Chapter Four:

1
Foreign Resources and Economic Development
Introduction
 Foreign resources have played an important role in the economic development of many
economically advanced countries of today. The purpose of this bulleting is to review
some of the factors associated with local economic growth.
 For example, between 1870 and 1914 the ratio of capital inflow to gross domestic
capital formation was about 40 per cent in Canada. The same ratio for Australia was
about 37 per cent between 1861 and 1900, and for Norway it was 29 per cent between
1885 and 1914 and 31 per cent between 1920 and 1929 (Hagen 1975).
 Even in countries like Japan and the USA, where such ratios were lower during their
early stages of economic development, foreign capital played a significant role.
 The LDCs of today are more or less in the same stage of economic development as the
DCs used to occupy in the eighteenth and nineteenth centuries.
 This is explained in terms of concepts such as ‘the savings gap’ and ‘the foreign
exchange gap’.
 2 The concept of foreign resources

 The flow of foreign resources (FR) can be of many types and it is important to know the
different elements.
First, there are institutions (e.g. OXFAM, War on Want etc.) which provide grants to many
countries to alleviate the after-effects of a natural disaster such as famine, flood or
earthquakes. Such grants need not be repaid by the recipient countries, nor do they carry any
interest charges.
Second, some loans are given, chiefly by the international lending agencies (e.g. the World
Bank) at interest rates which are lower than those in the market.
 However, foreign private investments in the LDCs are not exactly ‘foreign aid’ as they are
made on commercial terms. Foreign private investment usually carries commercial interest
rates and does not stem from altruistic motives
 3 CONT..

 Foreign private investment usually forms a significant proportion of the total inflow of
FR. Government lending could be carried out on a bilateral or multilateral basis.
 Sometimes, several governments could set up a consortium to provide FR to a country
or countries. Such lending could carry commercial terms; but frequently these loans are
provided at concessionary rates and they have to be repaid after a long period.
 Sometimes, grace periods are offered to relieve the burden of debt repayments.
 It seems clear that all FR are not ‘aid’ or charities, some parts of them being
international lending on a commercial basis.
 4 Criteria for distribution of foreign resources

 Several criteria for allocating FR are discussed in the literature. Some of them can be
highlighted here:
First, FR are usually given for political reasons. It is generally the case that FR will not
be given to one’s enemies (Little and Clifford 1965).
Second, FR are supposed to replenish the dearth of domestic saving in the LDCs.
Generally, the difference between planned investment (7p) and planned saving (Sp) is
taken as an indication of the FR (F) that are necessary to attain a target rate of economic
growth.
 5 Cont..
 Generally, the difference between planned investment (7p) and planned saving (Sp) is taken as an
indication of the FR (F)
F=Ip−Sp
 Where Trade gap (say Tg) is given by the difference between imports (M) and exports (X).
 Tg=M−X
 The equilibrium relationship between the ‘savings gap’ and the ‘trade gap’ can be expressed as:
Ip−Sp=M−X
 These two gaps, must be equal ex post because of the method of national accounting. It is contended
that where the trade gap predominates over the savings gap, a supply of FR could have a positive effect
on growth and as such FR should be provided after careful estimation of these two gaps
 6 Cont..

Third, the other criterion which is sometimes advocated is known as ‘absorptive capacity’ (RosensteinRodan 1961).
Basically, it means a country’s ability to absorb capital and to use it in a productive way.
 Such ‘productive’ use of capital is measured by positive ‘reasonable’ rates of return on total investment.
Obviously, ‘absorptive capacity’ would depend upon the level of income and its growth rate, the supply of skill
and the level of average and marginal rates of savings.
 If the principle of providing FR is to step up the process of capital formation in the LDCs, then such a principle is
more likely to be met in those LDCs where the marginal rates of savings are much higher than the average. It may
be pointed out that the absorptive capacity of an economy depends, inter alia, upon the nature of the infrastructure
of an economy.
 An economy with a poor system of transport and communication, with managerial skill handicapped further by
lack of proper training and educational facilities, is likely to have a low absorptive capacity.
 7 Cont..

