Globalization

Globalization has become a catchword in the new millennium. Globalization

is the process of placing and regarding a country’s economy as a part of global

economy. It implies increasing openness of economy. Liberalization is a first step

towards globalization of country.

WHAT IS GLOBALISATION?

Though globalization has become a buzzword I modern economics, it is yet

to be defined in a precise sense. People indistinctly refer to globalization as a

process of internationalization, multinational or transnational business,

globalization of market economy, high degree of openness and so on. Globalization

is a wider concept involving several issues and aspects of a global corporation.

Essentially, globalization is a philosophy of business coined by the multinational

corporations (MNCs) to their host countries in exerting their economic influence.

The philosophy of global business implies several characteristic features of

globalization, such as:

Global business outlook.

One economic entity, one people and one market on this globe.

Global approach to market, a free/unrestricted/competitive market.

Common use and application of advanced technologies.

Global quality standards in the production of goods and services.

Global perspective.

Global-orientation of management.

Global acceptability of products.

Global macroeconomic policies.

Global economic co-operation.

Worldwide advertisement and sales of products.

NATURE OF GLOBALISATION

Globalization means several things for several people. For some, it is a new

paradigm- a set of new methods, and economic, political and socio-cultural

realities in which the pervious assumptions are no longer valid. For developing

countries, it means integration with the world economy. In simple economic terms,

globalization refers to the process of integration of the world into one huge market.

Such unification calls for removal of all trade barriers among the countries. Even

political and geographical barriers become irrelevant.

At the company level, globalization means two things:

1. A company commits itself heavily with several manufacturing locations

around the world and offers products in several diversified industries, and

2. It also means ability to compete in domestic markets with foreign

competitors. In popular sense, globalization, refers mainly to multi – plant

operations.

A company, which has gone global, is called a multi-national (MNC) or a

transnational (TNC). MNC is, therefore, one that, by operating in more than one

country gains R&D, production, marketing, and financial advantages in its cost and

reputation that are not available to purely domestic competitors. The global

company views the world as one market, minimizes the importance of national

boundaries, sources raises capital and markets wherever it can do the best.

To be specific, a global company has three characteristics:

1. It is a conglomerate of multiple units (located in different parts of the globe)

but all linked by common ownership.

2. Multiple units draw a common pool of resources such as money, credit,

information, patent, trade names, and control systems.

3. The units respond to some strategy.

Nestle International is an example of an enterprise that has become

multinational. It sells its products in most countries and manufactures in many.

Besides, its managers and shareholders are from many countries. The other MNCs

whose names can be mentioned here are IBM, GE, McDonald’s, Ford, Shell, Philips,

Sony, and many more.

WHY DO COMPANIES GO GLOBAL?

The primary motive for going global is that there is money in the overseas

markets. Other U.S. giants such as McDonald’s have made massive penetration

into foreign markets. In 1994, McDonald’s experienced six percent increase in

domestic sales, but its foreign sales accounted for half of its overall volume.

The other reasons for seeking international markets are:

1. The rapid shrinking of time and distance across the globe, thanks to faster

communication, speedier transportation, growing financial flow, and rapid

technological changes.

2. It is being realized that the domestic markets are no longer adequate and

rich. Japanese flooded the U.S. market with automobiles and electronics

because the home market was not large enough to absorb whatever is

produced. Some European countries have gone global for similar reasons.

Ciba-Giegy, for example, could not survive only in Switzerland where

population is just six million. It was forced to go in search of international

markets and has consequently set up overseas production facilities.

3. Raymond Vernon has propounded a theory explaining why companies go

international.

BENEFITS OF GLOBALISATION:

For successful globalization countries need to chalk out strategies and

policies to open up the doors for the inflow of foreign direct investment (FDI). The

FDI by the MNCs brings with it flow of foreign capital, inflow of technology’ real

capital goods, managerial and technical skills and know-how.

Globalization can easily promote exports of the country by exploiting its

export potentials in a right way. Globalization can be the engine of growth by

facilitating export-led growth strategy of a developing country. ASEAN countries

such as Indonesia, Malaysia and Thailand have demonstrated their success of

export-led growth strategy supported by the FDI under globalization approach.

