Economics (9708) | Relationship between countries at different levels of development

Hello Future Economist! Welcome to International Relations!

This chapter, Relationship between countries at different levels of development (Syllabus 11.5), is one of the most interesting parts of A-Level Economics. It explores how rich countries (HICs) and poor countries (LICs) interact, and why these interactions often determine the success or failure of development efforts.

Don't worry if the vocabulary seems complicated—we’ll break down these global connections into clear, easy-to-understand parts. Understanding this topic helps you evaluate real-world solutions to global poverty and inequality. Let’s get started!

1. International Aid (11.5.1)

International aid is essentially the transfer of resources (money, goods, services, or expertise) from one country or organisation to another, primarily aiming to improve living standards or provide disaster relief.

1.1 Forms of Aid

Aid comes in many forms, each with different goals and impacts:

• Bilateral Aid: Aid given directly from one government to another (e.g., the UK government sends funds to Kenya).
• Multilateral Aid: Aid channelled through international organisations (like the World Bank or UN) which then distribute it among many recipient countries. This is often seen as less politically biased.
• Humanitarian Aid: Short-term relief provided during emergencies (famine, earthquakes, conflict).
• Development Aid (or Project Aid): Long-term aid focused on fostering economic growth, building infrastructure (roads, schools), or improving healthcare systems.
• Technical Assistance: Providing specialized training, knowledge, or experts rather than just money (e.g., sending agricultural scientists to help improve crop yields).
• Tied Aid: Aid given on the condition that the recipient country spends the funds on goods or services produced by the donor country.

1.2 Reasons for Giving Aid

Economic and Self-Interest Reasons:

• Creating Trade Partners: Helping countries develop means they eventually become better markets for the donor country’s exports.
• Political Influence: Aid can be used to gain political allies or influence foreign policy decisions.
• Disposing of Surplus Goods: Donor countries may use aid to offload agricultural surpluses.
• Securing Resources: Aiding countries rich in natural resources might help the donor secure access to those resources.

Moral and Humanitarian Reasons:

• Poverty Reduction: A basic ethical duty to help those suffering from absolute poverty.
• Addressing Global Issues: Helping tackle diseases (like malaria) or environmental problems that transcend borders.

1.3 Effects and Importance of Aid

Positive Effects (The Case FOR Aid):

• Fills the Savings Gap: Many poor nations lack sufficient domestic savings (low APC). Aid provides the initial capital needed for essential investment (e.g., building a dam).
• Fills the Foreign Exchange Gap: Aid provides foreign currency needed to import essential capital goods (machinery) necessary for industrialisation.
• Specific Projects: Directly funds life-saving projects, such as vaccination programmes or primary education.
• Disaster Relief: Crucial for immediate survival following natural disasters.

Negative Effects (The Case AGAINST Aid):

• Dependency Culture: Recipients may become reliant on aid, disincentivising domestic effort and structural change.
• Corruption and Misallocation: Aid funds can be stolen or diverted by corrupt officials, not reaching the intended people.
• Tied Aid Problems: Forces recipient nations to buy potentially expensive or inappropriate goods from the donor, reducing the real value of the aid.
• Dutch Disease: A massive influx of foreign currency (aid) can cause the recipient nation’s exchange rate to appreciate, making their exports more expensive and reducing competitiveness.

2. The Role of Trade and Investment (11.5.2)

Trade and investment are the most important long-term drivers connecting rich and poor countries.

Trade, based on the principles of Comparative Advantage (which you studied earlier), allows developing nations to sell their products globally, generating income, foreign currency, and creating jobs. Investment, particularly Foreign Direct Investment (FDI), injects capital and expertise directly into the economy.

3. Foreign Direct Investment (FDI) and Multinational Companies (MNCs) (11.5.3, 11.5.4)

Foreign Direct Investment (FDI) is investment made by a company or individual in one country into business interests located in another country. When a large company operates across multiple countries, it is called a Multinational Company (MNC).

3.1 Defining MNCs and FDI

• MNC Definition: A firm that owns or controls productive assets in more than one country. Think of companies like Coca-Cola, Samsung, or Toyota.
• FDI Definition: An investment that gives the investor a controlling interest (usually 10% or more ownership) in a foreign business. This is different from Portfolio Investment, which is just buying shares without control.

Did you know? FDI is considered more stable than portfolio investment because MNCs cannot easily pack up factories and move them overnight.

