Economics of International Development and Finance - Example

Economics of International Development and Finance Contents Introduction 3 Literature Review 3 Methodology 5 Findings 6 Conclusion 9 Reference List 10 Appendix 12 Introduction International trade and foreign aid are two factors which are extremely important for economic growth of a country. International trade has been considered as an engine of growth by majority of development economists. The views of researchers regarding foreign aid have however not been unanimous. Some researchers are of the notion that only micro-level data for foreign aid has shown positive economic development while others are of the view that macro-level data of foreign aid and economic development is always ambiguous. The purpose of this paper is to analyze the impact of international trade and foreign aid on the performance of Brazil and China. The connection of economic growth with foreign aid and international trade is to be established mainly by exploring secondary data. The paper is organized into four main sections. The first section briefly provides a literature review of the theories of international trade and economic growth and also the theories that has been developed for foreign aid. This is briefly followed by methodology section providing an overall idea about the research design. The third section is that of findings interpreting the data which is finally followed by a summary. Literature Review There is a convergence of theoretical literature and empirical findings that rising trade between nations has been positively associated with economic growth. The theory of international trade suggests that a trading nation enjoys a host of factors which contributes towards its economic growth and they are higher capital accumulation, improvement of technological processes and advancement in institutional framework in a country. Economists like Krugman (1979) has shown that openness to trade increases the total value of production in an economy causing an improvement in terms of static output growth. In traditional models of economic growth, the effect of trade on rate of economic growth has not featured exclusively. In Harrod-Domar model of economic growth, capital accumulation has been cited as main factor that causes economic growth and liberalization of trade have an effect on output growth (Rodriguez and Rodrik, 2001). Neoclassical models of economic growth like the Solow growth model have on the other hand relied on the importance of technological progress and the role of trade is minimal in these models (Yanikkaya, 2003). Many researchers have taken up the study of the effect that trade have on the economic growth of a country. For instance researchers like Balassa (1986 cited in Edwards, 1992) and Dollar (1992 cited in Edwards, 1992) had shown that developing countries which were heavily dependent on trade have experienced rapid growth compared to countries that did not. Similarly in a research that was conducted by Sachs and Warner (1997) had constructed an index to calculate the economic growth rate before and after liberalization of trade. The results from the research had shown that trade liberalization has significantly raised the rate of economic growth as the countries had previously recorded a lower growth. Explanation provided by researchers had shown that technological diffusion occurs with trade which is helpful in raising the productivity of resources. It has been observed that importing of intermediate goods of high quality results in positive spillovers in an economy. Technological transfer and superior production technologies have recurred in the works of multiple researchers as a source of economic growth. The role of foreign aid in economic growth has been more controversial than the aspect of trade. Most of the studies that have been conducted regarding the relationship of foreign aid and economic growth have focused on economic growth theories like the Harrod and Domar (1979 cited in Easterly, 2003). Researchers following the gap models of growth have shown that foreign aid helps in the accumulation of capital and thereby removes any constraints that are associated with accumulation of physical capital. The research that was conducted by Chenery and Strout (1979 cited in Easterly, 2003) had made an attempt to expand the Harrod-Domar growth model and had shown that shortage of foreign exchange can indeed constrain the economic growth of a nation. The debt crisis of 1980’s had influenced more authors to explore the idea of foreign aid as a source of economic growth. For instance, the research conducted by Bacha (2000 cited in Lensink and Morrissey, 2000) had shown that limitations of government budgets rather than foreign exchange are the main factor which can stop the economic growth of a nation. Supplementary foreign aid has been found to be an important channel to raise economic growth. Empirical evidence on the relation between foreign aid and economic growth is also vast. The extensive empirical research conducted in the period of 60’s, 70’s and 80’s could not reach a robust conclusion regarding the impact of foreign trade on economic growth. The research conducted by Dalgaard, Hansen and Tarp (2004) had shown that foreign aid can help in the economic growth mainly by supplementing the savings growth of a country. The research conducted by Burnside and Dollar (2000) is also an insightful one that has also shown that foreign aid can only act as a beneficial factor for the economic growth only if the political conditions are stable. Unstable political conditions may deter the economic growth of a country. Another attempt made by Moreira (2005) had shown that foreign trade bears a