International assistance and development

In an open economy domestic savings can be supplemented by many kinds of external assistance. In this writing the role of foreign borrowing in the development process will be considered, together with the debt-servicing problems associated with it. Moreover, political economy of foreign aid, types of foreign assistance and the role of government in the development process shall also be considered.

We can remember the "dual-gap analysis" and foreign borrowing pioneered by Hollis Chenery. In national income accounting, an excess of investment over domestic savings is equivalent to a surplus of imports over exports. A surplus of imports over exports financed by foreign borrowing allows a country to spend more than it produces or to invest more than it saves.

The basic underlying assumption of dual-gap analysis is a lack of substitutability between foreign and domestic resources. This may seem a stringent assumption, but nonetheless may be valid particularly in the short period. If foreign exchange is scarce, it is not easy in the short run to use domestic resources to earn more foreign exchange, or to save foreign exchange by dispensing with imports. If it were easy, the question might well be posed: Why do most developing countries suffer chronic balance of payments deficits over long periods despite vast reserve of unemployed resources? If domestic savings is scarce, it is probably easier to find ways of using foreign exchange to substitute, raising the domestic savings ratio and the productivity of capital.

The debt service problem: The fact that the rate of return on investment in the borrowing country exceeds the rate of interest is no indication of whether the debt can be serviced since the loan must be repaid with interest in foreign currency. Moreover, borrowing after borrowing increases debt service payments which ultimately creates "debt trap". To tackle the debt difficulties the following measures may be adopted: (a) Poor countries need debt forgiveness or debt relief, which may be considered (b) Repayment of loans in local currency rather that foreign currency may be introduced. (c) Developed countries might set up machinery to guarantee loans from private sources (in addition to export credit guarantees) and establish a fund from which commercial interest rates might be subsidised. (d) Overseas Development Assistance (ODA) might be given as grants rather than loans. (e) There is urgent need to devise schemes to stabilise the price or terms of trade of primary commodities.

Capital flows to developing countries come in many different forms -- from pure grants or pure aid, to loans, to portfolio investment and direct investment by multinational companies. Different sources of international capital flows to developing countries are: (a) Official flows from bilateral sources (including developed and OPEC countries) and multilateral sources (IBRD, IDA, IFC, UN and various development banks) on concessional and non-concessional terms. (b) Direct private investment. (c) Commercial bank loans (including export credits).

In the words of Subrata Ghatak, an economist, foreign resources (FR) are supposed to replenish the dearth of domestic savings in the LDCs. Generally the difference between planned investment and planned savings is taken as an indication of the FR that are necessary to attain a target rate of economic growth. Indeed, in many development planning models, a target level of investment is specified to achieve a certain rate of growth of income and then an estimate of planned savings in made.

When the planned investment exceeds planned savings the gap is sought to be made up by FR. Different types of foreign resources are poured into poor developing countries. These are: (i) Tied aid (to protect the income and employment of the donors). (ii) Untied aid. (iii) Bilateral aid. (iv) Multilateral aid. (v) Project aid. (vi) Commodity aid and (vii) Food aid.

At the time of studying foreign assistance and economic development we have to consider the role of government. The economic roles of government are: (i) Allocative: allocation of resources. (ii) Distributive: equity in the allocation of resources by using taxation, social security and the distribution of public sector services to influence the distribution of income. (iii) Regulatory: government legislates and enforces laws of contract, consumer protection, justice and so on, in order that the market economy may function. (iv) Stabilisation: fiscal, monetary and other economic policies to pursue objectives for the control of inflation, unemployment, etc.

Conscious people are very much concerned with the role and effectiveness of foreign aid in development. It is part of a widespread and ongoing process of evaluation of past experience with foreign aid in the aid community, including recipient countries, researchers, and aid agencies.

The second world war marked a point of major change in the evolution of the world economy, and the post-war experience with foreign aid should be seen in the context of the emergence of a large number of new nation states and the breakdown of the earlier colonial system. In the 60 years since second world war much has been learnt, and has changed in the world: economic and political systems, motivating ideologies and the degree of integration of the world economy. The motivation for aid has evolved during this period and the turn of the century is an appropriate time to take stock: (a) What lessons have been learnt about development policy and the provision of foreign aid? (b) What are the key development issues facing the world community in the twenty-first century? (c) What is the role of foreign assistance in addressing the problems of development in the future?

The last four to five decades of the 20th century witnessed a massive outpouring of studies on foreign aid, because: (a) The cold war rationale for aid disappeared following the demise of the centrally planned economies in Eastern Europe, and private capital flows to some developing countries surged during the 1990s. Aid objectives have gradually widened over the years, and the shifts in political coalitions are significant. (b) There have been significant changes in our understanding of growth and development process, appropriate development strategies and policies, and the design and delivery of aid. (c) There has been continuing debate on the effectiveness of foreign aid, but recent work has benefited from the availability of a broader and more sophisticated array of analytical economic tools as well as more data.

