PROBLEMS OF LOWER INCOME COUNTRIES:Poverty trap theories:

<< AN INTRODUCTION TO INTERNATIONAL TRADE AND FINANCE

Introduction to Economics ECO401

UNIT - 16

Lesson 16.1

PROBLEMS OF LOWER INCOME COUNTRIES

There are huge income and wealth disparities in the world we live in. Roughly one-fourth of the

world's population accounts for on three-fourths of the world's resources and consumption.

The per capita income in the world's poorest countries is $330 per year whereas in the richer

countries, is $24,000 a year about 70 times higher!

More worryingly, contrary to expectations and wishes, these disparities have not gone away

since the 1950s the time when many of the world's poorest countries (colonies) got

independence. In some cases (e.g. Africa), disparities appear to have actually increased,

widening the living standards gap between the first and third worlds. Many people in the Third

World live in extreme poverty beyond the wildest imagination of the people living in HICs.

Theories about the Problems of LICs:

In order to explain this huge problem of poverty and of the asymmetric ownership of wealth

and income in the world, economists have come up with many theories.

Poverty trap theories:

Poverty trap theories explained the relative poverty of the Third World in the context of the twin

gaps: foreign exchange gap (exports being less than required imports) and an underlying

savings gap (domestic savings being less than required investment).11 As a result, the LICs'

economies were caught in the vicious cycle of low saving, low scale of investment, low

productivity gains (due to the absence of scale economies), low per capita growth (remember

productivity and technological progress were the engines of PCI growth), low savings .......

The Prebisch-Singer Hypothesis (PSH):

A rival theory was the Prebisch-Singer Hypothesis (PSH), which located the reasons for this

persistent poverty in the structure of trade between the rich and poor countries. The PSH

maintained that that LICs were stuck in the production of primary products (as prescribed by

static comparative advantage theories like Hechscher-Ohlin prescribed) which were subject to

both volatility and declining prices relative to manufactures and capital goods.12

Some economists pointed out the lack of human, social and public capital in LICs as the

single most important factor distinguishing them from, say, post-WW2 Germany and Japan,

countries which were able to rebuild themselves from total destruction to great economic

prosperity on the back of a strong and skilled workforce (human capital), well-developed

institutions like trust, meritocracy and accountability (social capital), and elaborate

communications, energy and housing infrastructures (public capital).

Others drew attention to the very fast rising populations in LICs, and the particular social

and economic pressures created thereby. Coupled also with disease and severe ethnic and

regional conflicts, some saw the situation in LICs as virtually ungovernable.

Lack of precious natural resources (like oil, gold, gas, iron, copper etc.) was also cited by

some as the reason for LICs' continued poverty, and examples were given of South Africa and

the OPEC countries, many of whom were able to raise living standards solely on the back of

natural resource exports. Strong counter-argument exist against this theory, for e.g., the LICs

which registered the highest rates of industrialization and GDP growth during the last four

decades, namely: Korea, Taiwan, Hong Kong, Singapore, did not possess any significant

natural resources. The same is true for Japan in the 20th century and the European countries

in the 18th and 19th centuries.

Recall from the discussion under BOPs that M-X = I-S + G-T, and thus, for a given G-T, I-S and M-X go hand

in hand.

Refer also to the micro lectures on elasticity where the BOPs problems of LICs are explained in the context of

income price and substitution elasticity's.

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Development Strategies:

Keeping the reasons for persistent poverty in LICs aside, there are three broad development

strategies that have been adopted to address the situation.