 The Next, the flow of FR is sometimes guided by historical factors. Much of the FR
flowing from France and Britain go to their former colonies. The provision of FR in such
cases is sometimes regarded as imperialistic or neoimperialistic (Hayter 1971).
 The other criterion which is said to have been applied in distributing FR is the
maintenance and promotion of the private sector of the economy. Japan, Germany and
the USA have sometimes maintained that resources would be provided in certain LDCs
so long as the private sector could be allowed to operate freely.
 8 Cont.….

 The ‘efficiency’ criterion for allocating FR has received considerable attention. The system seems to be
strikingly simple and important as it upholds the realistic view that FR should be distributed on the basis of
their most efficient use. In practice, its application is not so simple.

 Sometimes, the principle of stability, chiefly in prices and in trade balances, has been regarded as the
appropriate condition for allocating FR. Such a principle usually finds favour with the international
organizations such as the International Monetary Fund (IMF).

 The above discussion suggests the difficulties which are inherent in finding out an appropriate value-free
index to measure the performance of FR on growth and development of the LDCs not only at a point in
time, but also over time.

 However, the provision of FR without any political or ideological consideration is unlikely to occur in
practice.
 9 Different types of foreign resource:
1. tied and untied

 The allocation of FR can assume different forms. They can be tied to the imports from donor countries (i.e.
tying by sources); alternatively, their use could be linked to a specific project (i.e. tying by end use).The
reasons for such tying are not difficult to understand from the point of view of the donor country.

 First, tying helps to increase the exports of the donor countries and protects their income and employment.

 Second, tying of resources by some deficit donor countries may increase pressure in surplus donor
countries to similar tying because tying by the deficit countries is supposed to enhance their relative share
in the competitive market for exports. Such a phenomenon is regarded as ‘competitive aid-tying’.
 10 Different types of foreign resource:
Cont..

 Third, tying is supposed to result in efficient utilization of resources.

 Fourth, project tying is supposed to be effective as the projects could be identified easily. Also, such tying is
expected to enhance the reputation of the donor countries.

 Fifth, when resources are tied both by sources and by uses, then it creates a monopolistic situation in favour
of the donor country which it can easily exploit.

 It is easy to see from the above why tying of resources has created so much resentment among the recipient
countries.

 First, tying does not help the recipient countries to obtain resources at the cheapest prices.

 Second, tying will not necessarily improve the balance of payments of the donor country if the cause of
such deficit is an excess demand for resources.
 11 Different types of foreign resource:
Cont..

 Third, the objective of tying resources will be defeated if a recipient country decides to spend on goods and
services of the donor country, from its total reserves of foreign earnings, a fraction which is greater than or
equal to the value of tied resources.

 Fifth, in the event of a double-tying (i.e. both by sources and by end use), the monopolistic position of the
lender may result in a situation which could be less than optimal from the point of view of the recipient
country.

 Sixth, costs of tying of resources have been regarded as considerable for some LDCs.

 Seventh, the informal agreements about servicing over the life of the capital projects as well as some
indirect costs of tying (e.g. carrying the cargo in the ship of the donor country which charges a higher than
international price for freight) may well reduce the true value of the tied FR.
 12 Different types of foreign resource:
untied

 In view of the harmful effects of tying FR, some proposals have been made to untie them.

First, all resources should be untied as to their source. The difficulty in implementing this proposal from the point of
view of the country which provides FR to the LDCs and at the same time suffers from a balance of payments deficit
is understandable if tying has an important balance of payments effect.

Second, should the volume of international liquidity be raised to improve the balance of payments position of a
deficit country transferring resources to the LDCs, then the task of untying would be less difficult.

Third, greater coordination among the donor countries is necessary for untying FR.

Fourth, double-tying should be avoided whenever possible as it is likely to maximize monopoly gains of the donor
countries.
 13 Different types of foreign resource:
Cont..