Globalization can provide sophisticated job opportunities to the qualified and

also check ‘brain drain’ in a country.

Globalization would provide varieties of products to consumer at a cheaper

rate when they are domestically produced rather than imported. This would help in

improving the economic welfare of the consumer class.

Under globalization, the rising inflow of capital would bring foreign exchange

into the country. Consequently, the exchange reserves and balances of payments

position of the country can improve. This also helps in stabilizing the external

value of the country’s currency.

Under global finance, companies can meet their financial requirements

easily. Global banking sector could facilitate e-banking and e-business. This would

integrate countries economy globally and its prosperity would be enhanced.

DEMERITS OF GLOBALISATION:

1. Globalization is never accepted as unmixed blenings. Cities have pessimistic

views about its ill-consequences.

2. When a country is opened up and its market economy and financial sectors

are well liberalized, its domestic economy may suffer owing to foreign

economic invasion.

3. A developing economy when lacks sufficient maturity, globalization may

have adverse effect on its growth.

4. Globalization may kill domestic industries when they fail to improve and

compete foreign well-managed, well-established firms.

5. Globalization may result into economic imperialism.

6. Unguarded openness may become a playground for speculators. Currency

speculation and speculators attacks, as happened in case of Indonesia,

Malaysia Thailand, Philippines etc recently may led to economic crisis. It may

lead to unemployment, poverty and growing economic inequalities.

OPPORTUNITIES OF GLOBALISATION:

Despite its some shortcomings, benefits of globalization are likely to

outweigh their drawbacks.

Globalization essentially provides greater opportunities for the faster growth

and economic development of the country and improve economic welfare. It

provides wider and large-scale economic activities and employment opportunities.

In a planned economy such as India, an indicative planning of desirable

globalization process can be great use. India’s perspective planning for foreign

investments and entry of MNC’s should be positive towards modernization of India.

Besides, Research and Development (R&D) as well as technological up

gradobious should be an integral part of India’s liberalized planning towards

market economy.

In short, globalization implies undettered business activities and interaction

among the firms and people with a global approach. It needs change in the

outlook. It requires relaxing of control and regulations. It is heartening to note that

an awareness of the government in India is on this line. Relief to foreign investors,

new industrial policy, new trade policy, new fiscal policy, banking reforms, FERA

and MRTP relaxation, acceptance of WTO agreements etc all suggest a positive out

look of Indian policy-makers towards globalization. Indian government has

assumed the role of promoter, care taker and regulator of market economy in the

country in a desirable manner. Journey has begun. Destination is yet far.

PROBLEMS OF GLOBALISATION:

The current waves of liberalization and globalization have their pros and

cons.

World economy started developing very fast during 1980s till mid 1990s.

European countries, ASEAN nations, Mexico, China, etc have experienced a record

growth rate of nearly 8-10 per cent per annum. There has been quantum jump in

Foreign Direct Investments (FDI) in most developing countries. There has also a

remarkable flow inflow of foreign capital-short –term as well as long term. Portfolio

investment, i.e, investment in secondary share markets had increased due to a

large investment of funds in the capital markets had increased due to a large

investment of funds in the capital markets undertaken by the private foreign

financial sector in developing countries.

Due to expansionary monetary policy, credit was liberally and cheaply

available .This has resulted into hot money problem when the country is overhead

by undue expansion of money supply.

Mexico had seen its worst days of economic crises in 1982 onwards. The

country had to devaluate its currency and beg finance from IMF.

India experienced economic crises in 1991,but due to timely financial

assistance of the IMF and economic reforms implemented by the Government of

India, the country could overcome the problems and now managed to have a

steady growth rate of over 5 per cent per annum.

In 1997, ASEAN countries have suddenly fallen into the trap of currency

crises followed by financial and economic turmoil.

CAUSES OF 1997 ASIAN CRISES

The currency and financial setback of the East Asian economics

following the Thai Baht devaluation in July 1997 indicates a significant watershed

in the economic chronicle in these countries.

Several factors have been attributed for currency crises and financial turmoil

leading to an economic recession in countries such as Indonesia, Philippines and

Thailand. Major cause have been identified as follows:

1. Large short-term capital inflows: portfolio investment in capital markets.

2. Fixed exchange rates regims as in the case of Thailand where Baht was

pegged with US dollar are 1$=15Baht.