positive correlation with the economic growth of a country. This research had confirmed that there is no need to focus on the micro-macro paradox that has appeared in the works of number of researchers. Instead it has suggested that foreign-aid definitely impacts economic growth and the relationship is more pronounced in short-run than in the long-run. Methodology This paper conducts a secondary research by mainly consulting the works of other researchers in order to answer the research question. The data is collected from government websites like World Bank, government websites and other secondary research articles which have worked with similar topic. The research has collected data only for two countries namely China and Brazil. The method of correlation analysis has been used to analyze the data. The findings from the data has been compared and contrasted with the works of other researchers to compare and contrast the findings. The research does not involve any type of econometric modelling as the researcher does not want to test the hypothesis that whether trade and foreign aid is impacting economic growth. The research is simply a deductive one where the researcher just follows the traditional theories that both trade and foreign aid determines economic development (Lewis, Thornhill and Saunders, 2007). The use of correlation as a research technique will help in understanding association between economic growth and the chosen variables. The selected variables included in the research are GDP growth: This can act as a proxy of the economic growth. Many researchers have used the concept of GDP as a measure of the overall growth of the economy. Volume of Exports: The volume of exports is directly related to the trade of a nation. Volume of Imports: Volume of imports also has a direct relation with trade of a country. Foreign Aid: In order to collect the data for the foreign aid received by the two countries the researcher has used the variable of official development assistance. This is a crude measure of the official aid that is received by the countries. The data for these variables has been obtained from the World Bank site. SPSS software has been used to construct the correlation matrix and the results obtained for each of the country has been tabulated and shown in the appendix. Also graphical method is used to compare the rate of GDP growth and the inflow of foreign aid between the countries. The graphs provide a visual representation of the data collected and will also be easier to interpret. Findings The results from the correlation matrix show that the association between exports (0.973) and imports (0.986) of China with economic growth is very strong. This indicates that trade did have a positive impact on the economic growth of country. This finding can be supported with the works of Sun and Heshmati (2010) who had shown that the liberalization of the Chinese economy and the openness to trade have had a major impact on the economic growth. Their research had shown that the openness of trade in China has been heavily accompanied with the growth in the export of high tech products. Similar sentiments were also reflected in the research that was conducted by Wang (2009) who had shown that accession of China to the WTO had a major impact on liberalization of the trade and opening up of the economy. It has been suggested that entry of China in the WTO have made the investment climate very steady which has constantly increased the level of FDI in the country channelizing into solid economic growth. The correlation matrix from the research suggests that volume of exports and imports indeed have a strong connection with the economic growth of Brazil having coefficients 0.977 and 0.989 respectively. These findings are consistent with the findings of Polaski, et al. (2009) who had observed that the integration of the Brazilian economy with the world economy has indeed resulted in the growth of the country. The extent of trade of Brazil is however smaller than that of China and its rate of economic growth is also smaller. The greater size of the economy of China can be considered as one of the reasons which accounts for higher trade. In case of Brazil too it can be implied that the accession into WTO have increased the openness of the economy. There has been huge productivity growth in Brazil since the trade barriers have been removed (Ferreira and Rossi, 2003). The WTO has positively impacted the investment climate in Brazil as in China and this has made the country one of the most promising nations in the entire Latin America in terms of attracting foreign investment. The graph below compares the GDP growth of China and Brazil. Figure 1: Comparing growth of China and Brazil (Source: The World Bank, 2014) It can be clearly seen from the graph that the growth of China has always been higher than that of Brazil and the accession of China in the WTO has accelerated the growth rate. So it can be argued that trade in China has been a prime factor that has resulted in the higher growth. The corelation coeeficient between economic growth and official assistance or foreign aid received is 0.792 for Brazil and 0.879 for China. Figure 2: Comparing foreign aid of Brazil and China (Source: The World Bank, 2014) The above graph compares the extent of foreign aid in both of the countries. It can be seen from the graph that the extent of foreign aid received by China is also higher than that of Brazil. Additionally, the period of decline of foreign aid flow in China is accompanied by a fall in the growth rate. However, same cannot be commented about Brazil as the foreign aid of the country has not suffered much setback after the crisis, yet the growth has suffered a