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realities in which the pervious assumptions are no longer valid.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 48 th 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.