Investment boom in wrong or less productive sectors.

Asset price bubble.

Rising current account of deficts.

Accumulation of a large stock of short-term foreign liabilities.

Reckless borrowings of banks from abroad and accumulative

leadings.

Unchecked fast domestic financial liberalization which

resulted into a growth of weak and fragile financial system.

External capital account liberalization permitted massive

capital inflows prompted by internationally low interest rates.

Lack of prudential supervision and regulation of the emerging

financial system added fuel into the flame.

In the absence of securities market, current account deficits in

this countries were financed through banking system

intermediation-banks obtained short-term foreign loans to

meet the growing demand. But they failed to hedge large

country positions in proper ways, assuming that fixed/stable

exchange rate will remain.

Resulted currency/exchange crises further increased the real

burden of foreign currency debt.

The governments in the region, as in Thailand, when failed to

undertake prompt structural reforms lead to uncertainity

causing widespread capital outflows and furhter fall in

exchange rates.

Over capacity and poor cash flows in sectors such as

telecommunication, real estate, transportation and a part of

manufacturing sector in the countries have weakened the

macro economic fundamentals –which also implies the failure

of market system to most productive using the resource

allocation. There has been a progressive decline in the rate of

return on assets in major economic sectors.

The cumulative current account deficit, propelled by the

investment boom under wrong development strategies could

not be sustained at the level of the exchange rates prevailing

before the crises in some part of the region.

Experience of success over the last two decades developed

thinking in these countries to take prosperity for granted.

Economic crises in Thailand lead to political instability which

leads to further capital flight that reinforced the economic

crises. Indonesia also passed through a similar outcome of

people’s unrest.

Central banks in these countries found it difficult to intervene

to defend their currencies because it involved high costs in

term of high unemployment and insolvency.

REGIONAL TRADE BLOCKS:-

Concept of Regional Economic Integration:-

Regional economic integration is a new and striking idea for the expansion

of foreign trade among the developing countries. These countries seem to have

hypotinised by the success achieved by the European Economic Community (EEC)

as a means of trade expansion in their area. Particularly, in a view of their national

markets being rather narrow for the successful operation of the modern

industrialization and implementation of technological innovations, it is conceived

as a regional market to enhance modern industrial development and also to

achieve economics of scale in the respective member nations.

ADVANTAGES OF REGIONAL GROUPING:-

The healthy effects of such a regional economic integration are

presumed to be as follows:

Since a regional common market obviously provides a much larger

market that offered by the domestic market of a single country,

economies of scale, both internal and external, become possible with the widened

size of the market.

Secondly, the large market so created would permit of high degree

of sophistication and specialization of products conducive for

furtherance of modern industrial development. Moreover, the possibility

of specialization for regional trade would encourage the flow of

investment into industries which have a comparative cost advantage, so

that gains from international trade should rise.

Apart from an increase in the volume of total trade as a result of

such an integration, a favorable change in the cost and price structure

may also be effected along with the desirable change in the structure

and composition of foreign trade.

Furthermore, this may facilitate the realistion of the optimum

allocation of resources, and thus, lead to an increase in efficiency in

production.

Above all, the increased possibilities of competition in a regional

common market would ensure that all benefits accruing to the producers

from the existence of a large market would be passed on to the

consumer.

In fine, thus, there can be an increase in the general welfare due

to better production and enhanced consumption, and a rise in real

income generated by the overall growth and development.

In short thus, it has been conceived that, as a factor in the

development of the less developed countries, a regional common

market is far superior to the relatively small a national market sheltered

behind a protectionist tariff wall.

SOUTH ASIAN ASSOCIATION FOR REGIONAL CO-OPERATION

(SAARC)

In recent years, the global economy is witnessing certain dynamic and

unprecented changes. Regional economic integration becoming its

prominent feature. In the South Asian Association for global economic

system, South Asian Association for Regional co-operation (SAARC) is

the youngest regional grouping among the seven Asian countries,

namely, India, Pakistan, Maldives, Sri-Lanka, Bangladesh, Bhutan and

Nepal, came into existence in the first summit at Dhaka in 1985. This

group comprises of overall one-sixth of the world’s population. Nearly

50% of the world’s poor dwelve in this region.

