Evangel's IB Economics Blog

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Question 1: Distinguish between ‘internal’ and ‘external’ debt.

An internal debt is owed by a nation to its own citizens, while an external debt is owed by a nation to non-residents.

Question 2: Using examples from the article and from your own knowledge, examine the problems associated with a developing country having a significant amount of external debt.

• There is increasing inflation. The article states, “The country’s, inflation has steadily increased from 14.1 per cent in April to 16.0 per cent according to the May data released recently. At the same time, food inflation has increased from 39.3 per cent to 44.1 per cent while energy, fuel and other utilities grew from 8.9 per cent to about 9.1 per cent.”
• Increased interest rates meant that the debt that needed to be serviced increased. The article states, “debts have pushed domestic interest rates to a higher end and the cost of debt servicing is going up by the day, leaving insufficient funds for basic services provision including for education, healthcare, safe drinking water and infrastructural and energy projects.”
• The recession in the developed world meant that they imported less from developing economies, since there has been a long-term decline in the real value of most commodities.
• Net capital inflows reducing dramatically.
• Debt-export ratio rising meaning developing countries having to earn more money from the sale of exports just to pay their debts.
• Debt to GDP ratio rising as a larger proportion of their national income is debt.
• Debt-service ratio rising. This shows the percentage of export revenue that has to be used to repay debt plus interest. This is not a problem if exports are rising faster in real terms, but they were not.
• Interest as well as the capital sum has to be repaid. Failure to repay debts causes a loss of financial status, which can have an adverse effect on future foreign investment flows.
• Slender financial resources are used to pay debts and not to build schools, hospitals etc. so there is a substantial opportunity cost involved. The article states, “More resources will be committed to debt servicing rather than investment and welfare of Ugandans.”
• Borrowing continues in the developing countries. The article states, “In Uganda, the minds of politicians go to sleep with borrowing. No one feels tasked enough to solve the country’s problems. Whenever there is a problem, the answer is borrowing… In Uganda, the problem is that even when we borrow, money is either abused or remains unspent yet we pay commitment fees.”

Question 3: Explain how inflation affects the external debt of a country such as Uganda.

There are two types of inflation: cost-push inflation and demand-pull inflation. Cost-push inflation, often called stagflation, is inflation that is caused by an increase in the costs of production in an economy that shifts the short-run aggregate supply curve to the left. The cost-push inflation is detrimental to any economy, since there is loss in efficiency and thus in output, while there is inflation. Demand-pull inflation is inflation that is caused by increasing aggregate demand in an economy that shifts the aggregate demand curve to the right. Assuming that a developing country, such as Uganda, is going through demand-pull inflation, the inflation is good for the developing country in the long-run, according to the Keynesian model, because as aggregate demand increases, the output (i.e. real GDP) increases, which means that the country is growing economically. Therefore, the developing country, in theory, should be able to pay its external debts and not experience the debt cycle. Nevertheless, inflation has negative impacts to a developing country in the short-run because inflation brings up the interest rate. Higher interest rate means that the country has to pay more money to repay the debt. This may lead the developing country into poverty cycle because the government will increase the allocation of its capital to a higher percentage to repay the debt. This means that the government needs to reduce their spending on other aspects, such as education and health care. Reduction in government expenditure in education and health care is harmful to a developing country in the long-run because if the citizens are not educated well or are in bad health, they cannot work efficiently. Hence, the economy of developing country will not be able to grow.

Question 4: Evaluate the policies that a developing country, such as Zambia, can use to counter the effects of inflation.

There are several policies—both fiscal and monetary—a developing country, such as Zambia, can use to counter the negative effects of inflation. Assuming that the inflation is demand-pull, the country can shift the aggregate demand curve back to the right through fiscal policy (such as decrease in government expenditure, decrease in net exports, and decrease in consumption) to decrease inflation. However, this is not a smart idea because rightward shift in aggregate demand of a developing country means that it is unlikely to grow. Less government expenditure, especially in areas such as education and health care, will be harmful in the long-run because if the citizens are not educated well or are in bad health, they cannot work efficiently. Therefore, it is better for the developing country to solve its debt rather than decreasing the inflation. The best way to do so is to expand GDP faster than their debt ratio. Nonetheless, trying to bring about significant economic growth in the short-run is very hard to achieve in practice. Second way to deal with the debt is to have its debt re-scheduled; here the terms of the debt are renegotiated so the developing country has a longer period to repay the loans and interest. Third option is to ask the richer nations to write-off debts. This would help the developing economy to import more and hence boost developed world trade. Such imports could raise living standards and allow for more investment. A further option is debt swaps, where a creditor country cancels a debt at its nominal value. In return, the debtor invests part of the cancelled amount in development projects according to conditions previously agreed by both parties. UNICEF’s Debt for Child Relief is an example. The last option is beneficial to both the rich nation and the developing nation because the developing nation gets a cut in debt while the rich nation receives the money they have lent to the developing nation in different means. In conclusion, the developing country should gear more towards stabilizing its debt rather than focusing on reducing inflation.

“Upwardly mobile Africa: key to development lies in their hands”

Question 1: Define the term ‘foreign direct investment’.

Foreign direct investment (FDI) refers to the net inflows of investment to acquire a lasting management interest in an enterprise operating in an economy other than that of the investor.