The evolution of the world economy over the past decades has been complex. There has been interrelated changes in resource accumulation, population growth, growth in knowledge, and improvements in production technology, all operating in an environment characterised by frequent and dramatic transformation in policies and in institutions.

It is very natural that the rationale or reasons for giving aid to developing countries have been cropped up in the minds of many people. A number of alternative, but not mutually exclusive, justifications for aid have been articulated over the years: (a) Altruism: Humanitarian concerns explicitly motivated many aid donors, reflecting concerns about the extent and degree of poverty and inequality in the world. (b) Political ideology, foreign policy, and commercial interests: The cold war was used as a justification for providing aid to developing countries to stem the spread of communism. Similarly, aid from socialist governments was motivated by a desire to promote socialist political and economic systems. A number of donors support former colonies. They also pursue a variety of foreign policy and domestic commercial and private sector interests in the provision of aid. An example is the possibility of aid generating more exports, a justification that underlies the modality of tied aid. (c) Economic development: This justification has been used both as a goal in itself and a necessary condition for the realisation of other development goals such as: poverty alleviation, the spread of democracy, gender issues, social development, and the expansion of markets (including providing a hospitable environment for foreign investment).

There are many lessons about appropriate development strategies that have emerged from post second world war experience. We have learnt from both successes and failures, and the development agenda has expanded considerably. While lots of disagreements remain, important elements of consensus now exist about many of the components of successful development strategies. These include: (a) development of market institutions, including supporting legal and regulatory structures; (b) well-functioning government institutions; (c) reliance on market mechanisms, reflecting that the command-economy model is no longer an alternative; (d) investment to achieve critical levels of social and physical infrastructure (health, education, transportation, communication, etc); (e) maintaining a stable macroeconomic environment; (f) achieving critical levels of resource mobilization; (g) reducing or eliminating gross distortions in incentive systems; (h) increased role of foreign trade (both exports and imports); (i) potential role of foreign private investment (including issues of short versus long term and portfolio versus direct investment); and (j) transfer of knowledge and technology from developed countries.

Since the 1950s foreign aid has been associated with development successes and failures. There are many examples where aid played a significant part in supporting what turned out to be successful development strategies. In that sense aid has worked, and worked well; and the cross-country evidence shows that on average successes have outweighed failures. Conversely, there are many examples where for various reasons aid has failed to support elements of a correct strategy

One can distinguish two kinds of aid failure. The first is a failure in aid strategy. In this case, aid is pursued in spite of the fact that we know that it fails to support any of the elements of successful development strategies. The second kind of aid failure relates to aid delivery, including design, modality, or implementation.

It is often argued that poor countries with good policies should get more aid than ones with mediocre policies. However, in an environment where it is not feasible to improve, for example, macroeconomic management, it may well be feasible and desirable to use aid to support other elements of a successful development strategy, although perhaps with a longer time horizon in mind. Indeed, in the very poor countries, development priority should be given to long run investments in social and physical infrastructure and institutional development.

There is wide agreement that aid should in the future be focused on the poorest countries, which are mostly in Africa and Asia. In these countries, aid programmes have to be designed in an environment where it is difficult to set priorities and much remain unknown. This makes aid risky. One may expect failures and learn from them.

In order to understand the economics and politics of foreign aid we have to know about political economy of foreign aid. Political economy means political action by economic agents. Economic agents include consumers, producers, entrepreneurs, investors, donors and the native government. It also deals with the economic problems of the government and involves economics of democratic process, i.e., voter's choice or preference in respect of economic policy of the government.

There are various traditions in political economy, ranging from economic determinism and rational choice modeling to idea-grounded social constructivism. We can think of at least three approaches. In one, foreign aid is determined by the economic interests of powerful groups within donor countries. Executive and legislative branches make economic policy with a view to its implications for their power. The second approach explains aid (bilateral and multilateral) as an effort to maximise benefits to donor states, deriving preferences for them from their situation in the international system. In the third, aid is the outcome of bargaining among units, a kind of political market made up of donor aid bureaucracies, multilateral aid agencies and recipient government officials. All three help explain donor motivations.

As world political conditions change, foreign aid changes: both its size and purposes. There has never been a pure economic development assistance regime. Rather, foreign policy has created and sustained various aid regimes among donors.

In the 1990s, threats to political and economic values emerged from the rise in wars and conflicts, the financial instability in global markets seen in the Asian crises and the increase in pollutants and diseases which flow across borders. Donor countries have an interest in reducing these threats. A more benign and secure global environment is a key donor goal to which aid can be attached. This goal is now widely cited by donors, both in general and in announcing specific commitments. A second goal motivating donors is the benefits they derive from economic development in recipient states.

It is often said that foreign aid is a necessary evil because a large portion of assistance is not properly utilised. Empirical evidence and studies reveal that a considerable part of international assistance is eaten up, embezzled and misused by many ways for which foreign donors, native government and aid utilisation agencies are partly responsible. Foreign assistance should not only supplement the domestic savings but at the same time should create employment opportunities which will alleviate poverty of the poor developing countries.

Rashedul Islam is Senior Finance Controller (Defence Purchase), DGDP.