OBJECTIVES OF SAARC: -

To promote the socio-economic welfare and cultural development of

people in the region.

To achieve the goal of collective self- reliance.

To encourage active collaboration in the economic social, technical

and scientific

fields among the grouping nations.

To strengthen over all co-operation and harmonious economic and

political

relations among the countries of the SAARC.

To facilitate optimum utilization of human and material resources.

To develop free regional trade.

To stimulate investment flows and accelerate pace of economic

development.

The progress of SAARC, in general has reminded very slow due

to lack of adequate consequences among the countries. For the success of SAARC

co-operation the countries should undergo preferential trading arrangements, open

data bank, start joint R&D programe and develop a common support service

programme.

THE ESCAP:-

The Economic and Social Commission for Asia and the Pacific(ESCAP)

constitutes a widest regional block, with 48 member countries and 10 associate

members, having a geographical coverage from Azerbaijan in the west to the cook

islands in the east and from Mongolia in the North to Australia And New Zealand in

the South.

The ESCAP is meant to provide a beacon light to the developing

world.

The structure of the ESCAP was revised at the 48th session held in

Beijing in April 1992. The 50th session of the ESCAP was hosted by India during 5-

13 April 1994.

Infrastructure development was the main theme of this session.

Several thematic committees were to discuss the issues such as regional economic

cooperation environmental and sustainable development, poverty alleviation

through economic growth and social development, transport and communication

needs and the special requirement of the least developed and land-locked

developing countries.

The ESCAP region is sub-divided into:-

1. Pacific Island countries

2. The developing ESCAP countries

3. ASEAH-4 countries

4. The developed ESCAP countries

5. China and the newly industrial economies

6. South Asian Countries (Bangladesh, India, Pakistan, Maldives, Sri-

Lanka, Bhutan and Nepal)

The ESCAP is the regional arm of the UNO in promoting Economic and Social

development of the region.

The Economic and Social Commission for Asian and Pacific (ESCAP) has

promoted regional cooperation in a significant way. It has helped in creating an

integrated communications infrastructure in the Asian region. The Asia Pacific

region is considered to be the main growth machine of the world economy in the

forthcoming century. A special emphasis is put on infrastructure development as a

key to economic growth and regional economic cooperation in the New Delhi

Declaration of Action Plan for collective efforts to ensure economic growth and

social development of the Asia – Pacific plans.

The Action Plan on Infrastructure development contained the following main

recommendations for the necessary action at the country level.

1) Upgrading information and reform of the administration of

infrastructure facilities.

2) Modification of consumption pattern.

3) Effective planning, priorization and investment infrastructure

projects.

4) Participation of the private sector.

5) Mobilization and allocation of public sector resources.

6) Human Resource Development (HRD) to be integrated into the

infrastructure development process.

7) Poverty Alleviation.

Similarly the action plan at the regional levels include:

Technical assistance

Data collection

Comparative studies

Identification of projects

Human resource of development

Inter agency cooperation etc.

GULF COOPERATION COUNCIL (GCC)

The GCC represents an economic integration among Kuwait, Oman, Qatar,

Saudi Arabia, and United Arab Emirates(UAE) in the middle east. It was basically

formed for the political and strategic reasons. Since these countries have limited

economic base, gains from trade creation activity is limited in scope.

THE EUROPEAN ECONOMIC AREA

The European Economic Area came into existence on the new year

day of 1994. It is the largest economic to block ranging from The Artic to the

Mediterranean capturing the market constituting 372 million people. It is a

furtherance of European integration with the EFTA countries seeking close trading

like with the Euro, Australia, Finland, IceLand, Norway, and Sweden among the

EFTA numbers have joined the EEA.

Two EFTA members Liechtenstein and Switzerland, however, did not

join the group.

NORTH AMERICAN FREE TRADE AGREEMENT (NAFTA)

It is the extension of the Canada- US Trade Agreement(CUSTA)

framework. Negotiations about it began in 1991 for the creation of a market

of 364 million people. It is the series of bilateral agreements between

America, Canada and Mexico. NAFTA commenced from January 1994.

