment to national development
is its role in filling the resource gap between targeted or desired investment and locally
mobilized savings. A second contribution is its contribution to filling the gap between targeted
foreign-exchange requirements and those derived from net export earnings plus net public
foreign aid. This is the so-called foreign-exchange or trade gap. Third gap said to be filled is the
gap between targeted governmental tax revenues and locally raised taxes. Fourth, there is a
different type of gap in management, entrepreneurship, technology, and skill presumed to be
partly or wholly filled by the local operations of private foreign firms. Not only do multinationals
provide financial resources and new factories to poor countries, but they also supply a “package”
of needed resources

Arguments are they may lower domestic savings and investment rates by substituting for private
savings, stifling competition through exclusive production agreements with host governments,
failing to reinvest much of their profits, generating domestic incomes for groups with lower
savings propensities; its long-run impact may be to reduce foreign-exchange earnings or at least
make the net increase smaller than it appeared; their contribution is considerably less than it
might appear as a result of liberal tax concessions; The management, entrepreneurial skills,
ideas, technology, and overseas contacts provided by MNCs may have little impact on
developing local sources of these scarce skills and resources.

4. To what extent do private portfolio investments in developing countries benefit the recipient
countries? What are the potential costs and risks to both investors and recipients? Explain your
answer.

From the investor’s point of view, investing in the stock markets of middle-income countries
with relatively more developed financial markets permits them to increase their returns while
diversifying their risks. From the perspective of recipient developing countries, private portfolio
flows in local stock and bond markets are a potentially welcome vehicle for raising capital for
domestic firms. Well-functioning local stock and bond markets also help domestic investors
diversify their assets and can act to improve the efficiency of the whole financial sector by
serving as a screening and monitoring device for allocating funds to industries and firms with the
highest potential returns. Developing countries that rely too heavily on private foreign portfolio
investments to camouflage basic structural weakness in the economy are more than likely to
suffer serious long-term consequences. Risk is that if developed-country interest rates rise or
perceived profit rates in a developing country decline, foreign speculators will withdraw their
“investments” as quickly as they brought them in

6. What is meant by tied aid? Most nations have increasingly shifted from grants to loans and
from untied to tied loans and grants. What are the major disadvantages of tied aid, especially
when this aid comes in the form of interest-bearing loans?

Tied aid is a foreign aid in the form of bilateral loans or grants that require the recipient country
to use the funds to purchase goods or services from the donor country. Conflicts generally arise,
therefore, not out of any disagreement about the role of aid, but over its amount and conditions.
Naturally, any developing country would like to have more aid in the form of outright grants or
long-term, low-cost loans, with a minimum of strings attached. This means not tying aid to donor
exports and granting greater latitude to recipient countries to decide for themselves what is in
their best long-run development interests. Unfortunately, a good deal of aid that comes in this
form has either been wasted in showcase but unproductive projects or actually has been
plundered by corrupt government officials and their local cronies.

8. What are the differences between official development assistance (public foreign aid) and
private development assistance from nongovernmental organizations (NGOs)? Which type of aid
is more desirable from the perspective of recipient countries? Explain your answer.

Official development assistance is the net disbursements of loans or grants made on concessional
terms by official agencies, historically by high-income member countries of the Organization for
Economic Cooperation and Development. NGOs often involved in providing financial and
technical assistance to developing countries and include religious groups, private foundations
and charities, research organizations, and federations of dedicated doctors, nurses, engineers,
agricultural scientists, and economists. On my opinion, it is more desirable for the recipient
countries to receive aid from the NGO because in ODA, which means it is the official assistance
for the whole country and there will be lots of people to divide it with which means the
assistance to be received will be smaller than what can be receive from the NGOs.

10. What do you think would persuade the public to get over its “donor fatigue” and support
more aid for the least developed countries?