Macroeconomic Issues in Foreign Aid

The macroeconomic rationale for aid relates to its ability to supplement savings, foreign exchange and government revenue, thus contributing to growth. This processes presumes a simple Harrod-Domar context in which growth is driven by physical capital formation. However, the macroeconomic reality of aid is more complicated. Three areas of complication are discussed: (i) the effects of aid on fiscal behaviour, (ii) debt problems and (iii) Dutch disease effects. In the long run, rather than merely filling gaps, aid should help close gaps, since reliance on future aid and foreign borrowing is thus diminished and economic policy autonomy is increased. Closing the savings gap entails financial and technical support for mobilisation of domestic savings. Closing the trade gap entails supporting a macro environment conducive to export growth, helping to expand and improve physical infrastructure and direct support for export activities, notably those of a non-traditional nature. Closing the fiscal gap entails support for increasing government revenue and improving expenditure management, which is the more delicate task since donors and recipient governments have to carefully balance the disadvantage of lower-than-needed government spending against the disadvantage of higher, and potentially distortionary, taxation.-3