I. DEVELOPMENT THROUGH TRADE

Up till the 1970s, it was thought that LICs needed to develop their import competing industries

(import-substituting industrialization), reduce their dependence on consumer goods imports by

switching to domestically produced goods, and hence gradually attain self-sufficiency and

foreign exchange adequacy. Inspired by dynamic comparative advantage theories and the

massive Soviet industrialization drive launched under Stalin, this model was passionately

followed by many South Asian, African and Latin American countries. The results were not

very positive, unfortunately. For one, the nationalization policies that often accompanied the

pursuit of the ISI model led to a crowding out of private entrepreneurship (and with it, the spirit

of competition), and the birth of highly inefficient public enterprises, which later became a

breeding ground for corruption, nepotism and labour dumping (excess hiring). Second, the

huge savings expected on imports never quite materialized. Given the large current account

deficits delivered by weak exports and stubbornly high imports, therefore, many of these

countries went into BOPs crises after the 1970s.

The East Asian Model:

A rival trade model which proved very successful was the East Asian one. These countries

(Korea, Indonesia, Taiwan, Hong Kong, Singapore, Malaysia, and to a lesser extent Thailand,

Indonesia and The Philippines) industrialized not to produce for the local markets (i.e. to

substitute their imports) but to produce for the international market (competing with foreign

producers). As a result they had a focus, from the very start, on productive efficiency and did

not rely on high tariff protection for very long and therefore attained a sustainable ascent on

the comparative advantage ladder (from primary products to high tech goods). These are the

countries which have been the fastest growing (or miracle) economies of the last quarter of the

20th century.

The success of the East Asian model, notwithstanding, there is major criticisms that are

leveled against richer countries with respect to their double standards on trade. The criticism is

that, while supporting free trade internationally and whenever it suits their interests, many of

these countries impose quotas, tariffs, subsidies and indirect restrictions (environmental and

labour standards etc.) to prevent poor countries from selling their primary products and light

manufactures to the rich country markets. One example is the agricultural sector, where the

wealthy west gives lavish subsidies to its farmers, enabling the latter to out-compete LIC

farmers who are not receiving any subsidies form their governments. One argument,

therefore, is to require rich countries to open their markets to exports from poor countries.

II. DEVELOPMENT THROUGH RESOURCE TRANSFER

The main idea here was that (as mentioned earlier) poor countries suffered from savings and

foreign exchange gaps that could not be filled domestically, and needed to be funded by some

sort of international resource transfer from the rich countries (former colonial powers called

"donors") to the poor countries (those which got independence in the mid-20th century).

Supporters of the model were basically those who felt that the colonizing west needed to take

responsibility for the exploitation of the colonized Third World. The best way to do it was to

give aid: both grants (which never had to be repaid) and concessional loans (which had to be

repaid on very soft terms) to poor countries to help them in their initial years and to facilitate

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their entry into the group of prosperous nations.13 For this reason, the UN charter of 1948

prescribed an annual 0.7% (of GNP) contribution by all rich countries to poor countries.

However, aid has not generally been successful in lifting former colonies out of poverty. Living

standards in many of the aid-receiving countries have actually fallen, indicating a clear failure

of aid. There are many reasons why this could have happened, but the most important ones

are perhaps the misuse of aid proceeds by recipient country governments through

misallocation, embezzlement and corruption; the negative role of donors in forcing recipient

countries to use aid proceeds for importing the goods and services from only the donor

country; the politicizing nature of aid and its associated conditionalities14; aid fatigue on the

part of donors (i.e. tiredness resulting from having to give aid year after year without any

concrete benefits), the inadequacy of aid (the aid given has never quite been enough, and only

about 0.35% of rich country GNP has been allocated as development aid); the crowding out of

domestic savings (that is, as aid comes into the country the incentive for local citizens to save

reduces, thereby compounding the low saving rate problem of poor countries).

Official aid is not the only type of resource transfer. There are private capital flows (portfolio

investments and bank lending) that can also fill resource gaps in LICs. However, the

experience with these has not been successful either. The debt crisis of the 1980s in Latin

America, Africa and Asia, and the recent spate of financial crises in Mexico, East Asia, Russia,

Brazil and Argentina have all testify to the dangers of modern day private capital flows. Such

flows are highly reversible and often pro-cyclical accentuating boom-bust cycles in recipient

countries.

