Let us make an in-depth study of the arguments for and against foreign aid.

Case For Foreign Aid:

Foreign aid is a hotly debated topic in LDCs. One group of people (both the Left and the Right) argue that LDCs must not seek foreign aid as it is not an essential component of growth.

Often, China and Japan are considered as ‘role-model’ since the contribution of foreign assistance towards the development of these two Asian economies is minimal. They argue that aid is an instrument that sponsors neo-imperialism.

Since such foreign economic aid in recent past came to be linked with military aid and political and military movements in poor low-income countries. Some even argue that the developed countries need to concentrate on the typical domestic problems of LDCs, such as poverty, hunger, inequality, malnutrition, etc.


The other group do not believe in such exaggeration in the dangers of aid as propounded mainly by the Left. These group argue that foreign aid can play a vital role in helping LDCs to promote economic and social develop­ment.

Here we will now present economic rationale (rather than political and moral or humanitarian rationale) for foreign aid.

First the macroeconomic role of aid can be modelled in terms of a ‘two-gap model’. LDCs are usually characterised by shortage of resource— a shortage of savings over investment. This ‘resource gap’ is called a ‘savings gap’. This kind of internal imbalance in the macro economy of a developing country leads to an external imbalance of imports exceeding exports.

This kind of ‘resource gap’ is called the ‘foreign exchange gap’ or ‘trade gap’. These gaps or bottlenecks can be filled up by an inflow of capital from abroad through loans, or foreign development assistance or private foreign investment. In other words, foreign aid supplements LDCs low domestic savings and low foreign exchange reserves. Thus, foreign aid permits a country to invest more than what it is able to save.


Furthermore, with the aid of foreign assistance, a country can import more than what it is capable of financing by its own exports. Thus, the resource constraint that stands in the way of development of LDCs can be greatly removed if foreign assistance is sought for.

Secondly, aid fills up ‘technological gap’ and ‘manpower gap’ of the developing countries. These countries are technologically poor. But by importing foreign technologies alone, prosperity will not flow. It requires high-end manpower that is also scarce in LDCs. This demands aid in the form of manpower transfers. These technological and manpower gaps work in the same way as the financial gap filling process works.

For instance, the green revolution of the mid- 1960s was driven by a technology revolution. It is a product of agricultural research programme conducted by the Rockefeller and Ford Founda­tions that helped to transfer and adopt scientific advances to many developing countries. This brought in substantial increase in output of food grains in many Asian and African countries.

Thirdly, foreign aid by supplementing inade­quate domestic savings, foreign exchange, and the transfer of technology and manpower can help to build up a country’s infrastructure of roads, air­ports, power stations, health centres, schools and colleges, shelter, a clean and pure water supply, etc. In this way, it helps increase the investment level that produces a big multiplier effect. As a result, social returns of foreign aid become higher than its costs. External economies of aid are thus believed to be stronger.


Finally, Anne Krueger gives a different reason for aid—aid by multilateral agencies provide policy dialogue that help LDCs to sort out their macroeco­nomic and structural imbalances. She says that the recipient country may be asked by the donor agencies to change its macroeconomic policies in the course of the dialogue.

However, aid will flow to that country which agrees to the policy change recommendations. “Regardless of the influence used, foreign assistance could certainly become a means of speeding policy reform in developing countries.” This policy package advice subject to conditionally may thus cause some good to LDCs.

Anyway, foreign aid is thus not undesirable for development. At a micro level, aid has a positive impact.

Case Against Foreign Aid:

Against these economic arguments, P. T. Bauer has pointed out that foreign aid is neither a nece­ssary nor a sufficient condition for any country’s development. As far as recent experiences of Hong Kong and Singapore and past experiences of Japan and England are concerned, foreign aid is not a necessary tool for development as these countries developed without any substantial foreign aid. On the other hand, it is not sufficient because evidences galore where little development has occurred in spite of large foreign aid. Thus, foreign aid may not produce large economic benefits.

Let us first consider extreme left view relating to aid. It is argued by Marxists that trade perpe­tuates dependence as it destroys self-reliance, props up authoritarian regime, and prevents economic development. It may not be out of place here to remark that in 1980 foreign aid as a percentage of GNP for oil importing LDCs accounted for less than 2 p.c. Thus, says Deepak Lal: “Given the smallness of the sums relative to GNP, total invest­ment. or even the government budget in most developing countries, it would be strange if so much evil could flow from so little.”

Secondly, whether aid has fulfilled the positive macroeconomic role has not been statistically verified. It is feared that aid may displace savings, particularly public sector savings. Above all, aid may produce some undesirable effects on the balance of payments of a country as this leads to drainage of foreign exchange reserves by way of royalty, dividends, etc., to be paid to the donor countries. Further, some macroeconomic studies have failed to show a systematic relationship between aid and economic growth. Aid serves other purposes apart from promoting economic growth. Aid also brings inappropriate technologies.

Thirdly, whether foreign aid is a growth- promoting instrument (device) crucially depends upon the uses to which it is put. Foreign aid fosters capital accumulation by reducing its scarcity and thus making possible higher output. Thus, in the end, it promotes growth. However, this happy result cannot be ensured if aid is used for maintaining or even raising current consumption (rather than being devoted to capital formation).

Rather, foreign aid may result in an ultimate lowering of the recipient’s long-term growth rate. The U.S. PL 480 aid had laid the inevitable impact of hampering the growth of the agricultural sector through dumping (putting cheap crop into the market of LDCs thereby discouraging the growth of domestic production of food and primary commodities). If, instead, such aid could take the shape of imports of machinery it would bridge the technology gap in LDCs and could render a consi­derable help to the primary sector by restoring its long term health and ensuring its permanent viability.

Finally, because of foreign aid LDCs are often caught with substantial debt repayments. External debt grows in magnitude in these countries when foreign loans are used to finance an excess of imports over exports and interest payments on existing debt. Further, the “conditionality” clause of loans of multilateral agencies is the most worrying aspect of foreign aid.


This seriously attacks the sovereignty of nations as well as promotes politicisation since a few major industrial countries (mainly the USA) are the most strong decision-makers in shaping the Fund-Bank programmes. In view of these strong reactions against foreign aid, leftists argue that aid leads to the extension of international Western style capitalism and supports the political motives of the strong neo-colonial powers. Thus, when aid serves political interests, the economic benefits of aid are lost.


It may be noted at the end that there are certain things which foreign aid cannot do. Experience has shown that foreign aid cannot right all social wrongs or solve every economic problem of a developing country. It cannot bring about instant progress.

A country’s economic development depends, ultimately, upon its own people, their participation and suitable long-term economic planning. It is not true that countries receiving aid grow at a much faster rate than countries without aid. Nevertheless, it is also true that aid plays an economically useful role in poor countries.