Question 2: Describe the extent of FDI involving China and Latin American Countries.

China is investing greatly in Latin American countries. The article states, “China has diversified its investment in Latin America from natural resources to manufacturing and the services industry.” This means that China’s foreign direct investment to Latin American countries has expanded to multiple aspects ranging from “oil from Venezuela to timber from Guyana and soybeans from Brazil.”

Question 3: From the article and the table shown above, discuss the benefits to China that result from the Chinese government and Chinese firms investing in Latin America.

According to the article, China believes that its relationship with Latin American countries is a “win-win” relationship, where “the region sells China raw materials, such as copper, iron and oil, while Latin American countries receive goods from China, including mobile phones and cars.” Certainly, this relationship is beneficial to China; it gets natural resources that it lacks most likely at a very low price, since China is more developed than the countries in Latin America. Using those resources, China is able to grow more quickly. In addition, this relationship allows China to export more. Using the natural resources from Latin American countries, China produces processed goods, such as mobile phones and cars, and exports them to Latin American countries. As the article says, “China is Brazil’s largest trading partner and biggest export market. Trade with Chile, China’s second-largest trading partner in the region, reached $17.7 billion in 2009.” Seemingly, this relationship that is constructed through foreign direct investment is advantageous to China in that China can lower its cost and export more through a freer trade with Latin American countries. 

Question 4: Evaluate the impact of inflows of FDI on a developing country of your choice.

Foreign direct investment is beneficial in the short run to both investor and investee. For example, China is benefitting from its investment to Brazil as it receives materials to develop their own economy and from a bigger international market where it sells the processed goods. At the same time, Brazil increases its exports of natural resources to China. Hence, this shifts Brazilian domestic aggregate demand curve further to the right, increasing real GDP level. In addition, it imports China’s goods easily due to the friendly relationship. FDI is also beneficial to Brazil in the long run, since it eventually shifts the long run aggregate supply curve to the right—an ultimate goal of many nations. Nevertheless, FDI is not always beneficial. In the long run, Brazil may be affected negatively due to FDI. The article states, “In Brazil and Argentina, manufacturers have accused China of dumping products in their markets, prompting new tariffs on some Chinese importers. Other countries worry about China’s aggressive efforts to win access to energy reserves.” Dumping is the selling of a good in another country at a price below its unit cost of production, and hence a killer for a developing country that is trying to grow its production of manufactured goods. Also, in many case, country that is less developed does not get paid sufficiently for its exports, while the manufactured goods it receives are outrageously priced. This means that developing countries, such as Brazil, do not benefit from the relationship generated through China’s foreign direct aid in the long run unless Brazil uses its investment effectively without government’s corruption to grow their economy so that it can compete with China.

“Doha trade round faces risk of collapse after 10 years of talks”

Question 1: Describe the role of the World Trade Organization.

The World Trade Organization (WTO) is an international body that sets the rules for global trading and resolves disputes between its member countries. It also hosts negotiations concerning the reduction of trade barriers between its member nation. By doing so, it tries to ensure that trade flows as smoothly, predictably and freely as possible. According to the WTO website, ten benefits of WTO are the following:

1. The system helps promote peace
2. Disputes are handled constructively
3. Rules make life easier for all
4. Freer trade cuts the costs of living
5. It provides more choice of products and qualities
6. Trade raises incomes
7. Trade stimulates economic growth
8. The basic principles make life more efficient
9. Governments are shielded from lobbying
10. The system encourages good government

Question 2: Using diagrams to aid your explanation, analyse the impact of imposing a tariff on an imported good.

Tariff—a tax placed upon imports—is a type of protection that a government imposes. As shown in Figure 1, tariff on imports shifts the world supply curve (S_W) upwards to curve S_W+T, raising the price of imports from P₁ to P₂. This gives domestic suppliers a comparative advantage, as it enables them to produce meat at a lower opportunity cost than world suppliers, which means that it gives the foreign supplies comparative disadvantage; the level of domestic production increases from 0Q₁ to 0Q₂, whereas the level of imports falls from Q₁Q₄ to Q₂Q₃.

(Figure 1) Tariff on Imported Goods

Question 3: Discuss why Brazil, China and India are reluctant to agree to the demands from the US and the EU to reduce the level of protection on their manufactured goods.

Brazil, china and India are reluctant to agree to the demands from the US and the EU to reduce the level of protection on their manufactured goods because if they decrease their protectionism, the world supply curve will shift downwards to curve S_W+T2, lowering the price of imports from P₂ to P₃ (as illustrated in Figure 2). Cut in tariff still gives domestic suppliers a comparative advantage to world suppliers. Nevertheless, the level of domestic production decreases from 0Q₂ to 0Q₅, while the level of imports increases from Q₂Q₃ to Q₅Q₆. Seemingly, decrease in tariff hurts domestic suppliers of Brazil, China and India, for lower tariff allows world suppliers to export more, ceteris paribus. As competition increases in the market, some domestic suppliers, especially small suppliers, may be replaced by large world suppliers. This replacement could disallow the developing countries to become a major suppliers of manufactured goods, which means that they will not be able to become more developed countries. Also, the replacement could potentially lead to higher unemployment domestically. Also, Brazil, China, and India would be more dependent on world suppliers to provide meat for its country in the long run.

(Figure 2) Reduction of Tariff