Fifth, the LDCs should try to promote international tendering of projects to find out roughly the competitive or
world price. It is observed that the excess costs imposed on some LDCs were about 50 per cent when such costs are
measured by the ratio of the difference between the highest bid price and the successful bid price.

Finally, the donor country could treat such excess cost on the recipient country as an export subsidy rather than a
transfer of resources.

 However, in the absence of a concerted effort among the economically advanced countries, the prospect of untying
of FR does not seem very bright, particularly after the oil crises of 1973 and 1979, when many industrialized
countries went into a recession and faced considerable balance of payments deficits.
 14 Different types of foreign resource:
2. Foreign Resources for Projects or Plans

 Sometimes FR are given to a particular project or projects in LDCs. The point has been made that such FR may fail
to promote the basic objective of the national plan and hence it is necessary to work at the problem of financing the
plan rather than the projects.

 the extent that projects included in the plan are so selected as to achieve some national objectives, the problem of
financing the plan or the project disappears and the possibility of switching arises.

First, donor countries may reveal their preference for financing the projects rather than the plans if the national plans
are likely to be revised suddenly with frequent changes in the government.

Second, if the resources given by the donor country form a small proportion of planned investment, project financing
could be considered as more attractive than the financing of the plan.

Third, projects are easily identifiable from the point of view of the donor country.
 15 Different types of foreign resource:
Cont..

 Fourth, financing of marginal projects by FR has some advantages.

• First financing of the plan has the advantage of generating greater effort in the recipient country.

• Second, it could improve the relationship between the lending and the borrowing country which is
certainly an important goal of supply resources.

• Third, plans are supposed to achieve the overall development of a country and their financing is
regarded as preferable by some of the recipient countries.

 However, since there are now very few countries which would allow projects to be set up without
analysing their impact on the national plan, the discussion of project versus plan financing seems
rather academic.
 16 Different types of foreign resource:

3. Bilateral and multilateral financing

The BL flow of FR is usually advocated on the following grounds:
1. BL financing could be tied while a large part of ML financing is untied.
2. The donor country can keep ‘operational control’ with less difficulty in the case of BL financing.
3. Effective utilization of FR is more likely to take place if financing is BL rather than ML.
4. Politically, BL rather than ML financing is more likely to be acceptable to the electorate.
Notice that the advantages from the standpoint of the donor country are not always so from the point of
view of the recipient country.
 17 Different types of foreign resource:

The major criticisms levelled at BL financing can be summarized as follows:

1. BL financing is generally used to extend political influence over the LDCs; it is regarded as an
instrument for ‘buying’ friends.
2. BL financing is not always meant for the economic development of a country because, more often than
not, ‘strings’ are attached to it.
3. Even without the ‘strings’, BL financing is regarded as morally indefensible since ‘extended in the
wrong way, generosity can be perceived by its intended beneficiary as insulting and contemptuous. The
problem of BL financing is psychological and political rather than managerial’ (Fulbright 1966).
Despite these criticisms of BL financing, it is difficult to switch over from BL to ML financing. ML
financing properly co-ordinated could eliminate the inefficiencies in the use of resources.
Further, the problem of debt-servicing, which is worrying many LDCs, particularly after the oil crisis of
1979, can be better tackled if financing is ML rather than BL. It is pointed out, however, that ML
financing is unlikely to be optimum for several reasons (Balogh 1967).
 18 Different types of foreign resource:
First, there is absence of coordination among different donors and between donors and recipient countries.

Second, absence of skilled manpower may aggravate the problem.

Third, the decentralized and democratic controls of the present institutions are not always exercised.

Under this ‘consortium’ approach, an international agency can be set up for consultation and
coordination of the transfer of FR to LDCs. Donor countries may be allowed to transfer FR bilaterally
but according to certain principles which are agreed upon internationally within the ‘consortium’.

