Foreign Aid

1
Foreign Aid

• S. Dodaro
• Econ 306
• Stfx University

2
Foreign Aid Defined

• Non Commercial from the perspective of the donor
  (i.e., motivated by developmental concerns)
• Characterized by concessional terms (compared to
  commercial loans)
• Lower interest rate
• Longer repayment periods

3
The Two Gap Model

• Savings Gap
• S falls short of what can be productively
  invested
• Foreign Exchange Gap
• Foreign exchange earnings fall short of the
  amounts required to purchase necessary inputs
  from other countries
• Saving s Gap I S
• where I investment S savings
• Foreign Exchange Gap M X
• where M imports X exports

4
Derivation of the Savings and Foreign Exchange Gap

• Y C I (X M)
• Sources or resources used in the economy Y M
• Uses of resources in the economy (expenditure
  targets) C I X
• Y M C I X
• Subtracting C from both sides we get
• Y C M I X
• Y C S
• Therefore S M I X
• S M withdrawals from the economy
• I X injections into the economy
• Rearranging we get the following
• M X I - S
• Whichever of the two is greater dominates

5
Forms that Foreign Aid can take

• Financial capital
• Physical capital goods
• Technical assistance
• Agricultural commodities
• Military equipment

6
Why is it Given

• Humanitarian Reasons
• to promote development
• Profitability (especially in the case of tied
  aid) on the part of
• Manufacturers of equipment and capital goods
• Sellers of intangibles (consultants, technicians,
  bureaucrats, etc.)
• Farmers and grain companies, etc.
• Political Reasons
• To secure political advantages
• To protect vital interests

7
Why is it Accepted

• Economic Reasons
• To supplement scarce resources
• To gain access to means to develop
• To get access to otherwise unavailable resources
• Political Reasons
• Provides leverage and legitimizes the present
  leadership
• Strengthens the leadership (including through
  military equipment)
• Provides political link with donor

8
Why is it Accepted Continued

• Moral Reasons
• As compensation for past exploitation
• To provide basic needs for the population
• Profitability reasons
• Bureaucrats and political leaders (corruption)
• Enterprises, etc.

9
Multilateral versus Bilateral Aid

• Multilateral
• Aid channeled through international organizations
  (world bank, UN agencies, etc.)
• less likely to be influenced by political and
  other non economic considerations
• may offer fewer negotiation offers for LDCs
• Bilateral
• aid channeled nation to nation
• more susceptible to non economic factors an
  easier to tie to purchases from the donor
• offers greater negotiation possibilities,

10
Fungibility of Aid Funds

• Aid funds aimed at certain projects can be used,
  indirectly, for other purposes
• funds can be easily diverted and cannot be easily
  contained in rigid channels
• aid can be used to free resources to use for
  other purposes, projects or programs

11
Tied versus Untied Aid

• Tied Aid - aid loans need to be used to purchase
  goods and services produced by the donors
• These include the following
• raw materials
• capital goods and equipment
• technical advise
• transportation and insurance
• project evaluation
• Untied Aid - comes with no strings attached

12
Problems with Tied Aid

• Goods and services may not be the lowest priced
  ones - lowers value of aid
• goods and services may not be appropriate from
  the perspective of needs and resources or
  recipients - also lowers the value as well as the
  development impact of aid
• tends to have an ongoing characteristic or effect
  as a result of need for - spare parts,
  servicing, technical advise, etc. These are
  normally not covered by aid

13
Consequences of Tied Aid

• Projects financed by tied aid tend to be
• capital intensive
• import intensive
• have built in import factor that requires scarce
  foreign exchange
• capital intensive technology is what the donors
  have
• recipients are precluded from shopping around for
  the best prices and the most appropriate
  technology

14
Food Aid

• Can free resources from food production that can
  be used
• to produce more export goods
• increase modern or industrial production
• replace normal imports of food and save on
  foreign exchange
• add to the surplus required for expansion of
  urban or modern sector - food is main wage good

15
Dangers Associated with Food Aid

• Cheap food resulting from foreign aid may inhibit
  agricultural development in LDCs and in the
  process
• Undermine the linkages between the agricultural
  sector and the industrial sector
• Limit agricultural exports (an important
  component of export-led growth)
• May establish dependence on foreign food sources
• Changing peoples tastes and preferences away
  from local foods
• The aid may have been provide to establish a
  market (especially when it is given as a result
  of price support systems in the donor countries
  i.e., dumping of surpluses)
• May have anti-developmental effects if not used
  properly