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Foreign Aid and Its Role in Economic Development

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Foreign Aid and Its Role in Economic Development IPRI Journal i C ONTENTS Volume V Summer 2005 Number 2 Articles 1. Is Foreign Aid Necessary for the Economic Development of Less 1 Developed Countries with Special Reference to Pakistan? Syed Akhtar Hussain Shah, Imtiaz Ahmad, Muhammad Sarwar Zahid 2. The Reforms Agenda in Iran 28 Maqsudul Hasan Nuri 3. China’s Kashmir Policy: Back to Neutrality 43 Ghulam Ali 4. World Trade Organization: Apprehensions of the Developing Countries 62 Nuzhat Khanum 5. Devolution of Power in Pakistan 83 Asifa Hasan 6. The Political Economy of Pakistan-South Korea Relations: 1947-2004 101 Ahmad Rashid Malik 7. NFC Award Controversy: A Broader Perspective 116 Rashid Ahmad Khan IPRI Journal 1 IS FOREIGN AID NECESSARY FOR THE ECONOMIC DEVELOPMENT OF LESS DEVELOPED COUNTRIES WITH SPECIAL REFERENCE TO PAKISTAN? Syed Akhtar Hussain Shah, Imtiaz Ahmad, Muhammad Sarwar Zahid∗ Introduction oreign aid is the transfer of resources from developed countries to under-developed countries, either through bilateral donors or F multilateral donors. Many countries in the world accept foreign assistan ce and get different benefits along with a few adverse results. The implication of foreign assistance has made it a debatable issue. There are different schools of thought on foreign assistance, i.e. Extensionist School (ES) and Non-Extensionist School (NES). The Extensionist point of view is held by most of the developed countries, which claim that they give foreign aid to developing countries for their socio-economic and political development at individual as well as societal level. In the case of foreign assistance for Pakistan, a group of economists lead by Hollis Chennery and Arthur MacEwan and followed by Pakistani economists, express the need for foreign assistance to Pakistan for accelerated growth. Non-Extensionist School of thought comprising Griffen and Enos (1970), Weisskopf (1972), Ridell (1987) and White (1992), followed by Pakistani economist Shahrukh Rafi Khan, point to the existence of a negative relationship between assistance and growth. Foreign aid is normally subject to certain limitations, which reflect the motives of the donors as to how much they are sincere to the development and welfare of the developing countries, or pursue their own overt and covert interests. Both the parties have progressive designs for optimization of their respective utilities. The underlying motive is not retarding or the ruthless exploitation of any of the parties; rather both the parties have the same direction of development of their local as well as international status. It is in fact a form of generalized reciprocity between two states (the donor and recipient), which leads to transaction of money, goods, and services in lieu of implementation of policies of the donors by the recipient state. However, the unit of exchange for transaction varies from time to time and is highly influenced by the ∗ The authors are respectively Deputy Secretary, Government of NWFP, Lecturer in Economics, Government College, Daska (Sialkot), and Assistant Chief in Planning and Development Division Islamabad. The authors are currently associated with PhD programme in Economics at Pakistan Institute of Development Economics, Islamabad. 2 IPRI Journal international geo-political scenario and global economic trends. Similarly, the endogenous factors such as internal political stability, economic strength and public support to government policies also affect the bargaining power of a recipient country. The more stable a state is, the higher bargaining power it posses. Then the frequency of foreign aid transaction decreases with the increasing stability of the Least Developed Country (LDC) and vice versa. It is an important fact that large-scale flow of funds/foreign assistance is taking place from multilateral and bilateral donors. Hence we will have to analyze different issues pertaining to actual foreign assistance, such as how much is the flow of and what role it plays in the overall development of a country? Whether to accept foreign assistance or not? Which type of foreign aid should be accepted? This paper highlights the theoretical aspects of foreign assistance, different types of foreign aid, the objectives of donors and the applied aspect of foreign aid. What is the impact of foreign aid, which type of foreign aid should be accepted and how foreign aid can optimally be utilized? To analyze the issue we have divided this paper into a number of sections. Section I explains the meaning of foreign aid. Section II deals with the various forms of foreign aid, which are determined by the conditions of the donors. Section III explains the motives of donors, while section IV tells why developing countries accept aid. Section V discusses the most important aspect of foreign aid, that is the role of foreign aid in the economic