Describe persistently unequal world distribution of income and the evidence on

its causes
Summarize the major economic features of developing countries
Explain the position of developing countries in the world capital market and the
problem of default by developing borrowers
Recount the recent history of developing-country currency crises and financial
crises
Discuss proposed measures to enhance poorer countries gains from
participation in the world capital market

The world unequal distribution of income originated from 1960. Catch up has
since begun from then and countries like Ireland, from 54% poorer than United
states in 1960 to 3 % poorer in per capita income measurement. Suggesting a
theory of converging of the world national income?
One possible reason is the free movement of capital, and they tended to flow to
the emerging markets since they have more potential for growth higher
capital returns. //This difference could be overstated due to higher
unemployment rates and lower labor-force participation rates than the US.
No clear tendency for per capital income to converge. Several sub-saharan Africa
countries still remain at the bottom, latin American countries slowed and only a
few countries (Brazil and Chile) surpassed US growth rates.

Asia on a whole did very well, and tended to grow at rates above the
industrialized world. Those countries that sharply diverge to the higher income
brackets have strong fundamentals in their political and economic systems and
improve on them to respond to world and countrywide crises. Structural
features are imperative to other objectives such as low inflation, low
unemployment and financial-sector stability


Most developing countries are characterized by at least some of these historical
features
1) History of extensive direct government control of the economy, including
restrictions on international trade, government ownership or control of
large industrial firms, direct government control of internal financial
transaction and a high level of government consumption as a share of
GNP. Role of government in the economy has been reduced over past
decades
2) History of high inflation. Many countries, the government was unable to
pay for its heavy expenditure and losses of state-owned enterprises
through taxes alone. Tax evasion was rampant and much economic
activity was driven underground. Government sought to earn money from
printing money and spending (seignorage) resulting in hyper inflation
3) Domestic financial markets liberalized, weak credit instituitions often
abound. Risky lending as loans are made based on personal connections.
Bank supervision tend to be ineffective due to incompetence,
inexperience and outright fraud. Causing ineffective use of savings for
investment purposes. Prone to crisis
4) Where exchange rates are not pegged, they tend to be heavily managed.
History of allocating foreign exchange through government decree, which
is termed as exchange control. Most developing countries restrict capital
movements by limiting foreign exchange transactions.
5) Natural resources or agricultural commodities make up important share
of exports. However due to fear of losing terms of trade and high poverty
levels prompt emerging markets to move resources out of primary
exports into import substitues
6) Attempts to circumvent controls, taxes and regulations causing
corruption. Leading to wastage of resources that can be channeled to
generate income. Corruption and poverty go hand in hand

Economics of financial inflows to developing countries
Many developing countries have received extensive financial inflows from
abroad and carry substantial debts to foreigners; much of this borrowing
can be explained by the incentives for intertemporal trade (chap 6). Low
income countries generate too little savings to invest, henceforth must
borrow from abroad. In capital rich country, savings is high but investment
opportunities are low. Henceforth the flow
However, when loans are made to unprofitable investment, may result in
non-repayable debt. Faulty government depress national saving rates may
lead to excessive foreign borrowing. (*recent strong desire to accumulate
international reserves.
Causing default, when the borrower without the agreement of the lender,
fails to pay on schedule
Countries such as American states have defaulted on European loans in the
19
th
century. They had repayment problem. Soviet union repudiated
foreign debts and closed the economy to the rest of the world. Great
depression, world economic activity collapsed. Nazi Germany defaulted of
the debt.
Resulting in sudden stop: losing access to all the foreign source of funds +
debtors ask for prompt payment + bank runs. The panic of irrational lender
would make default a real possibility. S-I = CA. When people cut lendings
(KA = 0) Force CA to increase S-I > 0 consumption/G/I decreases.
y<0.
Creating bank runs: Foreign exchange reserves are needed to pay off
foreign short term debts. Running down official reserves causing ort to
be negative. CA + KA + ORT will cause BOP to decrease. Resulting in a
possible balance of payment crises. Government cannot peg (loss of
exchange), banks get into trouble as domestic and foreign depositors,
fearing currency depreciation withdraw funds and purchase foreign
reserves. Large scale withdrawals push them to brink of failures.
Triplets go hand in hand together

When a government default, it is called a sovereign default.
Conceptually different situation is when the private domestic borrowers
cannot pay their debts to foreigners government may need to bail out private
sector by taking foreign debts
Alternatively, the government may provoke private defaults by limiting
domestic residents access to its dwindling foreign exchange reserves. Makes it
harder to pay foreign debts. Need to be involve with negotiations
Free flow of private capital expanded after 1970s. Financial inflows can take
several forms. Five major channels to finance their external deficit

Bond finance sold bonds to private foreign citizens to finance debts
Bank finance - borrowed extensively from commercial banks in advanced
economy
Official lending = from interbank organizations/ world bank
FDI sale of financial assets = FA
Portfolio investment in ownership of firms Selling to private owners large
state owned enterprise
Debt (liabilities) financing v.s. Equity (sale of assets) financing debt financing
will leave a developing country much less vulnerable to risk of foreign lending


Original sin
Developing countries incur debts to foreigners in foreign currency
Due to developed economys fear of extreme devaluation and inflation
Also, richer countries typically borrow in their currency
Ability to denominate debt in their own currency
When the BOP is in deficit, reduces your ability to pay, currency will depreciate.
Assets are denominated in foreign currency, so your assets appreciate.
Debts are in domestic currency, so your liabilities decreases.
Fall in world demand for US goods substantial wealth transfer
international insurance.
For developing countries, the converse holds true
Secondly, developed countries can simply reduce real resources owed by simply
depreciating its currency.

