I start with the definition of a developing economy a pedestrian start, yet a useful one. The initial position of a so-called developing economy is one of low-level stagnation. The warranted rate of growth, to use Harrod’s well-known terminology, is lower than the natural rate of growth, and the actual rate of growth, unlike in the Harrod formula, has no tendency to keep pace with the natural rate.
The former happens because the propensity to save is low relatively to the growth of population. And the latter is due to the lack of entrepreneurship in the economy. It is this latter that prevents chronic inflation. You have the spectacle in such an economy of the rate of capital formation lagging behind the growth of population and a state of chronic depression accompanied by growing unemployment. The description fits fairly well the Indian economy as it was till the Second World War. During the war the economy received a jolt through a large foreign investment by way of exports, not accompanied by corresponding imports or internal savings. The result was, thanks to insufficiency of excess capacity in the economy, the notorious inflation of the forties. So foreign balance is important.
Let us, then, revert to the initial position of a developing economy. Let us assume that the initial state is one of balance, both internal and external. Internally savings are equal to investment, and externally imports are equal to exports. There is neither inflation nor deflation, and yet the rate of investment and hence of capital formation is low relatively to the growth of population and there is chronic poverty. The purpose of the present paper is to follow up the impact of a process of rapid economic development of such an economy it is in this sense that we call it a developing economy upon its foreign balance. So foreign balance is important.
The process, let us say, is initiated by the state as a matter of policy, seeing that left to itself the economy would not move out of its rut. The State can do this by persuading or forcing the people to save more, thus moving the warranted rate of growth towards the natural rate and itself providing the needed entrepreneurship, so as to keep the actual rate of growth up to the warranted rate. It can also do this by taking loans or other forms of aid from foreign countries, in which case, for the time being at any rate, the burden of saving is shifted to foreigners. If the latter alternative is open and that depends upon the readiness with which foreign countries are prepared to offer aid the process of economic development gets on smoothly. If the aid comes in the form of loans, there is no doubt the question of amortization. But if we confine ourselves to a period over which foreign loans are continuous and they are also sufficient to take care of amortization, then there is no complication; over the given period the difference between loans and grants fades away. So foreign balance is important.
Difficulties arise when the developing country fails to secure foreign aid and has to depend upon its own resources. Foreign aid serves two purposes. On the one hand it relieves the economy of the burden of extra savings; on the other hand it provides foreign exchange to the economy with which it can import capital goods and know-how essential for rapid economic development. Note that it is in the context of rapid economic development that the need for foreign exchange assumes special significance. For after all if the economy can bear slow progress, or is not anxious to avoid excessive costs, internal resources may be enough to give it the necessary push; surely the first country that started economic development did not seek another planet to import capital goods from! The whole question boils down to the degree of substitutability, within a prescribed time limit, between domestic resources and foreign resources: the shorter the time within which a given level of development has to be compressed, the lower is the degree of substitutability.
Given the need for additional foreign exchange and given the fact that foreign aid is not available at any rate not available to an extent adequate for the rate of growth aimed at, the State has to face the task of converting the newly created domestic savings into foreign capital. So foreign balance is important.
Now even here, in so far as the additional savings result in the release of commodities which can be exported at constant terms of trade, there is no trouble. If, on the other hand, exports are not sufficiently elastic, then a part of normal imports of the country is to be converted into capital goods needed for economic development.
Here again the process of conversion does not create any hitch if the additional savings are accompanied by a curtailment of normal spending on imports to an extent sufficient to pay for the necessary capital goods. If they are not, then the need for import restrictions arises; the economy faces potentially an adverse foreign balance. So foreign balance is important.