The ML agencies have gained considerable support because of their activities in the field of debt
servicing, granting of long-term loans with low interest rates and easy terms of repayments
19 Gains and losses of investment by the (MNCs) in LDCs: some
theoretical issues

The direct benefits from the transfer of technology by the multinational corporations
(MNCs) to the LDCs can be summarized as follows:
1. A higher amount and better quality of output available to host countries
2. Higher wages and salaries of local workers
3. Higher tax revenue for the host government from the investment income which can be
utilized for development purposes.
The indirect gains from the transfer of technology can be summarized as follows:
1. Transfer of skills, know-how management and marketing techniques
2. Supply of information about larger markets and cheaper sources of inputs
3. Provision of access to the international capital markets where funds are usually supplied
on the basis of complex negotiations and bargaining. However, these benefits should be
set against costs already mentioned in the text to reach final judgement about the net
benefits.
 20 Private foreign investment and the transfer of technology to LDCs

 One of the crucial factors in promoting economic growth in the LDCs is technology. In one
sense, here the LDCs of the present time have an advantage over the LDCs of the past. Because
they can now choose from a ‘menu’ of technology available to them from past inventions and
innovations.

On the other hand, the availability of the menu of technology could pose problems for the LDCs.
At the outset it is very important to decide the ‘appropriate’ technology for different LDCs.

According to some economists, such appropriateness has to be judged in the light of the relative
factor endowments and factor price ratios of the LDCs. Others have pointed out that such an
argument would simply reinforce the static theory of comparative cost.

Next, it is necessary to analyze the effects of such a transfer of technology on the level of wages,
employment and balance of payments of the LDCs.
 21 Cont..
 Fourth, the impact of transfer of technology on the pattern of income distribution of the LDCs should be examined
carefully.

Fifth, the transfer of technology may have important socio-political implications which could influence the power
structure of the LDCs

 Sixth, the transfer of technology has to be analysed along with the transfer of the product. It has been suggested that the
choice of ‘consumption’ technology cannot be discussed in isolation from the problem of choice of product

 Thus, considerable debate has recently been observed about the transfer of technology and the role of MNCs regarding
the net social benefits of such transfers to LDCs.

Notice that all MNCs are not involved in transfer of technology. It is equally noteworthy that since the technology-
supplying industries, and even the final product-supplying industries, are so often oligopolistic and multinational in
character, technology dependence raises the further issue of the relationship between nation states and the giant
corporations
 22 Transfer of technology and alternatives for LDCs

 the analysis of the effects of transfer of technology on the LDCs, let us list at the outset the options
open to the LDCs. Thus the LDCs could:
1. Import the final product
2. Import the technology for producing the final product using (a) imported raw materials and (b)
indigenous raw materials, or (c) adopt some combination of imported and indigenous raw materials
3. Import an intermediate product, using indigenous plant for the final mixing of the product
4. Develop indigenous technology similar to the imported technology
5. Develop indigenous alternative technology.

 Most LDCs try to meet the gap between domestic demand and supply through imports of products of
technology, or some combination of the two.
 23 General Remarks Regarding Transfer Of Technology In The LDCs

 First, to the extent the LDCs suffer from the skill constraint to absorb technology, they would have to
import either skilled labour or substitute capital for labour. Neither of them is inexpensive given the cost
of training a highly skilled labour or the high cost of capital in LDCs.

 Second, many LDCs suffer from high growth rate of population and consequent unemployment.

Third, the market for technology is very imperfect and heterogenous. It is generally characterized by
monopolistic or oligopolistic situations with some MNCs operating on a large scale crossing national
boundaries.

Fourth, the policy of import substitution via the imposition of tariffs or other forms of control generally
leads to many forms of distortion. In such a situation, the transfer of technology is not the basic reason
for such distortions though some of its effects could easily aggravate such distortions within the LDCs.
 24 Types of transfer of technology

 The transfer of technology can assume different forms. To summarize the major ones, we have:
1. Initiative where the LDCs construct plants chiefly imitating the technology in the DCs
2. Contractual where an LDC obtains capital and know-how usually through licensing
3. Joint ventures where foreign firms collaborate with the home industries and could agree with minority
holdings in assets
4. Subsidiaries where the foreign companies set up wholly- or partly owned subsidiaries with the host
country exercising little or some influence
5. Turn-key projects where the whole plant is transferred along with all the different stages of production
to the point of final consumption through the marketing and distribution of the final products.
 Contractual agreements, joint ventures and direct foreign investments are usually the major avenues of
technological diffusion.
 25 Cont..