Due to the failure of the above alternative types of resource flows, attention has, of late, shifted

to foreign direct investment (FDI). This type of resource transfer has been deemed more

successful than others due to its ability to relieve three constraints simultaneously: the foreign

exchange and savings constraints (mentioned earlier), the skills constraint (the fact that LICs

do not have the skills managerial or technical for industrial upgrading and export market

tapping). FDI had been unwelcome in many LICs in the 1950s and 60s as it was seen as a

continuation of colonialism. Foreign money coming into one's country was one thing, foreign

firms coming, operating and taking control quite another! Indeed there was the perceived risk

that foreign firms would take over the strategic sectors of society financial services,

communications and power. Over time, LICs' aversion to FDI has decreased considerably.

Many now recognize the benefits of irreversible FDI and its skill-transfer related advantages

for countries lacking in stability and human capital, respectively. Indeed, countries which have

relied on FDI more than debt and portfolio investments to integrate into the global economy

(China, Chile and many of the East Asian tigers), have been the most successful development

examples of the last 25 years.

OPTIONAL: For a detailed review of the alternative forms of resource transfer and their

relative merits, please see International Resource Transfer.ppt

III. DEVELOPMENT THROUGH STABILISATION AND REFORM

The reasoning here was that trade and resource transfer could not, by themselves, lift LICs out

of poverty. Unless LICs' macroeconomic imbalances (high inflation, current account deficits

etc.) were removed (stabilization), and the structural impediments to their growth relieved

(structural reform), trade and resource transfer could not translate into long-term improvement

in living standards. This became particularly obvious after the 1980s debt crisis that swept

across Latin America, Africa and Asia. It is at this point in time that the two international

financial institutions (IFIs) the International Monetary Fund (IMF) and the World Bank (WB)

became involved in macroeconomic stabilization and structural reform, respectively.

An early example of the success of aid was post-World War II Germany, which received a lot of financial

assistance from the U.S. (Marshall Plan) and managed to become an economic giant inside 2 decades after the end

of the war. It was hoped that by giving aid to other poor countries, the same result would obtain.

These conditionalities are often perceived as an infringement of the freedom of the recipient country, making the

pursuit of donor-prescribed policies politically unviable.

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Importantly, the countries in which the IFIs got involved, did not have much bargaining power

vis-à-vis the IFIs, because the latter had bailed out these countries (by offering them soft

multilateral loans) out after their debt defaults. As a result, the IFIs were able to determine the

pace and direction of macroeconomic policy reform in these countries. For a summary of the

origins of the IMF and the World Bank and their structure and ownership, please see IFIs.ppt.

Most of the IMF's stabilisation policies (and indeed WB's reform ones) were derived from

neo-classical economics, known since 1990 as the "Washington Consensus". IMF's main

stated objective was to ensure both through internal balance (supply=demand, i.e. low

inflation, full employment) and external balance (sustainable BOP and external debt position).

The approach was "stabilization" through "demand" management, the three tools of the latter

being:

· Tight monetary policy: "demand reducing"; expected to work via higher interest rates

which reduced private sector consumption and investment demand, suppressed

inflation and boosted domestic savings. High interest rates also caused higher capital

inflows (lower capital flight) and helped restore external balance via the capital

account.

· Tight fiscal policy: also "demand reducing"; worked via higher revenues (increased

taxation and broader tax base) and reduced expenditure on subsidies, public sector

corporations etc. There was also reduced demand (including, for imports) and

government's borrowing requirement (boosted the creditworthiness of the government

as a borrower making borrowing cheaper).

· Devaluation: produced "demand switching" from imports to home produced tradable

goods. Worked via increased competitiveness, export diversification, reduced need for

export subsidies (as exporters became competitive), and increased investor confidence

in the local currency (preventing dollarisation by people fearing an impending

devaluation).

