RESEARCH PROPOSAL

TOPIC: THE IMPACT OF FOREIGN AID IN ECONOMIC GROWTH OF

DEVELOPING COUNTRIES. A CASE STUDY OF PAKISTAN.

INTRODUCTION:

Researcher observed that Aid is a useful tool that facilitates the transfer of resources from one
country to another. It enables recipient countries - predominantly developing countries - to
increase consumption and investment. Aid provides an opportunity to reduce poverty, increase
the standard of living and generate sustainable Economic growth. However, concern for the
effective utilization and management of aid dollars in recipient countries has recently been
expressed. The imperative to employ aid inflows adequately may stress the administrative
capacity of governments. In addition, volatile aid flows create problems financial management
and debt sustainability in the future.
Foreign Aid, more commonly known as official development assistance (ODA), consists of
resource transfers from the official sector, in the form of grants and loans at concessional
financial terms, to developing countries. Many studies in the empirical literature on the
effectiveness of foreign aid have tried to assess if aid reaches its main objective, defined as the
promotion of economic development and welfare of developing countries. When focusing on the
traditional purpose of foreign aid –promotion of the economic growth of developing countries –,
one notes that the results obtained differ according to the approach used. Studies at the micro-
level, mainly using cost-benefit analyses, support the view of those in favor of the effectiveness
of foreign Aid.
BACKGROUND ABOUT FOREIGN AID:

Foreign aid is defined as financial flows, technical assistance, and commodities that are(1)
Designed to promote economic development and welfare as their main objective ( thus
Excluding aid for military or other non-development purposes); and (2) are provided as either
Grants or subsidized loans. Financing is divided into two types, concessional financing which
refers to grants and subsidized loans, where the non-concessional financing refers to loans that
carry market or near market terms. Furthermore, aid flows can be classified into three broad
categories, first, the Official Development Assistance (ODA) which consists of aid provided by
donor governments to low and middle-income countries. Second, Official Assistance (OA) is the
aid provided by governments to richer countries with per capita incomes higher than
approximately $9000.
Third, private voluntary assistance which includes grants from non- governmental organizations,
religious groups, charities, foundations, and private companies (Radelet, 2006, 4). Types of
Foreign Aid:

There are two (important) types of foreign aid, according to their source:

(a) Bilateral Aid: Bilateral aid is the aid which is given from the government of the donor
country to the recipient country. It depends upon political and economic relationships of various
countries and it also depends on the will of donor country.

(b) Multilateral Aid: Multilateral aid is the aid given by certain financial institutions, agencies or
organizations to the government of developing country. It is distributed in a fair manner in order
to raise the pace of economic development. So it is better than bilateral aid which is given on the
basis of political considerations and the fear of the domination of a donor country is also
removed in the case of multilateral aid which may be helpful in raising the pace of economic
development.
BACKGROUND OF PAKISTAN ABOUT FOREIGN AID:

Since independence Pakistan has had to depend on foreign assistance in its development efforts
and to balance its international debt payments. In 1960 the World Bank organized the Aid-to-
Pakistan Consortium to facilitate coordination among the major providers of international
assistance. The consortium held 92 percent of Pakistan's outstanding disbursed debt at the end of
June 1991.
The consortium's members include the United States, Canada, Japan, Britain, Germany, France,
and international organizations such as the World Bank and the Asian Development Bank
(ADB). The World Bank accounted for 26 percent of the outstanding debt, and the ADB, which
was the largest lender in the early 1990s, accounted for 15 percent. Most no consortium funding
comes from Saudi Arabia and other oil-producing Middle Eastern countries. Most aid is in the
form of loans, although the proportion of grants increased from around 12 percent in the late
1970s to around 25 percent in the 1980s, mainly because of food aid and other funds directed
toward Afghan refugees. With the decline in this aid after 1988, the proportion of grants
decreased to 16 percent in FY 1992.
The United States has been a major provider of aid since independence and was the largest donor
in the 1980s. All United States military aid and all new civilian commitments, however, ended in
October 1990 after the United States Congress failed to receive certification that Pakistan was
not developing a nuclear bomb. As of early 1994, United States aid had not resumed, but Agency
for International Development projects already under way in October 1990 continued to receive
funds.
2.0 OBJECTIVE:

TO IDENTIFY THE DETERMINATION OF THE EFFECTIVENESS OF

FOREIGN AID IN PROMOTING ECONOMIC GROWTH OF PAKISTAN.

