11.5 Relationship between countries at different levels of development
- Syllabus
- 9708–2026–2027
- Topic
- 11.5
- Level
- A2
Learning objectives
11.5.1International aid• International aid:- forms of aid- reasons for giving aid- effects of aid- importance of aid11.5.2Trade and investment• Trade and investment11.5.3Multinational companies• Role of multinational companies (MNCs):- definition of MNC- activities of MNCs- consequences of MNCs11.5.4Foreign Direct Investment• Foreign Direct Investment (FDI):- definition of FDI- consequences of FDI11.5.5External debt• External debt:- causes of debt- consequences of debt11.5.6International Monetary Fund• Role of the International Monetary Fund (IMF)11.5.7World Bank• Role of the World Bank
Aid outcomes depend on its purpose, route, finance and conditions
International aid is assistance transferred on non-commercial or concessional terms to relieve humanitarian need or support development. Official aid comes from governments/public agencies; private NGO relief is assistance but not official foreign aid.
| Dimension | Forms and exam distinction |
|---|---|
| Purpose | Humanitarian/emergency relief versus long-run development aid |
| Route | Bilateral: donor government to recipient; multilateral: through an international organisation |
| Finance | Grant: no repayment; concessional loan: repayment on softer-than-market terms; debt relief |
| Resource | Money, food/equipment in kind, technical assistance/training |
| Conditions | Tied aid requires specified donor goods/services; untied aid leaves procurement choice |
| Possible benefit | Limitation/condition |
|---|---|
| Infrastructure, health, education and technology raise productivity/capacity | Poor project choice, corruption or weak maintenance can waste resources |
| Foreign exchange and capital relax savings/import constraints | Loans add debt service; tied purchases may be expensive |
| Emergency relief protects lives and productive assets | Repeated dependence can weaken local initiative or production |
| Training and public services improve human development | Benefits may reach narrow groups or follow donor political priorities |
Evaluate importance against the recipient's binding constraint and the counterfactual: grants for productive, locally owned projects with maintenance and accountable delivery are more likely to raise long-run living standards than debt-financed consumption or donor-led projects with weak local capacity.
Aid is not automatically a grant, bilateral, untied or development-enhancing. Classify each dimension separately before judging short-run relief, long-run capacity and repayment/dependency effects.
Trade opens markets; investment creates productive assets
| Channel | Development mechanism | Main condition/risk |
|---|---|---|
| Trade access | Larger export markets, specialisation, foreign exchange, imported capital/technology and competition | Commodity volatility, trade barriers, weak terms of trade, import displacement |
| Cross-border investment | Adds capital, infrastructure, management, technology and productive capacity | Profit/interest outflows, imported inputs/labour, debt, enclave activity and external costs |
| Labour/remittances | Wages sent home raise secondary income, household spending/saving and foreign exchange | Brain drain, dependency and unequal access |
‘Trade not aid’ argues for durable earning capacity through greater access to high-income markets, not autarky, import substitution or using aid to subsidise exports. Removing rich-country agricultural subsidies can improve developing-country producers' competitive access.
Both partners can gain when exchange uses comparative advantage and contracts are fulfilled: for example, seasonal workers fill a labour shortage while remitted wages benefit home households. Infrastructure investment can raise both countries' trade capacity, but imported construction inputs, tied loans and repayment can shift gains.
For any case, trace (1) immediate AD and foreign-exchange flows, (2) productive-capacity and skill effects, (3) domestic supplier/job/tax linkages, and (4) later import, profit, interest and wage outflows.
More trade or investment is not automatically development. Low investment is often associated with low income, but direction of causation and distribution of gains must be evaluated.
An MNC coordinates production or ownership across countries
A multinational company (MNC) owns or controls productive operations in more than one country. Exporting or trading internationally alone is insufficient: the firm must conduct production/business operations across countries.
MNCs may build or acquire factories, extract resources, organise global supply chains, contract local suppliers, transfer technology/management, train workers, sell locally and export. These activities usually involve FDI, but MNC describes the firm while FDI describes the investment flow/asset.
| Potential host gain | Potential host cost or leakage |
|---|---|
| Jobs, training, productivity and technology transfer | Imported skilled labour/inputs or only low-paid local jobs |
| Higher AD, GDP/GNI, exports and infrastructure | Repatriated profit, imported inputs and exchange-rate/resource effects |
| Tax revenue and supplier/market access | Tax concessions/avoidance and strong bargaining power |
| Diversification and competition | Domestic-firm displacement, structural unemployment and monopoly power |
| Resource development | Pollution, depletion, cultural/non-material costs and corruption |
Judge net contribution by local value added, worker/supplier linkages, technology retained, taxes collected, reinvestment, competition and external costs—not by gross MNC sales. Host tax, labour, environmental and local-content rules alter each channel.
MNC presence does not always promote growth or living standards. It can raise actual/potential output while worsening distribution, non-material welfare or the current account through imports and profit outflows.