LICs' experience with IMF policies has generally not been successful: The above policies have

drawn heavy & wide-ranging criticism. Critics have drawn attention towards

· Short-term policy conflicts: demand management policies compromise internal

balance esp. income & employment; lower government expenditure means less

output, jobs. Higher interest rates can lead to corporate bankruptcies, bad debts and

financial sector crises.

· Devaluation can raise prices of imports, including necessities, raw materials and

investment goods. Also, devaluation translates into inflation when there is real wage

resistance; i.e. when a devaluation-induced rise in import prices feeds fully into the

domestic price level through wages.

· Demand-reduction policies are anti-growth: increased taxation can stifle the

productive sector, as widening the tax net proves difficult and most of the burden falls

on a few taxpayers; cutting government expenditure can cause reduced public

investment in infrastructure, education and health; higher interest rates can discourage

private investment.

· Stabilisation hurts the poor: expenditure cuts almost always fall partly on the social

sectors most relevant to the poor (health, education, food/fertilizer subsidies etc.). This

can lead to political instability, jeopardize economic stabilization and delay or reverse

"reform". Esp. difficult for democratic governments to push the harsh stabilization

measures through.

It is now recognized that these policy conflicts need to be integrated into the Programme in

advance through the institution of proper safety nets for the poor, and assurances that all

"IMF-induced" aid (or debt relief) is channeled strictly to poverty reduction programmes.

World Bank's structural reform policies:

The World Bank's structural reform policies have usually involved the following:

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Liberalization of prices, removal of subsidies

Deregulation involving dismantling of licensing systems and red-tape

Privatization of state-owned enterprises (SOEs). SOEs were usually considered

inefficient due to political interference, and a lack of competition, cost awareness and

fear of bankruptcy

Trade liberalization, including tariffication of non-tariff-barriers, harmonization of tariffs

and an eventual reduction thereof

FDI liberalization, to create a transparent, predictable environment for foreign investors

to operate in

Financial liberalization, involving ending of financial repression policies (artificially low

interest rates, credit rationing, restrictions on banking competition) and government

involvement in investment allocation

Capital account liberalization, i.e. removing controls on capital flows

Governance and administrative reforms: reducing waste in, and improving

reliability/quality of, pubic services; strengthening tax administration; fiscal

decentralization; elimination of corruption; enhancing predictability of legal and

regulatory framework; reducing over-employment in public sector

While most of the policies prescribed by the World Bank appeared desirable, some of them

came with conditionalities that were perceived as politically sensitive, "patronizing", and

involving dismantling of strong entrenched interest (like domestic industrialists). Predictably,

therefore, non-compliance was a major feature of such programmes.

Even in cases where the domestic government intended to implement the prescribed reforms,

compliance problems occurred due to poor sequencing and/or bad timing. Example 1: relaxing

capital controls given a poorly regulated domestic financial system exposed countries to

increased risk of financial crisis. Examples 2: Trade liberalization (reducing tariffs) or financial

liberalization (raising interest rates) before achieving fiscal consolidation (i.e. rationalization of

government expenditures and widening of tax base), caused borrowing costs to balloon and

fiscal deficits to widen (Zambia, Zimbabwe, Pakistan).

Insistence on rapid liberalization of all sectors has over-stretched many LICs' institutional

capacities.

So what are the proposed solutions?

· Some Left-leaning critics totally reject the globalization doctrine and want the free-

market model dumped in favour of a more interventionist set-up. Japan and East Asia

are presented as examples of countries which witnessed tremendous growth despite

having serious market-unfriendly "distortions" in their economies. The argument these

critics present is that, in a second-best world, certain distortions may be desirable.

· Many NGOs, and LICs themselves, argue for the reform of the global trading system to

open up rich country markets and address commodity price instability.

· Right-leaning groups (including the US Treasury and the Republican Party) which wish

to see the withdrawal of the IMF from development finance in favour of the World Bank;

they would like to see the IMF focusing only on crisis-prevention and providing short-

term liquidity to countries facing BOPs problems. Many NGOs agree that IMF's

development finance policies have failed but are unclear on whether or not the IMF

should totally withdraw. They fear that in the absence of alternatives (like grants etc.),

overall aid to LICs may fall.