2.1 Increasing Resources for Investment.

The main macroeconomic mechanism by which aid can promote growth is to enlarge the pool of
capital available for investment and growth. Even in a favorable policy environment, however,
foreign aid may permit domestic resources to be diverted from investment to consumption, with
no net effect on growth. Empirical studies of this issue, as was indicated earlier, have yielded
inconclusive results. Studies of individual countries are equally inconclusive: aid seems to
contribute to saving in some cases but not in others. ( Cassen and others, Does Aid Work? p. 24.)

2.2 Providing Public Goods.

Foreign aid might help raise the level of investment in the economy by easing the constraints on
public funds available for necessary public investments--that is, goods that are important for
production and for which the returns cannot be captured and used to repay borrowing; public
investments may include infrastructure such as rural roads. Foreign aid might also limit the
strains on the domestic tax base and prevent costly distortions. For example, the recipient might
levy tariffs to fund those public investments if it does not receive aid.

According to the Agency for International Development, the success of foreign aid in supporting
public investment also varies widely. The Inter-American Highway in Central America was
funded largely through foreign aid (though it was not called that at the time), and it has
contributed enormously to improving the prospects of growth for Central American countries.
But such projects have also failed. Many aid-financed projects languished after their completion,
because the recipient government was unwilling or unable to provide adequate maintenance.

2.3 Increasing Human Capital.

Foreign aid might be able to help a country develop its human capital--for example, by
supporting elementary education or basic health care. Investment in human capital in developing
countries is often more difficult to finance than are physical capital projects. Even in relatively
rich countries, private investors are wary of lending for skills and education without a
government guarantee for a return on investment. Foreign aid, however, may be able to provide
targeted funds for enhancing human capital and thereby raise the economy's stock of skills and,
perhaps, stimulate growth.

Foreign aid can claim some credit in this area. Aid resources have helped strengthen agricultural
production by funding new crop varieties, irrigation programs, and extension practices. They
have also played a role in sponsoring research, education, and immunization programs that have
led to the control of various diseases such as smallpox, polio, diphtheria, and measles.

But simply investing more in physical or human capital will not necessarily lead to fast
economic growth. Many countries have invested heavily over long periods but have not grown
quickly. Productive investment in human--as well as physical--capital still depends on the policy
environment. In the words of the 1995 World Development Report, "Greater investment in
human capital can neither compensate for nor overcome an environment inimical to economic
growth.”

In addition, the particular investment choices also matter. For example, the World Bank argues
that excessive spending on education bureaucracy and school infrastructure, rather than on
teaching staff and supplies, undermines the quality and quantity of schooling. So may invest too
much in higher education relative to basic literacy or elementary education. The skills being
taught should match the needs and economic opportunities of the country.

2.4 Facilitating the Transfer of Technology.

Another channel through which aid might foster growth is technical assistance and technology
transfer. That type of aid promotes growth not by accumulating greater resources but by making
existing resources more efficient and effective. Technical assistance programs may also include
educating and training government officials who play a large role in creating the policy
environment and using foreign aid. Helping developing countries to organize institutions that
protect property and minority rights is another example. As in other cases, the success of such
programs will probably depend on the political and economic environment in which they
operate. For example, according to some analysts, "assistance to encourage agricultural
production had a substantially higher payoff in the presence of realistic exchange rate and trade
policies."