Debt crisis of the 1980s
Due to an adjustable-rate dollar- denominated debt immediate and
spectacular rise in interest burden magnified by the dollars sharp
appreciation. Started with mexico, seeing potential similarities, banks in
industrial countries cut off credits and demand repayment on other latin sates
Soviet bloc were also hit by borrowing from European banks. African countries
debt were to the IMF and world bank. Most of east asia countries can maintain
economic growth and avoid rescheduling of debt. A coordinated lending
response was the best assurance that earlier debts would be repaid. Resolved
only when US insisted American banks to give some form of debt relief to
developing countries.

Saw a renewed private capital flows
Low interest rates in US renewed capital flows. + government want to
deregulate market and lower trade barriers.
1980s no growth in latin America promising young policy makers which
are well-trained economist looked at their mistakes and East Asias policies in
place to avoid the crisis made reform attempts.
Argentina
Many reforms with the most significant being the convertibility law
Dramatic effect on inflation, dropped from 800 percent to 5 percent. But due to a
steep appreciation of the American dollar argentina pesos have to appreciate
unemployment and current account deficit. Although no more appreciation,
unemployment remained high due to rigidities in the market world economy
slipped into recession foreign credit dried up. Output fell by 11%

Brazil
Introduced the new currency, the real and pegged to the dollar. Then shifted to
upwardly crawling peg due to steep real appreciation. Inflation dropped.
Reduced import barriers, privatize and fiscal retrenchment. Debt repayment +
high appreciation drain reserves. Devalue the real by 8%. Recession followed
but short lived, inflation did not take off. Brazil elected a populist president. Key
factor in brazil success due to strong commodity exports to China.

Chilean
More consistent reform. Remove bailout guarantee, crawling peg to bring
inflation gradualy, but system operated flexibly to avoid extreme real
appreciation. Limit real appreciation of funds by restricting capital inflows.
Reduce the risk that a sudden withdrawal of foreign short term funds would
provoke a financial crisis. Chile policies paid off handsomely

Mexico
Introduce broad stabilization and reform program
Aggressive reduction in deficits and debts with exchange rate targeting and wage
price guidelines negotiated with representatives of industry and labor unions.
Made significant commitment to free trade.
Kept a level ceiling to prevent possible appreciation but announced a gradually
rising limit of the currencys allowable extent of depreciation. Fluctuations was
permitted to increase over time. Held near its appreciation ceiling, appreciated
sharply in real terms, and a large current account deficit emerged. Forex fell to
low levels, and civil strife, looming presidential transition and devaluation fears
contributed to this fall. Foreign reserve leakage was a continuing extension of
government credits to banks experiencing loan losses. Quickly privatize its banks
without adequate regulatory safeguards. Opened its capital account. Banks were
confident about bailout if they met trouble. Hoping to spur growth and reduce a
current account deficit, devalued. Speculators attacked the devalued currency
peg retreated to a float. Investors panicked and sell even more pushing
pesos down. Unable to borrow at penalty interest rates. Avoided disaster with
$50 billion emergenecy loan. Inflation soared due to depreciation.
Unemployment more than doubled due to discal cutbacks, sky high interest and
a generalized banking crisis. Regained access to K and repayment ahead of
schedule. Expanding its democratic instituitions.

Asias high growth
Have high rates of savings and investment, rapidly improving educational levels
and high degree of openness to and integration with world markets. Financed
bulk of their high investment from savings. Popularity in emerging markets lead
to substantial lending to developing asia. Hence causing large current account
deficits precursor to a crisis similar to the one that had hit mexico in 1994.
Experienced severe financial crisis. Issues stood out from previous latin
American countries case study.

1) productivity limit in expansion is apparent. Simply explained by rapid
growth of production inputs. Output per unity input is low. Most of the
income per capita come from a shift of workers from agriculture to
industry, a rise in educational levels, and massive increase in capital-labor
ratio within non agricultural sector. Continuing high rates of capital
accumulation would eventually produce dimishing returns, large financial
inflows were not justified by future profitability (south korea)
2) Banking regulation Poor state of banking regulation. Know that they will
be bailed out by the government. Moreover, they are not subjective to
effective government supervision over the kind of risks they are
undertaken. Moral hazard + easing of access to financial inflow + foreign
money was readily available to banks and corporate borrowers (original
sin). Despite high savings rates, east Asian countries were led to invest so
much current account deficit prior to crisis. Excessive dubious lending
poor quality investment spiral of declining prices and failing banks
3) Lack of effective legal framework to deal with companies that go
bankrupt. When economy turn bad, troubled companies would stop
paying debts. Since nobody would lend to them, creditors lacked legal
power to serize the limping enterprises.