· The IMF and World Bank themselves want to improve the quality of conditionalities

while reducing their quantity, encourage government participation in policy design and

the setting of these conditionalities so as to encourage ownership of the Fund and

Bank programmes.

· NGOs and rich country government, of late, have stressed the need to integrate

poverty reduction objectives and sustainable development into IMF/World Bank

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programmes: Poverty Reduction Strategy Papers have been written in this context to

ensure sustainable development with a human face.

Rich country governments also emphasize the importance of good governance in

public policy, better management of public resources, greater transparency, active

public scrutiny, and generally increased government accountability in fiscal

management.

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END OF UNIT 16 EXERCISES

The Human Development Index is a measure of well-being that is based on three equally

weighted indexes: per capita GDP, educational attainment and life expectancy. Dr

Mahboob-ul-Haque (who also served as Pakistan's Foreign Minister in the 1980s) was the

main force behind this idea. For what reasons are HDI and per-capita GDP rankings likely

to diverge?

When the other two elements of HDI educational attainment and like expectancy diverge

from per capita income in the rank order. One of the main reasons for this divergence is

inequality. Thus a country with a high GDP per capita, but which is very unequally distributed,

may have a large proportion of the population which is poor, with relatively little access to

education and with a relatively low life expectancy. This is the reason why countries like Qatar

and Saudi Arabia despite being very high on the per cpaital GDP ranking, appear quite low on

the HDI ranking list.

If a disastrous harvest of rice were confined to a particular country, would (a) the world

price and (b) its own domestic price of rice fluctuate significantly? What would happen

to the country's export earnings and the earnings of individual farmers?

a) The world price would not rise significantly as a result of its poor harvest. In the extreme

case of a small country facing a perfectly elastic demand for its rice exports, the world

price would be unaffected by its bad harvest.

b) If rice were a significant proportion of its total exports, the fall in rice production, and

hence sales, would cause the current account to deteriorate and the exchange rate to

depreciate (assuming a flexible exchange rate). This would increase the domestic

currency price of its rice exports.

The country's foreign exchange earnings would fall. Individual farmers' earnings would also fall,

unless, the rise in price from the exchange rate depreciation were sufficient to offset the fall in

output and sales (which is unlikely, unless rice exports constitute a major portion of total

exports).

Why is an overvalued exchange rate likely to encourage the use of capital-intensive

technology?

Because it reduces the price of imported capital equipment (assuming that such equipment has

low or zero tariffs imposed on it).

Would the use of import controls (tairffs or quotas) help or hinder a policy of export-

orientated industrialisation?

In the early stages of industrialisation they may help a country build up its infant industries

industries that later could become export orientated. If protection is maintained for too long, or is

too distorting, however, such industries could well remain inefficient and find it difficult to

compete internationally.

Will the adoption of labour-intensive techniques necessarily lead to a more equal

distribution of income?

Not if the amount of investment varies significantly from one sector of the economy to another. If

it did, then those working in sectors with new efficient labour-intensive technology would gain,

while the poor, the dispossessed, and those working in old inefficient industries would not.

Income distribution could become less equal.

Consider the arguments from the perspective of an advanced country for and against

protecting its industries from imports of manufactures from lower-income countries.

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Consumers will lose from such protection, because they will be denied access to lower-income

countries' products at such low prices. Workers and employers in the industries threatened by

cheaper imports from lower-income countries will gain from the protection. Nevertheless there

will be a net welfare loss to the country. A better solution to the problem of those in the

industries threatened by the imports might for the government to help in the redeployment of

labour.

What is the difference between mechanical efficiency and economic efficiency?

Mechanical efficiency is where there is a low energy loss from a machine. For example, if a

machine has an 80 per cent mechanical efficiency, this means for every 100 units of energy

used to power the machine, it produces 80 units of energy output. In the context of the internal

efficiency of a firm, economic efficiency involves producing a given output with the least costly

combination of factors.

