Emerging countries, their growth

and indebtedness and the risk of

crisis
Chapter 2
 What we are going to see in this
chapter
This chapter is oriented towards
development economics
• 1) The mechanism of non-development
• 2) Characteristics of developing countries
• 3) Indebtedness and crises
• 4) The various forms of capital flows
• 5) Case study: South-East Asia, miracle
and weaknesses
 1) The mechanics of non
development

Small income Small market

Per capita No economies
of scale
Political instability
Weak protection of
property rights

Insufficient
Weak
Investment
productivity
Weak effiency

Little capital
Few qualified
labour
 Measuring the gap between rich
and poor nations
Population GDP GNI / capita GNI /capita
World Bank Statistics 2005 (million) (bn USD) Market rate PPP
WORLD 6438 44385 6987 9420
Low income countries 2353 1391 580 2486
Lower middle income 2475 4869 1918 6313
Upper middle income 599 3665 5625 10924
High income countries 1011 34466 35131 32524
LOW & MIDDLE INCOME 5426 9926 1746 5151
East Asia & Pacific 1885 3033 1627 5914
Europe & Central Asia 473 2191 4113 9142
Latin America & Carib. 551 2456 4008 8111
Middle East & North Africa 305 633 2241 6076
South Asia 1470 996 684 3142
Sub-Saharan Africa 741 615 745 1981
 Explanations to the previous table
• Purchasing power parity estimates versus
market rate estimates: goods cost the same in
all countries, but services cost less in poorer
countries; the PPP corrects for that. For Vietnam
in 2003, the market ex-rate was 15510 dong /$
whereas the PPP ex-rate was 2783 dong (x5,6)
• GDP versus GNI: the GDP reflects the incomes
paid by resident units to the factors of
production; the GNI reflects the incomes
received by the residents (including from
abroad). For Vietnam, the difference is marginal:
in 2005, GDP/cap = 631$, GNI/cap = 620$
 Do poor countries catch up with
rich ones? Convergence
• The small table below shows the evolution of the GDP
per capita between 1950 and 2004 for a limited number
of countries. France, Italy, Japan and Spain «converge».

0 1950 2004 growth/year

Argentina 6942 10939 0,8%
France 5921 26168 2,8%
Italy 4217 23175 3,2%
Japan 2188 24661 4,6%
Mexico 2709 8165 2,1%
Nigeria 726 1210 1,0%
Spain 2928 20977 3,7%
Sweden 8507 27073 2,2%
United Kingdom 8082 26762 2,2%
United States 11233 36098 2,2%
Venezuela 4809 7068 0,7%
 A graph with more countries and
the test of « beta-convergence »
Beta Convergence of some countries

7%
TAIWAN

6%
KOREA
CHINA
HONG KONG
5%
average yearly growthrate from 1960 to 2003

SINGAPORE
THAILAND MALAYSIA JAPAN
4%
SPAIN
ITALY
3%
GHANA FRANCE
BRASIL UK USA
2%
CHILE SWEDEN
MEXICO

1%

NIGERIA PERU
ARGENTINA
0%
KENYA VENEZUELA

SENEGAL
-1%
0 2000 4000 6000 8000 10000 12000 14000
GDP per capita in 1960 (in dollars of 2003)
2) Structural features of developing
countries
All developing countries are different, especially since
1960. But they keep several features in common:
b) Strong government intervention, bureaucracy
c) Past episodes of high inflation (« inflation tax »)
d) Weak financial institutions: opacity of markets, weak
governance of banks
e) Frequent controls of the foreign exchange markets, in
order to avoid excess volatility
f) High share of natural resources in exports
g) Civil society avoids reglementations and taxes ;
corruption
 Relation between corruption and
the level of development
GDP per capita and corruption 2003

3,0

2,5

2,0

1,5
index of control of corruption (Kaufman)