2.5 Facilitating the growth of education sector:

Foreign Aid has a significant effect on education sector. A developing country like Pakistan can
grow its education sector by foreign aid by supplementing the educational budget of the
government; aid can increase investment in education in recipient countries. Furthermore, by
providing resources to finance education (e.g., build schools, hire and train teachers, free
textbooks and other school supplies for pupils), education aid can improve the quality of
education in recipient countries. Indeed, anecdotal evidence from several countries suggests that
aid in education reduces absenteeism and boosts enrolment and retention rates. The positive
association between education aid and enrolment rates is also consistent with the empirical
findings of Michaelowa and Weber (2006) and Dreher, Nunnenkampand Thiele (2006).

2.6 The aid and growth of GDP

Different types of studies were under taken in order to understand the impacts of foreign capital
inflows (FCIs) on the economic development and the different methods and variables were used to
analyze the role of foreign aid in economic development. None of the studies has shown with
certainty that whether FCIs are favorable or unfavorable for an economy.

2.7 Foreign debt and economic development.

There is a close link between large foreign debt burdens and economic development is strongly
indicated by the empirical evidence, which have generated a fairly robust statistical relationship
between high foreign debt burdens and poor economic performance (e.g. Cohen 1996, Ojo and
Oshikoya 1995, Oshikoya 1994, Salih1994, Ukpolo 1992 and Mbaku 1991). However, by
analyzing debt and economic performance in an aggregate context, this literature has tended to
leave potential fiscal problems unattended. This analytical limitation may be particularly
problematic in case of the poorest debtor countries, where the fragile budgetary stance of
governments may entail more difficult fiscal policy tradeoffs than elsewhere.

2.8 Remittances, Growth and Poverty

Research has shown that a very high proportion of remittances are spent on consumption instead
of productive investments. Theoretically, however, the relationship between remittances and
growth can be positive or negative. Remittances may generate positive spillovers through
efficient financial markets, easing the credit constraints of business as well as common men or
on the contrary, it may increase consumption more than investment and negative chain of events
can be triggered through low labor participation, low investments and so on (Goldberg et al,
2008).

2.9 Infant Mortality

Boone, 1996 attempted to find the relationship between aid and infant mortality but found no
Significant impact on lower levels of infant mortality. In countries with weak economic
management, there is no relationship between aid and change in infant mortality. While in
countries with good economic management there is evidence that aid reduces the infant mortality
in the host country Burnside et al (1998).

2.10 Institution Building.

Bilateral donors appear to have more practical experience in helping developing countries build
various institutions that foster development, such as a judicial system, than do multilateral
organizations. Thus, they are likely to be better placed to help aid recipients build such
institutions on their own, particularly if the donor and recipient share a common language and, to
some degree, a political heritage.

2.11 Foreign Aid helps in Natural disaster:

Foreign Aid helps countries in natural disaster. It provides foods, clothes, medicines and other
necessities to help the disaster victims. A powerful earthquake measuring 6.3 on Richter scale
rocked many parts of Pakistan in September 2010 and the epicenter of the quake was located in
the Hindu Kush mountain range, it said. People who were asleep here rushed out of their homes
after feeling strong tremors that lasted several seconds. There were no immediate reports of
casualties or damage to property. Multilateral Foreign Aid played a very important role to
overcome the situations and really helped Pakistan.

2.12 Aid and Exchange rate:

A complicating area of concern in analyzing the macroeconomic impact of foreign aid has been
the effect of aid on the exchange rate of the recipient country, and thus on the general
competitive stance of the export sector. Originally observed in connection with booming primary
exports, this phenomenon has been labeled ‘Dutch disease’, deriving its name from the unhappy
experience of the Netherlands after the discovery of major natural gas reserves in the sixties.23
Since then, examples of the syndrome include Zambia (copper), treated in Kayizzi-Mugerwa
(1990) and what Gillis et al.

2.13 Closing the Trade Gap:

Foreign aid fills the trade gap in the short run, where import reducing initiatives may also be
considered in order to pursue economic stabilisation.However, the long-run development
objective is that a country’s own export earnings should be more or less sufficient to meet import
requirements. Since import reduction is not conducive to the long-run growth process, this
objective has to be pursued through export promotion (or, more precisely, achieving growth in
export receipts in excess of that of import payments).