Why may governments of lower income countries be less strict than developed countries

in controlling pollution?

Reasons include:

a. Given the much lower average levels of income, there is a higher level of marginal utility

from increased output relative to the marginal pollution costs.

b. There is often less political pressure on governments to reduce pollution.

c. Possible greater ignorance of the full extent of the harmful effects of the pollution.

What difficulties is a government likely to encounter in encouraging the use of labour-

intensive technology?

Difficulties include:

a. Bias of firms towards using capital-intensive technologies which they see as `modern'.

b. Lack of efficient labour-intensive techniques available (due to a lack of research and

development).

c. Multinationals' preference for using techniques with which they are familiar. Such

techniques, having been developed in advanced countries, are likely to be capital

intensive.

d. Labour-intensive technology may require a higher level of skills from the operatives.

What would be the effect on the levels of migration and urban unemployment of the

creation of jobs in the towns?

Urban employment would rise with the additional jobs. But if each job created in the towns

encourages more than one person to migrate from the countryside, the level of urban

unemployment will also increase.

Is there any potential conflict between the goals of maximising economic growth and

maximising either (a) the level of employment or (b) the rate of growth of employment?

a) Maximising growth may involve using more capital-intensive techniques, because they

create a greater surplus for reinvestment. But the adoption of more capital-intensive

techniques will reduce the level of employment.

b) There is less likely to be a conflict here. If capital-intensive techniques lead to a faster

growth in output, they will tend to lead to a faster growth in employment, albeit from a

lower level. (This conclusion will not follow, however, if there is a continuous switching to

more capital-intensive techniques as profits are reinvested.)

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What is the relationship between unemployment and (a) poverty; (b) inequality?

a) The greater the unemployment, the greater will tend to be the level of poverty, given that

in most lower-income countries there is little or no state financial support for the

unemployed.

b) The greater the unemployment, the greater will tend to be the level of inequality. Society

will become increasingly polarised into those with and those without jobs.

If there were three techniques available, what would the isoquant look like? Would it

make any difference to the conclusions of this model?

The isoquant would have four straight-line sections. One vertical; then two downward-sloping

sections, the higher one steeper than the other; then a horizontal section. This is illustrated in

the diagram opposite. Each of the three `corners' of the isoquant would be at the capital/labour

ratio of one of the three techniques.

An isoquant like this would make no difference to the conclusions of the model. A capital-

intensity bias could still lead to a more capital-intensive technique being chosen from the three

available, than that warranted by questions of cost alone.

If more jobs were created in the towns, how, in the ruralurban migration model, would

this affect (a) the level of urban unemployment; (b) the rate of urban unemployment?

If more jobs were created in the towns, Lm would rise. This would cause Wue to rise.

a) If Wue rises, more people will migrate and thus the level of urban unemployment will rise.

b) If the urban wage (Wu), the rural wage (Wr) and the cost of migration (α) are unaltered,

then migration will take place until Wu.Lm/Lu has returned to its original level, with Lm/Lu

the same as before. Thus although the level of unemployment has risen, the rate of

unemployment has stayed the same.

What common ground is there between structuralist and monetarist explanations of

inflation and lack of growth in lower-income countries?

Structuralist economists generally accept that high inflation is accompanied by high rates of

growth in the money supply, even though they see monetary growth as a symptom of the

problem rather than its basic cause.

Both structuralists and monetarists accept the importance of supply-side policies to relieve

bottlenecks, increase growth and reduce unemployment. Monetarists, however, generally see

the means of achieving this to be a liberating of market forces, whereas structuralists generally

advocate interventionist policies.

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One solution proposed to help solve Argentina's weak financial position is that it should

abandon the peso as its unit of currency and replace it with the US dollar (i.e. "dollarise").

What advantages and drawbacks might such a solution have for the Argentine economy

both in the short and the long term?

