Macroeconomic Effects of Foreign Aid in Bangladesh Revisited

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MACROECONOMIC EFFECTS OF FOREIGN AID IN BANGLADESH REVISITED Rahim M. Quazi

ABSTRACT This paper revisits the topic of macroeconomic effects of foreign aid in Bangladesh and finds, in line with the radical anti-aid view, that aid has reduced both GDP growth and domestic savings in Bangladesh. However, the effects of aid on growth were found less damaging than predicted by the radical view. A Keynesian interpretation of the estimated results suggests that by raising consumption expenditures, aid also stimulates the demand-constrained Bangladesh economy, which causes greater utilization of production capacities. In turn, it increases national output through a multiplier-accelerator mechanism. Thus, aid induces indirect positive effects on GDP growth through increased consumption demand, which offset much of the direct adverse effects of aid. increases national output through a multiplieraccelerator mechanism. Thus, much of the direct Prelude adverse effects of aid are offset by the indirect positive effects of increased demand on GDP. Over the years two opposing views have emerged in development economics on the topic of The ensuing sections are organized as follows: macroeconomic effects of foreign aid. On the one section II provides an overview of the aid literature hand, based on early theoretical developments, the on Bangladesh, section III describes the model and traditional pro-aid view advocates aid on the premise presents the empirical results, and finally, section IV that it complements domestic resources, eases foreign summarizes the results and offers policy implications. exchange constraints, transfers modern know-how and managerial skills, and facilitates easy access to Literature Review foreign markets, all of which contribute to economic growth (Chenery and Strout 1966, Papanek 1972, There exists a growing literature on the 1973, etc.). On the other hand, based on the empirical macroeconomic effects of foreign aid in Bangladesh. evidence, the radical anti-aid view criticizes aid on Among the very early studies, Islam (1972) analyzed grounds that it supplants domestic savings, worsens the relationship between foreign capital (foreign income inequality, funds the transfer of inappropriate public aid and foreign private investment) and gross technology, finances ineffective projects, and in domestic savings in the erstwhile East Pakistan and general helps sustain bigger, more corrupt and concluded that foreign capital had affected domestic inefficient governments in the recipient countries savings negatively in the 1950's, but positively in the (Griffin and Enos 1970, Weisskoff 1972, etc.). 1 1960's. Mostly a descriptive survey paper in nature Bangladesh, which has received a cumulative influx and lacking in quantitative analysis, this study offers of almost US $33 billion in public foreign aid (grants only tentative observations. and loans combined), provides an important test case A more rigorous approach is taken by Alamgir (1974) for analyzing the effects of foreign aid on the who econometrically investigated the effects of recipient economy. Several recent studies, e.g. foreign capital on gross domestic savings and growth Ahmed (1992), Taslim and Weliwita (1998), etc., in East Pakistan during 1960-70. The estimated have estimated the macroeconomic effects of aid on results show that foreign capital affects gross the Bangladesh economy and generally found results domestic savings positively, but GDP growth that are in line with the radical anti-aid view. This negatively. Drawing on these results, the author paper presents results that suggest that the effects of concluded that since foreign capital finances the aid on GDP growth in Bangladesh are in fact not very imports of foreign investment goods, which are detrimental. Based on the results estimated by this complementary to domestic capital goods in study, a post-hoc Keynesian hypothesis can be put production process, additional foreign capital forth that...
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