Under the NAFTA provisions, all Tariffs and Quotas as manufactured

and agricultural goods are to be eliminated within 5 to 15 years of transitional

period. Restrictions on direct foreign investment between the NAFTA members will

be lifted. Intellectual Property Rights (IRPs) are to be protected in the member

countries. Mexico is to open up for the entry of the US financial services in the

country. Chile and other Latin American countries have great hopes in joining the

NAFTA in future.

ASSOCIATION OF SOUTH EAST ASSOCIATION NATIONS (ASEAN)

The origin of ASEAN lies in Association of Southeast Asia (ASA) proposed

by Malayan Prime Minister Tunku Abdul Rahman in1959. The ASA was short lived

because of territorial and political disputes among the member countries. Concrete

efforts for regional economic cooperation were further reviewed by the ASEAN

Declaration of 8th August 1967 which states that one of the aims of ASEAN is: “to

accelerate economic growth in the region through joint endeavors in the spirit of

equity and partnership in order to strengthen the foundation for a prosperous and

peaceful community of Southeast Asian Nations.

The ASEAN land area and population are larger than the15-nation

European Union. It represents the most longstanding and successful regional

grouping for economic integration and peaceful coexistence. The recent move of

ASEAN Free Trade Area (AFTA) and ASEAN regional forum has shown its zeal

towards global integration.

In fact, foreign trade is the life-blood of the ASEAN economies- both as a “

Rent for Surplus” and as a “source of Need.” The ASEAN group had undergone a

long transition period of accumulation which has sewed as a pathway to economic

transformation and progress. The Bangkok summit Declaration has aspired new

vistas and hopes. Market forces has a contributory role in promoting ASEAN

economic cooperation. The ASEAN by and large encourages global approaches to

international economic issues and problems. It has sewed complementary rather

than contradictory to globalization process towards new century.

INTERNATIONAL CAPITAL FLOWS:FOREIGN DIRECT INVETMENT:-

International exchange transactions are not only confined to

commodities, but include international movement of capital funds as well.

International capital movements, however, should not be identified with the

payments for imports. Capital flows internationally as a factor of production for the

sake of suitable investments and as aids to the lessdeveloped countries. Indeed,

international investment has played a significant role in the economic upliftment of

many countries in the last few decades.

Classification of International Capital Flows:-

International capital movements may be classified as follows:

i. Home and Foreign Capital;

ii. Government and Private Capital;

iii. Direct and Portfolio Capital;

iv. Short and Long Term Capital; and

v. Foreign Aids.

Home and Foreign Capital:- On the balance of payment of a country an

explicit distinction is made between home capital and foreign capital. Home

capital refers to investments made abroad by the residents of the country

concerned, while foreign capital refers to the investments made by the

foreigners in this country. Thus, the former implies outflow of capital and the

latter implies inflow of capital funds in the balance of payments account of the

country under consideration. Apparently, the net investment position of the

country can be known by the algebraic difference between the debits and

credits o both types of capital investments.

Government and Private Capital:- When in investing capital abroad, the

investor( whether government or private body) keenly participates in

organizational matters, it is referred to as direct investment. For instance, direct

ownership and organization of a foreign factory, mines, sales agency etc, are

cases of direct investment. If however, the investor has only a sort of property

interest in investing the capital funds in buying equities, bonds, securities or

depositing with commercial banks abroad or so, it is referred to as portfolio

investment. Under portfolio investment the investor does not migrate with his

capital and his basic interest remains in the earnings of interest or dividends

abroad or to make speculative gains in buying foreign bonds, equities and

securities. While under direct investment of capital, Investor’s migration is also

very frequent.

Short and Long- term Capital:- A short-term capital is embodied in a credit

instrument which is redeemable within 1 year. For example, chequable bank

abroad is a short-term capital. Similarly, foreign bonds, which mature within a

year, also constitute short-term capital. Short-term capital movements are

usually speculative in nature.

Long-term capital, however, refers to such credit

instruments which have a maturity period of more than 1 year or no maturity at

all but consist a title to ownership, such as share o stock and other equities or a

deed to property. Long-term capital flow is perpetual and stable over a period of

time.

