International Credit and Welfare: A Paradoxical Theorem and its Policy Implications

38 Pages Posted: 2 Mar 2005

See all articles by Kaushik Basu

Kaushik Basu

Cornell University - Department of Economics; IZA Institute of Labor Economics; Brookings Institution

Hodaka Morita

Hitotsubashi University - Institute of Economic Research

Date Written: January 26, 2005

Abstract

This paper considers a developing nation that faces a foreign exchange shortage and hence its demand for foreign goods is limited both by its income and its foreign exchange balance. Availability of international credit relaxes the second constraint. We develop a simple model of strategic interaction between lending institutions and firms, and show that the availability of international credit at concessionary rates can leave the borrowing nation worse off than if it had to borrow money at higher market rates. This paradox of benevolence is then used to motivate a discussion of policies pertaining to international lending and the Southern government's method of rationing out foreign exchange to the importers.

Keywords: Bank-firm interaction, foreign aid, international credit, welfare comparison

JEL Classification: L10, F30, O10

Suggested Citation

Basu, Kaushik and Morita, Hodaka, International Credit and Welfare: A Paradoxical Theorem and its Policy Implications (January 26, 2005). MIT Department of Economics Working Paper No. 02-18. Available at SSRN: https://ssrn.com/abstract=311281 or http://dx.doi.org/10.2139/ssrn.311281

Kaushik Basu (Contact Author)

Cornell University - Department of Economics ( email )

414 Uris Hall
Ithaca, NY 14853-7601
United States
607-255-2525 (Phone)
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IZA Institute of Labor Economics

P.O. Box 7240
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Germany

Brookings Institution ( email )

1775 Massachusetts Ave, NW
Washington, DC 20036
United States

Hodaka Morita

Hitotsubashi University - Institute of Economic Research ( email )

2-1 Naka Kunitachi-shi
Tokyo 186-8306
Japan

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