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Section 3 Financing Development

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Objectives

After studying this section you will be able to:

1. Understand the role investment plays in development.
2. Identify the purposes of foreign aid.
3. Describe the functions of various international economic institutions.

Section Focus

Less developed countries can obtain capital for economic development through investment, loans, and grants. Economic policy advice and technical help are also valuable aids to development.

Key Terms

• internal financing
• foreign investment
• foreign direct investment (FDI)
• foreign portfolio investment
• World Bank
• United Nations Development Program (UNDP)
• International Monetary Fund (IMF)
• debt rescheduling
• stabilization program

Building an infrastructure, providing education and health care, and creating technology and industry all require large sums of money. Less developed countries often turn to wealthier nations for the money they need to develop their economies. Businesses, individuals, foreign governments, banks, and development organizations all contribute to the financing of international development.

Investment

As you read in Section 2, the creation of capital is crucial to development. But where does the money for purchasing capital come from? A country can use two methods to finance its economic development. It can either use internal financing or external investment. Internal financing is derived from the savings of the country's citizens. A developing country can also look to the developed world for investment funds. External investment originates from other countries and is called foreign investment.

Internal Financing

Recall from Chapter 11 the role that personal savings and investment play in capital formation. Savers deposit money in banks. Banks, in turn, lend money to firms. Firms invest in physical and human capital so they can expand. They create new products and provide new jobs. Job growth enables individuals to improve their standard of living. The economy as a whole grows.

In many less developed countries, large segments of the population do not have enough money to save. Many do not even have enough to meet their basic needs. The wealthy elite, with plenty of money to save and invest, often keep their money in foreign banks. They also often invest in foreign companies. This is because overseas savings and investments are often more secure. As a result, there is often little internal financing. Most LDCs must, therefore, turn to foreign investment to finance development.

In Brazil, as in most LDCs, the country's large poor population (right) has no money to save, while the tiny elite population (left) chooses to invest its money overseas.

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