Foreign Aids:- Foreign Aids refers to transfer payments which are unilateral

gifts for aid. The receiving country has no obligation whatsoever the grants

made by the donor country. Usually, developed countries give such aids to

developing countries for their development planning. The aid may sometimes

may also be given for the military purposes also. Generally, aids are given for a

specific use and it must be fulfilled by the recipient country.

FACTORS AFFECTING THE INTERNATIONAL CAPITAL FLOW :

The factors are as follows:

i. The Rate of Interest:-

The differences in the rate of interest between countries serve

as the most important stimulus to export and import capital. Capital will flow

from low-return yielding country to the high-income yielding country, because a

country which has a low rate of interest apparently finds it profitable to export

capital to the country in which the interest rates are high.

ii. Speculation:-

Speculation may also determine the short-term capital flow

between countries; Speculation may also pertain to either expected change in

interest rate or anticipation of change in the rate of exchange. When people

expect rate of interest to rise at home in future, they would like to take advantage

of the consequent lower bond price then, but presently they will invest in abroad in

short-term securities. Thus, when a country expects a rise in interest rate in future

it will experience an outflow of capital for the present. Contrarily, when a country

anticipates a fall in interest rate in future, it pays foreigners to buy bonds and

securities at their current low price and sell them later on at a high price.

Eventually it will experience an inflow capital.

iii. Bank Rate:-

Since bank rate has a link with market rates of interests, the

central bank can use the bank rate as means of including short-term capital flows.

The raising of bank rate may thus stimulate an inflow of capital or prevent the

flight of capital abroad.

iv. Marginal efficiency of Capital:-

For investing abroad the entrepreneurs may compare the marginal

efficiency of capital against the rate of interest between different countries and in

different areas of investment. Thus, the country, which has a marginal efficiency of

capital, will attract an inflow of capital. Likewise a particular field of long-term

investment will be chosen where the expected rate of returns is higher than that of

alternative investments abroad.

v. Political Environment:-

Apart from good prospects for foreign capital, if a

country has political stability and internal and external peace, so that economic

and social progress is maintained, it will experience a better inflow of long-term

direct investment than otherwise.

vi. Government’s Policy:-

I the government is bent upon nationalization and

expansion of public sector and adopts a hostile attitude towards foreign capital,

private foreign capital will not move into such a country. On the other hand if

government adopts an encouraging policy in respect of foreign capital, it may

include inflow of foreign capital.

vii. Economic Climate:-

Overall healthy economic position of the country, such

as development of infrastructure of the economy, growth of financial

institutions, availability of trained and skilled labour and other production

facilities will play a significant role in attracting inflow of capital from abroad.

Similarly certain unexploited fields of exporting industries like plantations,

mines, etc also provide a good attraction to foreign investors.

viii. Tariff Policy:-

A high procedure duty may person foreigner’s export to

such country, so it will be profitable for the foreigner to start production in the

protected country to complete with domestic producers, A direct foreign

investment is thereby attracted.

ix. Exchange Control Policy:-

A country restoring to serve exchange control will put

automatic restriction on the outflow of capital abroad.

x. Business Conditions:-

Capital will tend to flow from a country experiencing

depression into a country which is in prosperity.

THE ROLE OF INTERNATIONAL CAPITAL MOVEMENTS:

In traditional economic, capital movements were treated merely as

international balancing items in a country’s balance of trade. It was held that a

creditor country having a surplus in its current account in order to balance out its

total payments account will invest or lend capital to deficit or debtor countries.

Apparently, debtor countries with deficit in current account will borrow from the

surplus countries in order to even out their balance of payments. Consequent

upon foreign capital movements, thus a credit in current account while to a deficit

country there will be a corresponding borrowing position on its capital account.

Modern economists, however, are of the view that capital movements are

much more than merely balancing items. In reality, all international capital

movements are not dependent upon the balance of payments deficit and

surpluses. A significant portion of capital flow may also be independent of the

balance of trade position which, in fact, is based on judgements, financial

decisions, and discretions of lenders and borrowers in the international money

markets. Where a country has a surplus in its current account, there will be an

outflow of capital funds to deficit countries, hence its holdings of short-term capital

and its foreign and banking reserves will be depleted, while a deficit country will

find an improvement in these holdings on account of the inflow of capital.