 Foreign direct investment (FDI) is probably the most important way to affect transfer of technology and
its impact is largely felt in the manufacturing sector. From the point of view of the technology-supplying
country, FDI is preferable to other methods of transfer of technology if the nature of the product is
important and durable, if the resources are available and if transfer of technology through other methods
could give away secret information to potential rivals.

The recipient country, usually anxious to be economically independent of the DCs, prefers collaborations
or joint ventures usually with minority participation in the equity capital by the foreign companies.

 However, there are major problems in joint ventures and collaborations regarding division of operations,
management and profits.

From the point of view of the donor country, lack of control in management reduced the incentive to alter
technology to the economic conditions of the LDCs.
 26 Cont..

 It could be argued that only a few LDCs have the administrative skill to choose ‘appropriate’ technology.
But this is not always true (Streeten 1971).

 On the other hand, Singer and Campo (1970:12) have advocated the establishment of an International
Development Fund to support an agency which will help the LDCs in choosing an ‘appropriate’
technology.

 These different points of view highlight the necessity to undertake realistic appraisal of the difficult
alternatives through a social cost-benefit analysis (Streeten 1971).

 Such a study could be facilitated by looking at the following benefits and costs of transfer of technology
by MNCs.
 27 Benefits and costs of transfer of technology to the MNCs

 The benefits of transfer of technology to the MNCs could be summarized as follows.

1. The transfer of technology by the MNCs could ease the ‘trade gap’ in the LDCs.
2. When the transfer of technology takes the form of FDI, the difference between planned investment and
planned savings could be reduced and to that extent the savings gap in the LDCs would also be
minimized.
3. By supplying skilled personnel and labour the ‘skill constraint’ could also be eased.
4. The MNCs contribute to the equity capital, the difference between planned expenditure for a project and
domestic resources mobilized (say, through taxes or borrowing) would also be reduced.
5. The MNCs, through transfer of technology, transfer necessary knowledge, skill and entrepreneurship
needed by the LDCs. Also, the MNCs help the indigenous firms to establish contacts with the
international capital markets.
6. The MNCs could increase competition in the economy of the host country and thereby improve the
efficiency in the allocation of resources.
7. The MNCs, through transfer of technology, could increase the level of output and employment within
the recipient country.
 Cont..
28
 The major costs of the operations of the MNCs can now be summarized as follows:
1. The MNCs usually transfer technology which tends to be capital rather than labour intensive and such a
technology is regarded as generally ‘inappropriate’ for the labour-surplus LDCs.
2. Since technology is related to final product, it is contended that the transfer of technology from the DCs has led
to the growth of ‘Western’ type ‘elitist’ consumption within a very small sector of the total market of the LDCs.
3. The effects of the operations of the MNCs are not spread very evenly in the different sectors in the LDCs (e.g.
between industry and agriculture or urban and rural areas). Further, the MNCs in the process of transferring
technology have introduced the distortions in the market of the LDCs.
4. The MNCs with their vast resources could easily destroy their indigenous rivals. Far from promoting
competition, the MNCs may actually make the market more imperfect by creating barriers to entry for their
potential rivals.
5. If the MNCs supply inappropriate technology and/or products on the basis of resources partly obtained from the
indigenous sources, then the diversion of such resources from socially desirable projects must be counted as a
cost.
6. It is struggled that the MNCs exercise such strength with some host governments that they get away with large
tax concessions, remittance facilities and royalties.
7. The existence of the MNCs in the LDCs could easily be the focus of political conflict between the DCs and the
LDCs.
29 Some policies to deal with the problems of transfer of technology and MNCs
 In an ideal world, if all the governments could get together and tax the MNCs jointly, then the dangers of
transfer-pricing or over-pricing would be considerably reduced.

