8.1　International lending to developing countries

International lending and borrowing between industrialized countries generally is well-behaved and provides the sort of mutual benefits that we have discussed.Financial capital flows from industrialized countries like Japan and Germany, where it is relatively abundant, to countries like the United States that offer rich investment opportunities.Both the lender and borrower benefit from the gains from inter-temporal trade, as countries with net savings get higher returns and countries that are net borrowers pay lower costs.Additional gain arises as international financial investments are used to lower risk through portfolio diversification.Conflicts sometimes arise over tax policies, but these are manageable.

International lending by industrialized countries to developing countries is another story.It should create these same gains from inter-temporal trade and risk diversification, and to a large extent it does.But there are also periodic international crises—lending from industrialized countries to developing countries is sometimes not well-behaved.In a financial crisis, the borrowing country experiences difficulties in servicing its debts and it often defaults—that is, fails to make payments as specified in the debt agreements.Lenders cut back or stop new lending, as the borrower is viewed as too risky.This section presents a brief history of capital flows to developing countries and the nature of the financial crises.Subsequent sections look at why crises occur, how they are resolved, and suggestions on ways to reduce the frequency of crises.