Again, if a country has invested its capital abroad, it receives income in the

form of interest, dividends, etc., which can be profitably used to finance its current

deficits, which thus help in balancing its balance of payments account.

It has also been maintained that unrestricted international capital

movements tend to equalize the rates of interest and profits between countries. As

a matter of facts, discrepancies in the rate of interest induce international flow of

capital. When there are checks on the movements, capital tends to flow from a

capital-surplus nation to capital-deficit nation on account of high yields in the later.

Eventually, interest rates in the capital-exporting country will be enhanced, while

in the capital-importing country it will decline. A condition of equilibrium in the

international flow of capital exists when interest rates and profit yields in different

countries are equalized. In practice, however, there are always some restrictions

on impediments to the free movement of capital which prevent such complete

equilibrium to emerge. Moreover, apart from the rate of return on investment,

many other factors such as risks involved, industrial and general economic policy

of the foreign government, political relations between countries, international

treaties and agreements on trade and commerce, etc., influence the investment

decisions on foreign capital.

Indeed, capital movement, especially direct investment and foreign aid plays

an important role in the economic development of backward countries. External

assistance is an important source of capital formation and finance resource for

planning of project in the capital-deficit poor country.

FDI

1. Through foreign direct investment(FDI)corporations extend their business

activity into foreign countries.

2. The main object of FDI is to acquire or retain control markets and/or

productive resources.

3. Main areas of FDI are: oil, coal & ores, as well service sector including

banking / finance, legal services, marketing and distribution.

Thus, capital movement in the form of foreign investments is advantageous

to the economies of both the lending and borrowing nations.

To the lending country, foreign investments may prove to be an additional

source of supply of the required products when investment is made in the

exporting industries abroad. Lending of capital raises the purchasing power of

borrowing nations in the foreign markets which may enable the lender country to

increase its exports. And when it is a tied loan with a condition that the proceeds

should be spent only in the lending country, it will definitely be a means for

enhancing its exports. Further, in the long run, with the help of foreign capital

when the borrower country’s productivity and income increases, their import

propensity may increase which may help in pushing up the exports of the lending

country further.

Similarly, the borrowing country entails the following benefits from foreign

capital:

I. The country can exceed its imports over its exports with the help of borrowed

capital without experiencing much difficulties of foreign exchange resources.

Foreign capital thus helps to offset temporary balance of payments deficits

experiences by the borrowing country.

II. Foreign capital can serve as an additional source of capital formation in a

capital-deficient country. Without curbing its current consumption level, the

borrowing nation can accelerate its pace of economic development with the

help of foreign assistance.

III. Direct foreign investment bring entrepreneurial talents and technical know-

how to a poor country which lacks such pre-requisites of growth.

IV. A country for defence purpose can make use of foreign capital as a source of

financing war.

V. The borrowing nation may use the proceeds of a foreign loan in buying gold

from abroad so that its monetary base is strengthened and it can increase its

domestic money supply. With the expansion of money supply, monetary

demand for domestic output may increase so that the price of domestic goods

may rise in relation to imported goods under the inflationary motion.

Resources in exporting industries would then be diverted to domestic

consumption goods industries. Further, imports of this country will also

exceed. Thus, over a period of time an international loan implies a transfer of

real goods to the borrowing nation.

In fine, the significance of capital movement lies in the fact that such

movement may tend to affect the income of countries involved, as capital flows

induce changes in investment expenditure which determines the level of income,

and when the level of income is affected changes in the level of imports and

exports of the countries concerned may also be caused due to their being the

functions of income. The change in the import of related countries caused by

capital movement depends on their marginal propensities to save and to import.

Indeed the increase in the imports of countries concerned will be larger when

their marginal propensities to import are greater and their marginal propensities to

save are smaller. Thus, capital flows directly influence foreign trade of the related

countries. With the outflow of capital, if a country’s expenditure is decreased while

that of receiving country’s increased, then the size of imports will either expand or

contract, depending on the respective degrees of the propensities.

Above all, capital flow may also play a significant adjusting role in respect of

several types of disturbances, such as differences in the timing and amplitudes of

the trade cycles between countries of their differing rates of growth.