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Foreign Aid: The Development Assistance Debate

Foreign aid refers to funds transferred from one government to another, either directly or through multilateral organizations like the World Bank. There are two main sources of foreign exchange for developing countries: public bilateral and multilateral development assistance, and private assistance from NGOs. Donor countries provide aid for political, strategic, and economic reasons. Economically, the two-gap model argues that developing countries face shortages in either domestic savings or foreign exchange to finance imports, and foreign aid can help address these gaps and relieve constraints on economic growth.

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46 views16 pages

Foreign Aid: The Development Assistance Debate

Foreign aid refers to funds transferred from one government to another, either directly or through multilateral organizations like the World Bank. There are two main sources of foreign exchange for developing countries: public bilateral and multilateral development assistance, and private assistance from NGOs. Donor countries provide aid for political, strategic, and economic reasons. Economically, the two-gap model argues that developing countries face shortages in either domestic savings or foreign exchange to finance imports, and foreign aid can help address these gaps and relieve constraints on economic growth.

Uploaded by

Moon Younghee
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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FOREIGN AID: THE DEVELOPMENT

ASSISTANCE DEBATE
Foreign aid
The international transfer of public funds in the form of loans or grants either directly
from one government to another (bilateral assistance) or indirectly through the vehicle of
a multilateral assistance agency such as the World Bank.
Conceptual and Measurement Problems
In addition to export earnings and private foreign direct and portfolio investment, developing
countries receive two other major sources of foreign exchange:

Public (official) bilateral and multilateral development assistance


Private (unofficial) assistance provided by nongovernmental
organizations
Concessional terms
Terms for the extension of credit that are more favorable to the borrower than those available
through standard financial markets.
Amounts and Allocations: Public
Aid
Official development assistance (ODA)
Net disbursements of loans or grants made on
concessional terms by official agencies, historically by
high-income member countries of the Organization for
Economic Cooperation and Development (OECD).
Why Donors Give?
Aid Donor-country governments give aid because it is in their political,
strategic, or economic self-interest to do so.
Political Motivations
Political motivations have been by far the more important for aid-granting
nations, especially for the largest donor country, the United States.
Economic Motivations
Two-Gap Models and Other Criteria Within the broad context of political and strategic
priorities, foreign-aid programs of the developed nations have had a strong economic rationale.
Two-gap - model A model of foreign aid comparing savings
and foreign-exchange gaps to determine which is the binding
constraint on economic growth.

Savings gap - The excess of domestic investment


opportunities over domestic savings, causing investments to be
limited by the available foreign exchange.

Foreign-exchange gap - The shortfall that results when the


planned trade deficit exceeds the value of capital inflows,
causing output growth to be limited by the available foreign
exchange for capital goods imports.
Foreign-Exchange
Constraints External finance (both loans and grants) can play a critical role in supplementing
domestic resources in order to relieve savings or foreign-exchange bottlenecks. This is the so-
called two-gap analysis of foreign assistance.
The basic argument of the two-gap model is that most
developing countries face either a shortage of domestic
savings to match investment opportunities or a shortage
of foreign exchange to finance needed imports of capital
and intermediate goods. Basic two-gap and similar
models assume that the savings gap (domestic real
resources) and the foreign-exchange gap are unequal in
magnitude and that they are essentially independent.
The implication is that one of the two gaps will be
“binding” for any developing economy at a given point
in time.
When the foreign-exchange gap is binding, a
developing economy has excess productive resources
(mostly labor), and all available foreign exchange is
being used for imports. The existence of complementary
domestic resources would permit them to undertake
new investment projects if they had the external finance
to import new capital goods and associated technical
assistance.

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