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Foreign Economic Aid and Its Consequences

English Essay on "Foreign Economic Aid and Its Consequences"

A developing country would find it difficult to support its capital programmes exclusively from domestic resources for they usually involve import of some capital goods. If such a programme of imports is financed entirely out of taxation, it is likely to be deflationary and to strain the balance of payments; the taxes which are levied to finance the imports would take some purchasing power out of domestic circulation.

This unpleasant consequence can be avoided if home consumption falls and the goods so saved are exported, earning foreign exchange to pay for imports. If this does not happen, the adjustment will take longer to come into effect. The resulting deflation will lead to fall in prices of domestic goods, encouraging exports and rise the prices of imports and discouraging them. There will be a new equilibrium after the necessary adjustments have taken place. But the impact of stepping up the rate of capital formation is almost certainly to cause shortage of foreign exchange which has to be made up running down the foreign exchanges reserves.

Therefore, the consequence of undertaking a programme of economic development that is financed out of taxes is likely to be unsavoury. The consequences of deficit financing are worse. The new money would generate new demand, part of which will be for imports, thus rendering balance of payments position more adverse, so we come to an inevitable conclusion that it is very hard, if anything, to finance a development proaramme, involving imports, purely out o’ domestic resources. Therefore, foreign aid is a great assistance for a developing country. It was with this consideration that the programme of assistance was evolved at Bretton Woods, in July 1944, resulting in the establishment of the International Monetary Fund and International Bank for Reconstruction and Development. The purpose for which the Fund was set up it “to promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation”. Foreign aid offsets the foreign exchange deficit and deflationary tendencies in an economy which undertakes a programme for economic development involving imports.

It particularly applies to the economies of underdeveloped countries. The link between foreign and domestic policy is stronger in these counties. A large share of their economic activity is composed of foreign trade and many of them depend upon their exports to sustain these economies. This is more so because the exports are, mostly, narrowly based, being either raw rnatt1idIs or food stuffs. Now the demand for these commodities is subject to violent fluctuations which are very upsetting for the underdeveloped countries, also, because of the nature of these commodities, the volume, terms, and balance of trade tend to move together.

Therefore, when exports collapse, the export surplus also decreases (or the import surplus increases) because there is a tendency that imports lag behind exports as the prices of imports fall more rapidly than those of exports. For the same reason, terms of trade also decline in such decline in a case. This discussion leads us to the conclusion that foreign aid would be necessary for an under-developed country if the deflation of foreign exchange reverses, deflation and violent fluctuations in their export earnings have to be offset. But the quality and quantity of foreign aid available to a country depends upon its absorptive capacity which means the amount of technical and capital assistance that can be effectively used. In economics, absorptive capacity can be defined as the amount of capital that can be absorbed without the marginal productivity of capital falling is zero. But this definition has a snag in the context of an underdeveloped country, because even if the marginal productivity of capital, at the time of application of aid, is zero, i.e., there is no increase in output with the application of foreign aid, it may result in considerably higher levels and rates of increase in Income after a few years. This may also be one of the particular kinds of technical assistance. Advice given in one year may be put into effect a few years later,

Therefore, we should keep in mind not only the immediate consequences of foreign aid, but also those which would be realize In the long run There is another considemtion related to this. The amount of assistance which can be absorbed in the sense explained above depends upon the form in which it is made available. Of course, capital assistance consists basically of foreign exchange which is in itself, uniform. But the amount that can be absorbed will still depend upon the currency in which the aid is offered, whether it is “tied to the donor country or free for expenditure anywhere, and the limitations imposed by donor country with regard to its use. In the case, of technical assistance, this problem is more pertinent.

This naturally rises the question: What are the factors off which absorptive capacity depends? This first factor is unutilized capacity of some kind which can form a suitable combination with additional capital that comes in the form of foreign aid. If such capacity exists, the results of foreign aid are immediate and spectacular. It has been observed quite often that a country receives certain capital goods which it fails to make use of and, therefore, these go waste. Then there should be a well constructed development plan backed by domestic financial resources. This would ensure the right form of assistance in the right direction. There should also be simple and obvious opportunities for improvements in technique, coupled with a technology minded and development minded people. If this condition is not satisfied, as has been the experience particularly in the backward economies, the offers of technical assistance to waste.

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