Asian financial crisis
Started because Thailand made several dubious lending to construction
companies who cannot payback. Thai baht has devalued and speculation sent
the currency to downward spiral. Foreign exchange reserves are greatly lost. But
only controlled 15%, so the depreciation plunge further.
Thailand itself is a small country but the speculation against the currencies fall
on its first immediate neighbor Malaysia, then Indonesia All of these economies
seemed to speculators to share with Thailand the weakness
Countries felt the awkward dilemmas, stemming from the dependence of their
economies on trade and large debts denominated in dollars
Currency allowed to drop, import prices threatened inflation and sudden
increase in domestic currency value of debts would push banks to bankruptcy

All except Malaysia turned to IMF for assistance and received loans for
implementation of economic reforms (such as higher interest rates to limit
depreciations and efforts to avoid large budget deficits. Structural reforms were
supposed to deal with weaknesses. Severe contraction. Economic crises and
political instability had cause Indonesia has caused the economy to go into a
deadly spiral. The rupiah lost 85% of its original value. Faced with mass
unemployment and inability to afford basic foodstuffs. Ehnic violence broke out.

Malaysia imposed extensive controls on capital movements, hoping that controls
would allow country to ease monetary and fiscal policies without sending its
currency into a tailspin. Downturn in east asia was V shape.
Spillover to Russia. Financial markets ad banking practices were largely
unknown. By end of 1990s, Eastern European economies made successful
transition to capitalist order

Lessons of developing-country crises
1) Choose the right exchange rate regime perilious for a developing
country to fix its exchange rate unless it has the means and commitment
to do so. Much of the financial sector and many corporations became
insolvent due to DLD. Developing countries that have successfully
stabilized inflation adopted more flexible exchange rate. Tended to
experience real appreciations and current account deficits leave them
vulnerable to speculative attack. Can manage quite well with a floating
exchange rate.
2) Central importance of banking currency crisis inextricably mixed with
banking and financial crises. Governments will be faced with restricting
money supply to support currency and the need to print large quantities
of money to deal with bank runs. Need to minimize moral hazard to be
less vulnerable to financial catastrophes.
3) Proper sequence of reform measures. An economy suffers from multiple
distortions, the removal of a few may make things worse. Mistake to open
up the financial account before sound safeguards and supervision are in
place for domestic financial instituitions. Otherwise reckless lending will
happen. When economy downturn, foreign capital will leave leaving
domestic banks insolvent. Developing countries should delay opening the
financial account
4) Importance of contagion. A small economy in southeast asia lead to crisis
in south korea. When Russian ruble plunge, people speculate against
brazil real.

Asian economic crisis and repercussion suggest a need for change. Seemed to
stem primarily from their connection with the world capital market. If there
were severe weakness in economies since some economists argue economies are
quite healthy if not speculative attacks. Strength of the banking system is
important.

Rethinking international finance. Speed and force with market disturbances
could spread between distant economies suggested preventive measures by
individual economies might not suffice.
Developing countries generally recovered quickly from financial crisis. Unclear
whether resilience was due to reforms, higher holdings of international reserves,
strong commodity flexibility or historically low interest rates enforced by
industrial country central bank

Trilemma exchange rate stability is more important for the typical developing
country than for the typical developed country. Less ability to influence their
terms of trade . Stability keeps inflation in check and avoid financial stress from
dld debts.

Reduction of capital flows by onerous restrictions on international
transactions reduce efficiency and contributing to corruption.

Capital is too mobile due to less controls and improve communication making
adjustable peg regimes extrememly vulnerable to speculation. Driving
economies to either rigid fixed exchange or no monetary autonomy. A smaller
developing economy find costs of volatility hard to sustain due to original sin.

A currency board can deprive a country of flexibility when it deals with financial
crises in which the central bank must be lolr.

Should reinstate restrictions on capital mobility to exercise monetary autnonmy
while enjoying stable exchange rate. Most economies regard capital controls as
difficult to enforce for long, too disruptive and potent source for corruption.

Prophylatic measure
More transparency in lending and the risks they face
By having accurate reports of their financial positions
Stronger banking systems, by closer regulation of the risk and increased capital
requirements
Enhanced credit lines deter speculation of a sudden devaluation
Increased equity capital inflows relative to debts inflows (FDI over lending)

IMF role the stringent conditions v.s. underfunded
Country cannot pay its debts renegotiations should happen . Provisions would
encourage moral hazard

GGS applies here LOL. Net flows to developing countries as US has sucked most
of the worlds CA surpluses

Real capital flow is not that huge due to lack of infrastructure.

Low corruption promotes productive economic activity

Find measurable factor that influences the instituitions governing private
property (corruption) but it is hard to find.