setback. Empirical research conducted in the similar field has shown that receiving of foreign trade has always been accompanied by mixed results. The research conducted by Ekanayake (2010) had empirically tested the impact of foreign aid on economic growth. His research had shown that foreign aid has a mixed impact on the economic growth of countries. However, in case of Brazil foreign aid has had a positive impact on economic growth. In this research also the correlation coefficient of foreign aid and GDP growth is high. The research conducted by Veiderpass and Andersson (2007) had established the link between foreign aid, economic growth and efficiency development of a number of developing countries which had included China. The results from that study had also suggested that foreign aid in China had a positive impact on improving the efficiency value of the country which has affected the economic growth positively. There is a growing consensus among researchers regarding the fact that the foreign aid is largely received by economies with slower growth rates compared to economies with higher growth rate. Donors of foreign trade can either be multilateral institutions like the IMF and the World Bank or government of other countries (Radelet, 2006). In case of China particularly it has been observed that bilateral foreign aid accounts for majority of the foreign aid in the country (Kitano and Harada, 2014). In case of Brazil it has been observed that the country contributes 76% of its foreign aid to multilateral institutions like the IMF and the World Bank and only 24% is disbursed through bilateral partnerships (Usher, 2011). Conclusion The economic growth of China and Brazil can be strongly attributed to the growth of the trade in the two countries. It has been observed that the joining of the WTO by China in 2001, an attempt towards liberalization of the Chinese economy, was indeed a great success. China’s foreign trade has increased rapidly and the high rates of economic growth can be attributed to the growth in trade. The attempt of the WTO to liberalize the economy of Brazil and promote free trade has also proved to be beneficial for Brazil and the country. However, it must be said that the growth experience of Brazil has not been as smooth as China. In terms of foreign aid, both Brazil and China have highly benefitted from the inflow of foreign aid. Though researchers have complained that foreign aid can have mixed results on an economy but the experience of Brazil and China has been relatively good as suggested by the empirical literature. The share of multilateral aid received from the World Bank and IMF has been greater for Brazil compared to China. Reference List Burnside, C. and Dollar, D., 2000. Aid, policies, and growth. American economic review, pp. 847-868. Dalgaard, C. J., Hansen, H. and Tarp, F., 2004. On the empirics of foreign aid and growth. The Economic Journal, 114(496), pp. 191-216. Easterly, W., 2003. Can foreign aid buy growth? Journal of Economic Perspectives, pp. 23-48. Edwards, S., 1992. Trade orientation, distortions and growth in developing countries. Journal of development economics, 39(1), pp. 31-57. Ekanayake, E. M., 2010. The effect of foreign aid on economic growth in developing countries. Journal of International Business and Cultural Studies, pp. 1-13. Ferreira, P. C. and Rossi, J. L., 2003. New Evidence from Brazil on Trade Liberalization and Productivity Growth. International Economic Review, 44(4), pp. 1383-1405. Kitano, N. and Harada, Y., 2014. Estimating China’s foreign aid 2001-2013. [pdf] JICA Research Institute. Available at: < http://jica-ri.jica.go.jp/publication/assets/JICA-RI_WP_No.78_2014.pdf> [Accessed 8 November 2014]. Krugman, P. R., 1979. Increasing returns, monopolistic competition, and international trade. Journal of international Economics, 9(4), pp. 469-479. Lensink, R. and Morrissey, O., 2000. Aid instability as a measure of uncertainty and the positive impact of aid on growth. The Journal of Development Studies, 36(3), pp. 31-49. Lewis, P., Thornhill, A. and Saunders, M., 2007. Research methods for business students. London: Pearson Education UK. Polaski, S., Filho, J. B. F., Berg, J., McDonald, S., Thierfelder, K., Willenbockel, D. and Zepeda, E., 2009. Measuring the gains from trade. [pdf] International Labour Office. Available at: < http://carnegieendowment.org/files/brazil_global_economy.pdf> [Accessed 8 November 2014]. Radelet, S., 2006. A primer on foreign aid. [pdf] Center for Global Development. Available at: [Accessed 8 November 2014]. Rodriguez, F. and Rodrik, D., 2001. Trade policy and economic growth: a skeptics guide to the cross-national evidence. NBER Macroeconomics, 15, pp. 261-338. Sachs, J. D. and Warner, A. M., 1997. Sources of slow growth in African economies. Journal of African economies, 6(3), pp. 335-376. Sun, P. and Heshmati, A., 2010. International trade and its effects on economic growth in China. [pdf] ECONSTOR. Available at: [Accessed 8 November 2014]. The World Bank, 2014. Databank. [online] Available at: [Accessed 8 November 2014]. Usher, K., 2011. Brazil: Aid from Below. International Affairs Review, 20(1), pp. 2-12. Veiderpass, A. and Andersson, P. A., 2007. Foreign aid, economic growth and efficiency development. [pdf] SADEV. Available at: [Accessed 8 November 2014]. Wang, L. Z. Y., 2009. Chinas pattern of trade and growth after WTO accession. Journal of Chinese Economic and Foreign Trade Studies, 2(3), pp. 178-210. Yanikkaya, H., 2003. Trade openness and economic growth: a cross-country empirical investigation. Journal of Development Economics, 72(1), pp. 57-89. Appendix Table 1: Correlation coefficient of Brazil Table 2: Correlation coefficient of China Read More