Reasons for Foreign Aid

The term foreign aid usually refers to financial assistance that is provided on intergovernmental or international level. It may take the form of economic, technical or military assistance. It generally involves transfer of resources like capital, goods and services from the donor to the recipient countries.

Providing Financial Assistance to a Country

There can be varied reasons for giving foreign aid, such as economic, political, strategic as well as cultural; the most important reason being, augmenting economic development of the recipient country. Less developed countries (LDCs) are characterized by low income and unemployment, which results in low savings and investment. Therefore, capital stock is small in these countries, while the population growth is comparatively high. In order to sustain such large populations, they need rapid economic development, which is simply not possible due to low levels of saving and investment. As a result they turn to richer countries for external help in the form of financial and technical assistance. Financial assistance given by the developed countries (DCs) not only aims at economic development of the recipient country, but also for the balanced growth of the world economy.

It is now an indispensable part of foreign policy and is sometimes used as an instrument to establish better ties with other countries. It is also used as a means to expand the market of the donor countries: for example in case of 'tied' foreign aid, the recipient country is required to make certain purchases only from the donor country, or countries suggested by it. Clearly, economic development in recipient countries would also enlarge the market for the products of developed countries. It is also given on humanitarian grounds, to cope with the crises caused by man-made or natural disasters. Another important reason is military assistance, to establish strong military ties as well as to strengthen the military defenses of the recipient country.

Pros and Cons of Foreign Aid

It is generally provided in the context of strengthening social and economic development of the developing and less developed countries, and it is in fact playing a key role in the development process of these countries. In less developed countries, it helps to reduce the shortage of domestic saving and investment. Besides, it also helps the LDCs in overcoming technical backwardness through technical assistance along with financial and physical capital. All this helps in raising the productivity of labor and capital in these countries.

LDCs lag behind in basic infrastructure development, like, transport and communication, power, education, health services and heavy industries such as iron, steel, oil and heavy engineering. Development of these key areas is a prerequisite for economic growth and development, but the public and the private sectors of the LDCs are not strong enough to undertake such high capital intensive projects which require huge investments. In such circumstances, foreign aid aimed in this direction, can go a long way in developing these economies. By investing in these key areas, it plays an important role in increasing the level of income and employment of LDCs. Besides, this aid also helps these economies in tidying over problems related to balance of payments (BOP) and inflation.

However, despite all the merits associated with foreign aid, it is often criticized as a wasteful investment. It is found that in many countries, it is invested in wasteful projects and production of luxury goods instead of essential commodities. This increases the burden of public debt, besides increasing external dependency. It has also been argued that it is not always essential for economic development as it inhibits domestic savings and investment. Most of all, this assistance is alleged to be an instrument of influencing the domestic policies of LDCs. It has also been observed that much of this financial help goes into the pockets of corrupt politicians and bureaucrats of the recipient countries, instead of being invested in developmental projects.

Nevertheless, there is no doubt that it has been instrumental in facilitating economic development in many less developed economies. If both the donor and recipient countries take appropriate measures to prevent misutilization of funds, then it could play a significant role in fostering rapid growth and development of the less developed economies. However, foreign aid should not be considered as a permanent solution to the economic problems of the LDCs and hence should be supplemented by adequate efforts to raise the level of domestic savings and investment.