Financing Development

Developing countries lack money to fund development, so they obtain financial support from developed countries. Finance comes from two primary sources: direct investment by transnational corporations and loans from banks and international organizations.

Foreign Direct Investment

International trade requires corporations based in a particular country to invest in other countries. Investment made by a foreign company in the economy of another country is known as foreign direct investment (FDI). FDI has grown rapidly from $172 billion in 2002 to $646 billion in 2016.

Growth in FDI

East Asia and Latin America have received the most FDI.

Investment does not flow equally around the world (Figure 10-48). Only one-third of FDI went to developing countries while the other two-thirds went to developed countries. And FDI is not evenly distributed among developing countries. In 2016, one-third of all FDI destined for developing countries went to China, and another one-third to Singapore, Brazil, Russia, and Mexico.

Sources and Destinations of FDI

The major sources of FDI are transnational corporations that invest and operate in countries other than the one in which the company headquarters are located. Of the 500 largest transnational corporations in 2018, 344 had headquarters in developed countries, including 126 in the United States. China (including Hong Kong) was the location of 120 of the 156 with headquarters in developing countries.

Pause & Reflect 10.3.3

Why might Apple, Microsoft, and Alphabet rank as three of the world’s largest transnational corporations?

International Monetary Fund

The two major lenders to developing countries are the International Monetary Fund (IMF) and the World Bank. The IMF provides loans to countries experiencing balance-of-payments problems that threaten expansion of international trade. IMF assistance is designed to help a country rebuild international reserves, stabilize currency exchange rates, and pay for imports without the imposition of harsh trade restrictions or capital controls that could hamper the growth of world trade. Unlike development banks, the IMF does not lend for specific projects. Funding of the IMF is based on each member country’s relative size in the world economy.

World Bank Project

Construction crew in the Central African Republic repairs a dirt road, with funds from the World Bank.

World Bank

The World Bank includes the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). The IBRD provides loans to countries to reform public administration and legal institutions, develop and strengthen financial institutions, and implement transportation and social service projects. The IDA provides support to poor countries considered too risky to qualify for IBRD loans. The IBRD lends money raised from sales of bonds to private investors; the IDA lends money from government contributions. Around $40 billion worth of loans are made annually, of which around 14 percent are to India and around 5 percent each to China, Mexico, Turkey, Brazil, Indonesia, Pakistan, Bangladesh, and Vietnam.

World Bank Loans, 2017

The World Bank and IMF were conceived at a 1944 United Nations Monetary and Financial Conference in Bretton Woods, New Hampshire, to promote economic development and stability after the devastation of World War II and to avoid a repetition of the disastrous economic policies that contributed to the Great Depression of the 1930s. The IMF and World Bank became specialized agencies of the U.N. when it was established in 1945.

Microfinance for Development

Many would-be business owners in developing countries are too poor to qualify for regular bank loans. An alternative source of loans is microfinance, which is the provision of small loans and other financial services to individuals and small businesses in developing countries that are unable to obtain loans from commercial banks.

Microfinance

The Peermade Development Society, Kerala, India, makes microloans to women trying to start small businesses.

A prominent example of microfinance is the Grameen Bank, which was established in 1977. Based in Bangladesh, Grameen specializes in making loans to women, who make up three-fourths of the borrowers. Approximately two-thirds of the artisans providing fair trade handcrafted products are women. Often these women are mothers and the sole wage earners in the home. Women have borrowed money to buy cows, make perfume, bind books, and sell matches, mirrors, and bananas. For founding the bank, Muhammad Yunus was awarded the Nobel Peace Prize in 2006.

The Grameen Bank has made several hundred thousand loans to women in Bangladesh and neighboring South Asian countries, and only 1 percent of the borrowers have failed to make their weekly loan repayments, an extraordinarily low percentage for a bank. Several million loans have also been provided to women by the Bangladesh Rural Advancement Committee. The average loan is about $60. The smallest loan the bank has made was $1, to a woman who wanted to sell plastic bangles door to door.