 Unfortunately, such a solution is hardly applicable in the real world. Hence, in an imperfect world, it is
possible to suggest only some second-best remedies as follows:
1. Since evidence suggests that the LDCs are unlikely to alter the nature of technology developed mainly in the
DCs simply by altering the factor price ratios, it is necessary to introduce a package of measures for
increasing the competitive environment within the economy. Most empirical studies suggest that the MNCs
are likely to choose the more appropriate technology for the LDCs whenever they face a more price-elastic
demand curve for their product (UN 1974). This clearly implies the necessity to develop a more competitive
economy.
2. Since the indigenous entrepreneurs are likely to be weak rivals for the MNCs, the governments in the LDCs
could take necessary measures to increase the countervailing power of the indigenous firms, through
appropriate fiscal and monetary policies.
3. Within LDCs, inconsistencies could easily be observed in the policies pursued by the different ministries.
The removal of such inconsistencies should be helpful to induce the MNCs to choose more appropriate
technology for the economy.
 30 Cont..

4. Trade in selective second-hand capital goods could be encouraged by choosing suitable policies of tax subsidies.
Here due care must be taken with regard to the availability of spare parts, servicing facilities and the period
within which such machinery could be obsolete. It must be emphasized that here the choice may not be too great.
5. Governments facing a surplus-labour but capital-scarce situation should try to alter the existing factor price
ratios between wages and interest rates in a manner which would reflect the real social opportunity costs of
inputs. there is an important case for increasing interest rates and providing wage subsidies.
6. More resources should be spent on research and development to promote appropriate indigenous technology or
to adapt imported technology to suit the local conditions.
7. The host country should try to obtain different items of technology separately rather than in a ‘package’. Such
‘unpackaging’ will tend to reduce the exploitation element in the transfer-price mechanism.
 31 Cont..
8. Protectionist policies in many LDCs provide a ‘safe’ market for the MNCs as well as domestic monopolies. Such
tariff structure ought to be reviewed to foster greater competition.
• Although a tariff inflates the profits of the subsidiaries of the MNCs, it is not always a necessary condition for the
establishment of such subsidiaries partly because they could be set up to take some special advantage of the
economic conditions of the LDCs.
• At a more mature stage of the product which could be successfully imitated in the DCs, subsidiaries could be set up
in the LDCs to take advantage of low average costs because of low wages and low cost of raw materials and the
finished product could be exported from the subsidiary back to the country of origin or to other export markets.
• However, the ‘product cycle’ or the ‘wage gap’ theory does not explain why some vertically integrated MNCs are
set up in LDCs with low still often using labour-intensive techniques.
9. The MNCs should be induced to participate in training local people in co-ordination with the government. Also,
local participation in management could remove some of the suspicions regarding the operations of the MNCs.
10. Greater information should be spread regarding the availability of technology. Here the international agencies
(e.g. UNIDO, UNCTAD) could provide valuable guidelines to the LDCs.
11. Major criticisms of the different types of mechanisms used by the MNCs in the transfer of technology emanate
because of the utmost secrecy observed in their financial and technical operations. One of the best ways to tackle
the many criticisms and suspicions with regard to the workings of the MNCs would be to remove much of the
secrecy.
 32 Foreign aid and economic growth

The impact of foreign aid on overall economic growth rates of LDCs is expected to be different for LDCs.
More specifically, such effects will depend on:

1. The effective use of aid

2. The state of economic development and its rate of growth
3. The rates of return on investment
4. The nature of the infrastructure and the availability of physical and human capital
5. The nature of economic regulation
6. The political economy of the rent-seeking society

However, without a careful analysis of a complex set of dynamic socioeconomic factors, it is difficult to
draw a definitive conclusion about the real impact of foreign aid on LDCs.
33

End