3.2 Consequences of MNCs and FDI

Benefits for Developing Host Countries (Pros):

• Job Creation: MNCs establish factories, offices, and infrastructure, creating employment opportunities.
• Transfer of Technology and Skills: They bring advanced machinery, production techniques, and management expertise (Human Capital development).
• Increased Competition: MNCs can break up domestic monopolies, leading to lower prices and higher quality goods for consumers.
• Tax Revenue: MNCs pay corporate taxes and employee income taxes, boosting government income.
• Export Earnings: Often, MNCs use the host country as an export hub, improving the host country’s current account balance.

Costs and Problems for Developing Host Countries (Cons):

• Repatriation of Profits: MNCs usually send profits back to their home country. This leads to a leakage from the host country’s circular flow of income and worsens the primary income balance in the Current Account.
• Tax Avoidance: MNCs are often experts at shifting profits to low-tax jurisdictions (tax havens), reducing the tax revenue gained by the host country.
• Exploitation: They may exploit weak labour laws, paying low wages or using poor working conditions.
• Environmental Damage: MNCs may avoid strict environmental regulations prevalent in developed countries.
• Political Influence: Large MNCs can exert significant pressure on host governments to obtain favourable regulations.
• Crowding Out: Local firms may find it difficult to compete with the sheer scale and resources of an MNC, sometimes leading to the failure of domestic industries.

4. The Burden of External Debt (11.5.5)

The relationship between countries is often defined by money owed. External debt is the total debt (money) that a country owes to foreign creditors, including commercial banks, foreign governments, or international financial institutions.

4.1 Causes of External Debt

How do low-income countries get into heavy debt?

1. Current Account Deficits: If a country consistently imports more than it exports, it must borrow foreign currency to cover the gap.
2. High Global Interest Rates: Rising interest rates (often set by major central banks like the US Federal Reserve) make servicing existing debt much more expensive.
3. Mismanagement and Corruption: Borrowed funds may be wasted on non-productive projects or stolen by corrupt leaders.
4. Shocks to the Economy: A sudden fall in the global price of a key export commodity (e.g., oil or copper) reduces export earnings, making debt repayment difficult.
5. Necessary Development Spending: Sometimes, countries must borrow for large infrastructure projects (like ports or power grids) that are essential for long-term growth but require huge upfront capital.

4.2 Consequences of External Debt

• Debt Servicing Burden: The primary consequence is that a large portion of the government’s revenue must be spent on interest payments and principal repayment, rather than on crucial social spending (healthcare, education).
• Reduced Investor Confidence: If debt levels are too high, there is a risk of default. This frightens away future investors (both FDI and portfolio investors).
• Austerity Measures: To secure new loans or restructure existing debt, countries are often forced to adopt harsh policies (like cutting government spending or raising taxes) which can harm economic growth and increase poverty in the short term.
• Loss of Economic Sovereignty: Creditor nations or institutions may demand policy changes (known as conditionality) in exchange for relief, meaning the borrowing government loses control over its own economic decisions.

5. The Role of International Financial Institutions (11.5.6, 11.5.7)

The complex financial relationships between nations are managed by powerful institutions, mainly the IMF and the World Bank.

5.1 The International Monetary Fund (IMF) (11.5.6)

The IMF acts like a global financial fireman. Its main purpose is to ensure the stability of the international monetary system.

• Main Role: Provides short-term financial assistance (loans) to countries experiencing Balance of Payments (BoP) crises (when a country cannot afford to pay for its imports or service its immediate debts).
• Mechanism: Loans are nearly always subject to strict conditionality. The recipient country must agree to implement specific policy changes (e.g., fiscal reform, currency devaluation) to sort out the problems that caused the BoP crisis in the first place.
• Controversy: Critics argue that the austerity measures often mandated by the IMF harm the poor and stifle necessary government investment.

5.2 The World Bank (11.5.7)

If the IMF is the fireman, the World Bank is the construction company. Its main focus is long-term development.

• Main Role: Provides long-term loans and grants to developing countries for large-scale development projects (infrastructure, education, health).
• Goal: To reduce poverty and support development through investment in productive sectors.
• Focus: Unlike the IMF’s short-term crisis focus, the World Bank focuses on funding long-term structural changes. For example, funding the construction of a major highway or investing in a national teacher training programme.