International Credit and Welfare: Some Paradoxical Results with Implications for the Organization of International Lending

Abstract

This paper models 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. It is shown that in this setting 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.