2.14 Foreign Inflows

The linkage between Foreign Inflows and poverty seems to be quite general but studies have shown
that there are country specific outcomes of the foreign inflows on poverty (Zaman et al; 2008).
Foreign Inflows can affect poverty directly on indirectly. The direct impact comes from the increase
in household income while indirect affect comes from the spillovers of different income generating
activities directly affect by foreign inflows (Carvalho et al; 1996). There are quite a few studies in
economic literature on foreign inflows but there are only handful of studies which are somewhatrelated to
our work plan. Siddiqui et al; (2006), found that foreign inflows significantly affect povertyin presence of
trade liberalization. Prasad et al. (2007) used the data of 83 countries for the period1970 to 2005 and
found positive relationship between growth and inflows using Panel Regressions.Marwah (2004) used
data from 1970 to 1998 for four countries and found the same result. In case ofAsian countries, Hong
(1997) for Korea, Rana et al (1988) for Asian developing countries, andBahasumshah (2005) for 8 Asian
countries found positive relationship between foreign inflows and growth using different time periods and
techniques.

2.15 Foreign Assistance

Foreign assistance generally comprises of non-returnable grants (Aid) and returnable foreign loans (Debt)
with interest. In this study, we have combined both Foreign Debt and Grant to for form a foreign
assistance variable and analyzed its impact on different variables. It is argued that foreign assistance,
particularly aid, has negative or insignificant impact on growth and poverty because it is not properly
utilized. Masud et al; (2005) portrayed three main arguments coming out of most of the aid effectiveness
studies. 1) aid is often misallocated (given to wrong recipients), 2) aid is not properly used/utilized by the
recipients and 3) GDP is not the correct measure for aid effectiveness Boone (1996). They further
explained that the argument about the misallocation of foreign assistance is in appropriate most of the
time because objectives of the donors are not always to assist the recipient countries in their development
and poverty reduction but there is underlying agenda coupled with each assistance agreement which is
more tilted in favor of donor’s strategic interests. Keeping this situation in mind, one cannot expect the
foreign assistance to help in poverty alleviation strategies and economic development. Gwin (2002) found
that foreign assistance have decreased poverty in the host countries and increased their social
development.
 3.0 METHODOLGY:

3.1 RESEARCH DESIGN:

THE PURPOSE OF STUDY:

The purpose of study is descriptive in nature. The study is to explore the various dimensions,
ways and channels through which impact of Foreign Aid is transmitted to the growth of the
economy. The main purpose is to find out the role foreign aid in economic growth of Pakistan.

THE TYPE OF STUDY:

It is a casual study that discusses the effect of foreign aid on various dimensions of the Economy.

THE RESEARCHER INTERFERENCE:

The researcher`s Interference is Minimal to examine the subject in Foreign Aid.

THE STUDY SETTING:

The study setting is Non-Contrived and field experiment would be performed.

THE UNIT OF ANALYSIS:

The Unit of Analysis is Country wise.

THE TIME HORIZON:

The Time Horizon would be Cross-Sectional.

3.2 SAMPLE DESIGN
POPULATION:

Elements: All entities receiving Foreign Aid

Extent: All entities having

BIBLIOGRAPHY:

1. Abu S. Shonchoy , The Dymanic of Spending and Absorption of Aid: Panel Data Analysis, IDE
Discussion Paper no. 245, August 2010.
2. Attia, Sayed Moawad, The Role of USAID in Development in Egypt, MPRA Paper No. 16578,
posted 03. August 2009.
3. Elizabeth Asiedu and Boaz Nandwa, The Impact of Foreign Aid in Education Growth Research
Paper No. 2007/60. September 2007
4. Jytte Laursen Technical Advisor (economics)Danish Ministry of Foreign Affairs (Danida) and
Howard White Fellow Institute of Development Studies (IDS)University of Sussex,
MACROECONOMIC ISSUES IN FOREIGN AID. October 1998
5. June E. O'Neill, A CBO Study THE ROLE OF FOREIGN AID IN DEVELOPMENT MAY
1997.