slide #6

• Typical pattern of developing countries


  Boom-and-bust cycle
• Typical pattern of developing countries

  1. Opening to international markets

  2. Attracting foreign capitals

  3. Large debt accumulation

  4. Default

  5. No further loans
• Cycles of overborrowing, crisis, and adjustments has characterized the history of many developing countries
• Why do developing countries keep borrowing capital?

  Potential benefits are larger than apparent dangers
• Savings in developed economies are much larger!
• Channels of foreign capital supply to developing countries

  • Foreign aid
  • IMF, World Bank, Regional Development Banks
  • Asian Infrastructure Investment Bank
  • Private capital flows
• Largest share of foreign capital provided by bilateral agreements
• In 2016, advanced economies provided $143 billion of bilateral assistance to developing countries
• Private capital flows to developing countries


  • Banks
  • Stock market
  • Bonds
  • Multinational corporations
• Third way of foreign capital flow to developing countries

  • Migrants' remittances through international money transfer companies
• China and India receive the largest amount of migrants' remittances
• Remittances are a less volatile source of foreign capital and have a larger impact on households' welfare compared to other sources of capital
• Commercial lending and the Latin American crisis

  1. Foreign aid increased in the late 1950s

  2. World Bank created the International Development Association to provide concessional loans

  3. Regional development banks followed the same model

  4. Foreign aid followed a decolonization strategy of advanced industrialized economies
• Many policy-makers viewed international aid as a new form of colonization and a weapon against Communism
• Commercial lending and the Latin American crisis

  1. Surpluses of "petroldollars" flew from oil producing countries to developing countries, which were large importers

  2. Massive flow of capitals followed creation of state-owned companies

  3. Expansion of government expenditures, as well as deficits
• Argentina's deficit went over 10% of GDP by the end of the 1970s
• By 1980, foreign debit soared to $590 billion(!) mostly owned by a few countries
• Most heavily indebted countries

  • Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela
• Initially, debt had a positive impact on growth
• Exports must grow to comfortably repay debt
• Governments invested mainly in projects which did not fuel export revenues (e.g. hydroelectric energy plants, military equipment, oil, consumer goods subsidization)
• Managing a debt crisis

  1. Initially thought as a liquidity problem (short-term)

  2. Solvable through macroeconomic stabilization, i.e. budget cuts

  3. In exchange for these policies, creditors provided new loans and restructured existing debts

  4. By 1985, creditors soon realized that stabilization was not enough - need for structural adjustments
• Structural adjustments


  • Massive privatization
  • Trade liberalization
  • Privatization of state-owned companies
  • Deregulation to promote economic competition
• • Government too involved in the economy
  • Private entrepreneurship stifled by government intervention
  • Limited export potential