development of the developing countries. This section is divided into two sub- sections. In the first sub-section the arguments in favour of foreign aid are discussed and we see what positive role it plays in the economic development of developing countries. While in the second sub-section the discussion relates to the harmful impact of the foreign aid, which shows how it hampers the economic development of developing countries. After considering the positive and negative roles of foreign aid in the economic development of developing countries, the concluding remarks give the guidelines as to what type of aid should be accepted and how optimally it be utilized. Meaning of Foreign Aid Foreign aid has been given different meanings by different schools of thought with respect to its structure, its factors such as interest rate determination, repayment period and other modalities. Foreign aid takes place when a recipient country receives additional resources in foreign currency over and above the capacity to import generated by exports. Foreign aid means those additional resources, which are used to raise the performance of the recipient country above the existing level. IPRI Journal 3 Foreign aid can be defined as the debt that is given by a country to another country on the concessional rates (Saeed 1995). The concessional elements may be: i. Rates of interest lower than the prevailing rates of interest in the international commercial money market. ii. Longer period for repayment. iii. Grant, which does not entail the payment of the principal or interest i.e. a free gift. Strictly speaking the concessional element of a foreign aid loan is the difference between the amount of the loan and the present discounted value of the repayment. If the capital market rates enter the present value calculations as discount rates and if they in fact exceed the interest ratio charged by the lender, then the present value of the stream of repayments is less than the amount of the loan. The lender has made a concession to the borrower. These concessional elements in foreign aid can involve at least three of the terms of the loans. The present value of the repayment is zero and hence the concessional element is 100% of the grant amount. The concessional element for a loan depends on: i. The interest rate; ii. Length of period for repayment; iii. Grace period. Foreign Aid in terms of Official Data All kinds of resources inflow that are publicly granted and are made either from government to government or from financial institutions to a government, only economic aid is included while military aid is excluded (Saeed 1995). The main points of this definition are: a. Resource inflow b. Publicly granted c. From government to government i.e. bilateral aid d. From financial agencies to government i.e. multi-lateral aid e. Economic aid, the aid that is used for economic purposes and for dams, projects, industries etc. Table 1 shows the disbursement of Official Development Assistance (ODA) by principal donors both in total amount and as percentage of GNP in 1996 and 2001. Although the United States (along with Japan) remains the largest donor in absolute terms, relative to others it provides lower percentage of GNP—0.12% in 1996, compared to an average of 0.25% for all industrial countries. 4 IPRI Journal Table 1 Official Development Assistance Disbursements from Major Donor Countries 1996 and 2001 1996 2001 Donor Country Millions of Percentage Millions of Percentag US Dollars of GNP US Dollars e of GNP Canada 1795 0.32 1533 0.22 Denmark 1772 1.04 1634 1.03 France 7451 0.48 4198 0.32 Germany 7601 0.32 4990 0.27 Italy 2416 0.20 1627 0.15 Japan 9439 0.20 9847 0.23 Netherlands 3246 0.81 3172 0.82 Sweden 1999 0.84 1666 0.81 Switzerland 1026 0.34 908 0.34 United Kingdom 3199 0.27 4579 0.32 United States 9377 0.12 11429 0.11 Total (21 countries) 55622 0.25 52336 0.22 Source: World Bank, World Debt Tables, 2002-03, tab. 6.9; World Bank 2003 World Development Indicators (Washington, D.C.: World Bank, 2003), tab. 6.9 and 6.10. Economics and Foreign Aid Economics suggests that foreign aid should meet two criteria. i. The objective should be non-commercial from the point of view of the donor. ii. It should be characterized by concessional terms in respect of interest rate and repayment period of borrowed capital; and these terms should be softer than commercial terms. It is the flow of resources and technical assistance to developing nations directly from the government of developed countries or from international organizations such as the World Bank. Foreign aid is defined by the authors of this paper as the flow of funds to a country having lower per capita income from a country with higher per capita income and transaction of services/ commodities by a country having comparative advantage to another country with less comparative advantage. IPRI Journal 5 Types of Foreign Aid Foreign aid is the transfer of resources from a rich country to a poor country.
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