Foreign aid

Foreign aidIs the significance of foreign economic aid to be judged simply by the amount of aid or by something more? Can an under-developed economy be self-sufficient in the matter of planned investment for development purposes? If not, what is the degree of dependence that home investment has on foreign resources, and how far is it possible for the planning country to secure the necessary foreign resources without foreign loans or grants?
The matter can conveniently be put in terms of finance. Suppose that the entire finance required for a scheme of public investment is available within the country either by way of internal savings or by way of taxation. Does it necessarily ensure command over the real resources that the scheme involves? If the necessary resources are all available within the country the answer is simple. If, on the other hand, a part of the resources has to be imported, complications crop up, and we have the familiar ‘transfer’ difficulties. This indeed is one of the things that a purely ‘financial’ approach to planning seems to ignore. Foreign aid removes these complications by placing foreign resources directly at the disposal of the receiving country. In so far as foreign resources are a necessary complement of domestic resources in a given scheme of economic development, the aggregate home investment that is made possible by foreign aid is a multiple of the amount of the aid. So foreign aid is important.

What is the value of this multiplier, and on what does it depend? So foreign aid is important.
Assume that the technical coefficient of the planned investment is fixed, so that the ratio between the foreign constituent and the domestic constituent of the investment plan is also fixed. Assume further that the economy where the additional investments are planned for developmental purposes is otherwise in a state of foreign trade equilibrium, and that beyond the point of equilibrium the elasticity of exports is zero. The foreign aid multiplier can then be readily deduced from the import content of the development plan;  for it turns out to be the reciprocal of the ratio of the foreign constituent to the aggregate investment planned. If, for example, this ratio is 1 :4 — if, in other words, the foreign constituent is 25 per cent of the planned investment, the foreign aid multiplier is 4.

If the ratio is 1:5, the foreign aid multiplier is 5. And so on the value of the multiplier varies inversely with the import content of the investment plan. If, on the other hand, the technical coefficient is freely variable — if, that is to say, the foreign resources can be freely substituted by internal resources, or alternatively, if the elasticity of exports of the country is infinity, the foreign aid multiplier comes down to unity. In this latter case, the benefit that the country derives from foreign aid is just equal to the amount of the aid; if foreign aid is surrendered, aggregate investment is less by just the amount of the aid. So foreign aid is important.

A numerical example will make the matter clear. Suppose that a country plans an investment of the order of Rs 1000 crores, of which the foreign constituent in physical terms is worth Rs200 crores. The import content is thus 20 per cent of the planned investment. Now, the planning authority, let us say, collects enough savings to finance the internal share of the investment, i.e. Rs 800 crores. On our first assumption, a foreign grant or loan of the balance of Rs 200 crores makes it possible for the country to carry the entire scheme of investment through, while its absence renders the entire scheme abortive. In this case the surrender of foreign aid of the order of Rs 200 crores results in a loss of investment of the order of Rs 1000 crores. On our second assumption, on the other hand, there are two possibilities. In so far as the method of production is freely variable, the investment pattern can be so chosen as to be independent of foreign resources.

And in so far as exports are perfectly elastic, one-fifth of the internal savings (i.e. Rs 160 crores) can be used for the purchase of exportable goods within the country against which an equivalent amount of foreign exchange can be secured. In either case the loss of investment due to the surrender of foreign aid turns out to be just Rs 200 crores, the volume of investment being reduced from Rs 1000 crores to Rs 800 crores. So foreign aid is most important.

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