The starting point and inspiration for this literature review was the conjecture of the intertemporal approach to the Balance of Payments, that it is optimal for countries with insufficient volumes of domestic savings to finance their capital accumulation by foreign capital, which helps to achieve higher growth rates and faster convergence to the long-term growth path. From an aggregate viewpoint, foreign credit can only be repaid by exports of goods and services. To produce these exports three preconditions have to be fulfilled: First, large parts of the foreign capital have to be invested. Second, the economy has to produce goods for which there is demand on the world market, which means in general using the countries comparative advantage to integrate into the world economy and don’t use actual exports to finance actual imports only. Third, aggregate domestic savings have to increase to narrow the savings-investment gap, which also means to produce in excess of actual consumption. With this, I have described a cyclical movement of the CA and the CpA balance, which follows Sieberts’ idea of a beneficial debt cycle. Other parts of the literature hint at the dominating role of institutions for the integration into the world economy – a necessary precondition for this debt cycle – and long term growth in general. Based on the literature I have reviewed in this paper, I would tend to the fact that better institutional quality facilitates the above described form of an ideal debt cycle. The quality of institutions seems to determine the success in transition to different stages of this dynamic development of the economy, which displays itself in the CA, the FA and the domestic savings-investment gap.
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Figure 2: The influence of institutions on national debt cycle dynamics
First and as expected, better institutions encourage aggregate investments, increasing production capital and productivity. This holds also for foreign private capital inflows, which seem to react strongly to the quality of domestic institutions. Relating to the structure of this external capital, the literature hints into the direction that FDI are more negatively affected by ailing institutional quality than are other types of liabilities. As FDI are supposed to created spillovers to the economy as a whole, in contrast to other types of financing, this is especially notable. On the other hand, the availability of foreign financing in general, be it direct equity or loans and bonds, has influences on the characteristics of export goods in an economy: the easier foreign finance is available, the higher the complexity of exported goods.
Source: Following Kindleberger, 1963, p. 460 with own adaptions and additions CA
31 This gives us the connection to the findings in the trade literature, which concludes that countries with better domestic institutions export higher complex goods, which means export upgrading and a potential escape from the Prebish-Singer trap for developing and emerging economies. Finally, there are some findings in the empirical literature that national (private) savings are also positively influenced by improvements in the institutional setting. For the fulfillment of a beneficial debt cycle, this would be the last element, as rising domestic savings in excess of domestic investment are necessary to complete a beneficial debt cycle.
In Figure 2, I have tried to give an abstract picture on how institutional quality influences the BoP dynamics as I would summarize it from this literature review so far.
Phase I stands for a low institutional quality, low income economy. Savings and aggregate investment are low, exports are focused on primary and other non-complex products. The domestic capital leaves the country due to high corruption and lacking investment opportunities, itself a consequence of ailing institutions, which causes a small CA surplus and FA deficit. Increasing quality in institutions marks the start of Phase II. Domestic investment rises and the country gets attractive for foreign capital.
The foreign investors try to utilize the comparative advantage of the economy for exports, most likely in the low-wage, simple products sector, where exports start to increase. This contributes to income growth and enables domestic savings formation to rise. Together with increasing foreign capital inflows this leads to high investment and imports of capital goods. Strongly improved institutional quality increases the availability of foreign finance, FDI projects and production networks develop. As a consequence, the export structure starts to upgrade towards more complex products or products with higher unit export values during this Phase III. The transition to export surplus starts, as the rising incomes in the private sector enable higher aggregate private saving rates and household consumption remains still low. During Phase IV, continuous income growth changes the habits of the citizens and consumption adopts. Savings decrease, also because the development of the domestic capital markets is now facilitated by institutional quality. Both exports and imports are stable at high levels;
integration in the world economy is strong. From the end of Phase IV on, further improvement of the institutional quality might have no conclusive effect. Some countries could run moderately high saving rates but very low investment, causing CA
32 surpluses like for example Germany, other EMU members or Canada etc. Other mature economies might have very low saving rates and moderate investment rates, causing a FA surplus like the USA. Further upgrading of the institutional environment is not decisive for the course of the BoP dynamics from there on. The influence of institutions on the BoP dynamics lies in the earlier stages of the economic development process.
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3 I
NSTITUTIONS AND SAVINGS IN DEVELOPING AND EMERGINGECONOMIES