Differences in Development between Countries

The two main external resources a developing country can use to support its growth.

Trade

Trade is the exchange of goods and services between countries. Export-led development uses trade as the main engine of growth.

Benefits:

• Earns foreign currency that can be used to import capital goods and technology.
• Expands market size beyond the domestic market, allowing economies of scale.
• Specialisation in the industries a country is best suited to (topic 19) raises productivity.
• Exposure to international competition forces firms to become more efficient.

Drawbacks for developing countries:

• Dependence on primary commodities with volatile prices.
• Falling relative export prices: commodity exports tend to get cheaper over time while imported manufactured goods get more expensive, so a given volume of exports buys fewer imports.
• Protectionism in rich countries sometimes blocks developing-country exports from the markets where they would sell best (especially agricultural products).
• Initial heavy reliance on one or two trading partners can leave the country exposed if those partners go into recession.

Trade is generally seen as the most powerful long-term engine of development if countries can diversify away from a narrow commodity base.

Foreign Direct Investment (FDI)

Foreign Direct Investment (FDI) is when a firm or individual in one country builds or acquires productive assets in another country (a factory, an office, a mine). It is direct ownership, not just buying shares.

Benefits:

• Brings in capital that the country could not raise itself.
• Brings in technology and know-how, often transferred to local workers and suppliers.
• Creates jobs directly and through the supply chain.
• Builds infrastructure (a multinational often improves the roads, power and telecoms it needs).
• Provides training that raises local human capital.

Drawbacks:

• Profit repatriation. Multinationals typically send most profits back to their home country.
• Environmental concerns. Multinationals may exploit weaker regulations in developing countries.
• Low wages and poor working conditions in some sectors.
• Cultural and political tensions with local communities or governments.
• Exit risk. A multinational can pull out if conditions change, leaving the host country with idle infrastructure.

FDI is generally seen as valuable but in need of careful regulation to ensure benefits flow to the host country.

Choosing between trade and FDI

Most developing countries use a mix.

• Trade for sustainable long-run growth, especially once the country has diversified beyond primary commodities.
• FDI for capital, technology and jobs, especially in manufacturing and services.

The two reinforce each other: FDI often builds the productive capacity a country then exports from, and open export markets are part of what attracts multinationals in the first place.