2
R = 0,7439
1,0
VIETNAM
0,5

0,0

-0,5

-1,0

-1,5

-2,0
100 1000 10000 100000
GDP per capita (dollars)
3) Loans, debt and development
• The developing countries need to invest,
however they have globally not enough savings
to do it by themeslves. Thus, they need to
borrow from rich countries.
• At present, 2755 bn$ debt. From the beginning
of the 19-th century until 1997, rich countries
financed the development of poorer countries.
However, since 1998, the USA became the
largest borrower in the world, in order to finance
their enormous trade deficit.
 3a) Capital flows to developing
countries
• There is an equality between insufficient
savings on the one side, and the deficit of
the trade balance on the other side.
Trade deficit = I – S
• External financing is normal because there
are plenty of profitable projects to finance
in less developed countries: they borrow
resources to invest them
 3b) But capital flows may be risky
• Loans granted by rich countries are not always
well grounded and may lead poor countries to
excess debt: non productive investments,
purchase of consumption goods etc.
• Poor countries may be in a situation where they
cannot repay their debts: there is a risk of
default.
• Vietnam had that in 1986, but many other
developing countries fell in default and ran into
crises
 3c) Three types of crisis
A) Debt crisis
B) Balance of Payments crisis
C) Banking crisis
• A) Debt crisis: suppose a country borrows each year 5%
of its GDP (T.Def = I – S). If lenders fear a default and
stop lending, the country should immediately reduce its
deficit of savings to 0% (either by reducing investment,
or by raising savings). This triggers a decline of demand
and output. The situation may be worse if lenders ask to
reimburse previous loans.  SUDDEN STOP
• B) Balance of payments (or exchange) crisis: in order to
avoid default, the country may use its foreign exchange
reserves. However, this is not compatible with the
previous level of the exchange rate, and the country may
be forced into devaluation.
• C) Banking crisis: holders of bank deposits, fearing a
dvaluation, may ask the conversion of their assets into
foreign currencies. These mass withdrawals from banks
may trigger a banking crisis; note that the financial sector
is in a fragile situation from the start.
• Conclusion: when all 3 forms of crisis combine, we may
have a « snowball effect » (each form of crisis reinforces
the others)
4) Various forms of capital flows to
developing countries
A first distinction is between « sovereign » and
private debts. A debt is sovereign when the
governement (or Central Bank) borrows or
guarantees a liability
b) Financing by loans:
• Bonds: frequent since 1990
• Bank loans : important in 1970-80
• Official loans (from the WB, ADB, EBRD etc):
they bear a low interest rate but are conditional
to the implementation of certain reforms
b) Financing by own funds:
• Foreign Direct Investments: creation or
acquisition of a local firmby a non-resident
enterprise. This is the prefered form of financing
for developing countries
• Portfolio investments: purchase of equity without
seeking the control of the local firm
c) The problems of « currency mismatch » and
« original sin »: developing countrie are obliged
to borrow in dollars or euros, whereas rich
countries borrow in their own currency. In case
of depreciation of their money, poor countries
see their debt rise
 5) Case study: South East Asia,
miracle and weaknesses
A) The miracle
• The case of South Korea (one of the poorest
countries in 1950): beginning of the reforms in
1963, abandon the Import Substitution strategy
and pass to Export-led growth strategy  GDP
multiplied by 10 in 40 years. Example followed
by Taiwan, HK, Singapore, then by others
• Explanations of the miracle: state intervention?
MNF?
• Common features: savings and investment
rates / schooling / low inflation / openness /
little external loans until the 90s
B) The weaknesses
• Productivity remains low (growth is due more to
the volume of factors of production than to
technology)
• Weak financial systems: insufficient regulation
and control by central banks
• « Crony capitalism » : opaque relations between
businessmen and government (Thailand,
Indonesia); financing of projects goes to non
productive investment (housing bubble)
• Legislative framework is lacking (no bankruptcy
law)
C) The Asian crisis
• Devaluation of the Thai Baht July 1997 by 15%.
This was anticipated, and triggered a decline in
for-ex reserves. The devaluation does not calm
down the fears and speculation continues
• Extension of the crisis to neighbour countries (all
the region is weakened by a recession in Japan)
• Dilemma: either let the moneys depreciate, or
raise interest rates. All countries (except
Malaysia) appeal to the IMF, which grants loans
but imposes severe reforms. Output falls in
1998, but new start in 1999, with depreciations
enhancing export rise and import decline
• Further consequences: Russian crisis in 1998 +
 End of the lesson
• Any questions?
• Exercise for next week