FDI creates lasting control, capacity and later cross-border flows
Foreign direct investment (FDI) is cross-border investment giving a lasting interest and significant influence/control in an enterprise, commonly by building fixed capital (greenfield investment) or acquiring an existing firm. Short-term purchases without control are portfolio investment.
| Route | Likely effect | Condition |
|---|---|---|
| Initial capital/factory spending | Financial-account inflow and higher AD; multiplier if spare capacity | More domestic inputs/labour increase local multiplier |
| Capital, training and technology | Higher productivity, LRAS/potential growth, wages and consumption | Spillovers require local skills/suppliers |
| Export production/import substitution | Current account may improve | Stronger when local inputs are high and foreign demand is income-elastic |
| Imported machinery/materials | Current-account debit during setup/production | Domestic sourcing reduces leakage |
| Profit repatriation | Primary-income outflow and GNI below corresponding GDP contribution | Reinvestment/tax collection retain more gains |
| Competition/resource use | Lower prices/efficiency or displaced firms; possible depletion/pollution | Regulation and market structure matter |
Investors consider market size, infrastructure, skills/productivity, political/currency stability, costs, tax/rules and ability to repatriate profit. Low wages and cheap land may not compensate for unreliable transport, power or institutions.
Assess standard-of-living effects through employment/income, public revenue and services, consumer choice, distribution and environmental/non-material costs. An observed FDI-growth correlation alone does not establish causation.
An FDI inflow can improve the financial account while imported inputs or later profits worsen current-account components. Do not infer the whole balance of payments, trade balance or welfare effect from one flow.
External debt helps only when returns and foreign exchange cover its service
External debt is the stock of public or private liabilities owed to non-residents. It may be short/long term and domestic/foreign-currency denominated; debt service is the interest plus principal repayments due over a period.
| Cause | Why foreign borrowing rises |
|---|---|
| Savings/investment gap | Low income and saving cannot finance infrastructure, capital and technology |
| Foreign-exchange gap | Export receipts/reserves cannot fund essential imports or current-account deficits |
| Fiscal deficit/shock | Disaster, conflict, recession, commodity-price fall or pandemic raises spending/reduces revenue |
| Cheap global credit | Low foreign interest rates encourage projects and refinancing, sometimes beyond productive use |
| Exchange/interest movement | Depreciation or variable-rate rises inflate the burden and may trigger more borrowing/rollover |
| If well used and manageable | If returns/terms are weak |
|---|---|
| Infrastructure/capital raise AD, LRAS, productivity, exports and tax revenue | Interest/principal outflows worsen primary income and use foreign exchange |
| Growth can exceed borrowing cost and lower debt relative to GNI | Fiscal austerity/crowding out reduces health, education or investment |
| Longer maturities/concessional rates create adjustment time | Rollover/default risk, lower creditworthiness and policy dependence rise |
| Export-generating projects supply repayment currency | Depreciation makes foreign-currency debt costlier in domestic terms |
Judge sustainability using debt and debt service relative to GNI/government revenue/export earnings, real growth versus effective interest cost, maturity/rollover profile, currency denomination, reserve access and project returns. A smaller debt-to-GNI ratio can occur even when nominal debt rises if GNI grows faster.
External debt is not the annual current-account deficit or total national/public debt. A large stock is not automatically unsustainable, and low initial interest rates do not remove exchange-rate, refinancing or project-quality risk.
The IMF supplies temporary external finance while economies adjust
| IMF role | Economic purpose |
|---|---|
| Surveillance and policy advice | Identify macro, financial, exchange-rate and external risks |
| Temporary lending to members with balance-of-payments/foreign-exchange problems | Finance essential imports and avoid disorderly default while adjustment occurs |
| Promote international monetary cooperation and exchange stability | Reduce destabilising policies and payment-system disruption |
| Technical assistance/capacity development | Improve monetary, fiscal, statistical and financial institutions |
A programme provides foreign exchange and credibility subject to agreed policy conditions and repayment. Fiscal, monetary, exchange-rate or structural measures aim to reduce the financing gap and restore sustainability rather than finance a permanent deficit.
| Potential benefit | Potential cost/condition |
|---|---|
| Prevents abrupt import compression/default and buys adjustment time | Conditional austerity or tight policy can reduce output, jobs and public services short term |
| Restores confidence/reserves and may unlock other finance | Forecast/design errors, weak ownership or poor implementation can fail |
| Corrects unsustainable external/fiscal policies | Distributional burdens and political resistance may be severe |
The IMF is not primarily a development-project bank: a water-treatment plant or long-run infrastructure project is normally a World Bank-type role. IMF support is not free aid and may also follow disasters only where an external financing need exists.
The World Bank finances long-run development capacity and projects
The World Bank Group provides long-term development finance, grants/concessional support for eligible countries, policy advice, research and technical knowledge. Typical areas include infrastructure, health, education, social protection, institutions and private-sector development.
| Project chain | Success condition |
|---|---|
| Identify a development constraint | Evidence supports the priority and opportunity cost |
| Finance infrastructure/services/institutions | Loan/grant terms and debt burden are suitable |
| Procure and implement | Governance, local capability and environmental/social safeguards work |
| Operate and maintain | Recurrent finance, skills and community access exist |
| Convert outputs to outcomes | Benefits reach intended groups and raise productivity/welfare |
A well-selected water, transport, health or education project can improve human capital, productivity, market access and potential growth. Weak selection, corruption, tied/import-intensive construction, displacement, environmental harm or missing maintenance can leave debt without durable benefits.
| IMF | World Bank |
|---|---|
| Shorter-term balance-of-payments and macro-financial stabilisation | Longer-term development projects, capacity and structural constraints |
| Foreign-exchange support linked to macro adjustment | Project/programme finance and development knowledge |
World Bank financing does not prove development occurred: evaluate implementation, access, maintenance, distribution and debt terms. Short-term bailout packages for an external-account crisis are principally the IMF role.