The advantages are that there would be much greater currency stability and a more stable

macroeconomic environment, with inflation more under control. In the short-term this would help

to restore confidence in the economy and encourage people to save. In the longer term it would

encourage inward investment and trade. The disadvantage is that interest rates would be

determined in the USA, and they might not be suitable for the Argentine economy at any given

time: in other words, Argentina would lose control over monetary policy. The arguments here are

similar to those concerning whether the UK should adopt the euro. The main difference is that

the UK would have considerable input into eurozone macroeconomic policy, whereas Argentina

would have no input into US macroeconomic policy.

What are the relative advantages and disadvantages to a lower-income country of

rescheduling its debts compared with simply defaulting on them (either temporarily or

permanently)?

Default is a high-risk strategy. The benefits are an immediate wiping out of debt. The potential

costs are great, however. Its assets in foreign institutions may be confiscated, as too may its

ships and merchandise in transit. Once having defaulted, it will be virtually impossible to raise

future loans to rebuild the economy. The threat of default, however, especially if made by

several debtor countries acting together, could force creditor institutions to offer lower interest

rates or more generous rescheduling programmes, or even to write off a certain portion of the

debt.

If reductions in lower-income countries' debt are in the environmental interests of the

whole world, then why have developed countries not gone much further in reducing or

cancelling the debts owed to them?

Because it would not be in the private interests of the banks concerned. Even in the case of

official government loans, individual developed countries may be reluctant to cancel debts on

their own, feeling that it is not their specific responsibility.

Would it be possible to devise a scheme of debt repayments that would both be

acceptable to debtor and creditor countries and not damage the environment?

A longer period to pay would reduce the pressure on lower-income countries to exploit their

environment. Also direct financial help to lower-income countries to protect the environment

would be in the global interest and could also help to reduce lower-income countries' debt

burden.

Would the objections of lower-income countries to debt-equity swaps be largely

overcome if foreign ownership was restricted to less than 50 per cent in any company? If

such restrictions were imposed, would this be likely to affect the `price' at which debt

were swapped for equity?

To some extent, yes. Lower-income countries would be able to retain the controlling interest in

their companies within their borders. There would still be foreign influence in the running of the

companies, however, but this may not be wholly unwelcome with the expertise that advanced

countries can bring.

Restricting ownership to less than 50 per cent would reduce the benefits to the developed-

country banks or companies. They would therefore be unwilling to pay such a high price for

equity than if they had been able to acquire a controlling share.

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Imagine that you are an ambassador of a lower-income country at an international

conference. What would you try to persuade the rich countries to do in order to help you

and other poor countries overcome the debt problem? How would you set about

persuading them that it was in their own interests to help you?

You could try to persuade them to reschedule your debts and to grant new loans on more

concessionary terms. This would be in their interests if it enabled you to give a firmer guarantee

that the loans would be repaid.

You might also try to encourage them to sign trade deals with you or companies in your country,

in order to improve your balance of payments. This would again be in their interests in that it

would enable you more easily to service any loans they had made to you.

You might also try to persuade them to reduce interest rates, both to make it easier for your

country to service its debts, and to give a boost to world demand and hence to the demand for

your exports. You could try to show them that a growing world economy was in everyone's

interests.

To what extent can international negotiations over economic policy be seen as a game of

strategy? Are there any parallels between the behaviour of countries and the behaviour

of oligopolists?

There is a collective gain to countries from agreement over harmonisation and the greater

international macroeconomic stability that would result. Each individual country, nevertheless,

would have to agree to take decisions which might be directly against its short-term national

interests. Each country may therefore be tempted to break the agreement.

Clearly there is a parallel with oligopoly. Collusion is in the collective interests of oligopolists, but

each will be tempted to cheat.

The greater the number of countries/oligopolists in an agreement, and the more divergent their

individual economic circumstances, the greater the likelihood of one country/oligopoly breaking

the agreement, and the less the commitment, therefore, of countries/oligopolists in general to the

agreemen

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