tion at the ADB. R
TJ As for instance argued in H.B. Chenery, and A.M. Strout, "Foreign Assis
tance and Economic Development" American Economic Review, Vol.56 (Septem- p ber, 1966)
8/ See for example, D. Avramovic, et al. Economic Growth and External Debt
(Baltimore, Johns Hopkins Press, 1964) and A.P. Thirlwall, Growth and ] Development with Special Reference to Developing Countries, (New York, lu Halsted Press, 1977) (Second Edition).
27
-must exceed the outflows due to debt service. If either of these conditions does not hold, then the borrowing country would be faced with debt-service problems which could have a negative impact on growth of the economy. —9/
A review of the literature on the role of foreign finance as supple mentary to domestic savings indicates that some of the inflows may have encouraged consumption rather than investment. There is some cross-section evidence which shows statistically significant negative relationships between domestic savings or growth in income and foreign capital inflows. — A time series data (1960-1974) study on 16 African countries also revealed a negative relationship between domestic savings and foreign finance, although the co efficients were statistically significant in 11 of the countries in the sample.
— The explanation for this relationship has not been readily available.
However, it has been suggested that the ready availability of foreign capital inflows to the borrowing countries tended to weaken the incentives to raise the domestic savings ratio. —12/ Partial evidence in support of this explanation could be existence of persistent budget deficits and the policy of low interest rates which make it unattractive to save on the part of private households.
Although this explanation for the observed negative relationship between domestic savings and inflow of foreign capital seems reasonable, there are other more plausible explanations which can be advanced. Since in developing countries, and in Africa in particular, the biggest foreign finance recipient has been the public sector, it is possible that some of the aid may have naturally gone into public consumption, mainly due to the need to finance
9/ In the case of the second condition, the borrowing country would simply be postponing the debt-service commitments (unless those inflows are non-debt creating such as grants and direct investment employed in the export sector).
10/ See K.B. Griffin and J.L. Enos "Foreign Assistance: Objectives and Conse quences," Economic Development and Cultural Change, Vol.18, N°3 (April 1970); K.B. Griffin "Foreign Capital, Domestic Savings and Economic Development", Bulletin of the Oxford Institute of Economics and Statis tics, (May 1970; and T.E. Weisskopf, "The Impact of Foreign Capital Inflow on Domestic Savings in Underdeveloped Countries", Journal of International
Economics, Vol.2, (1972). :
11/ J.U. Umo "Empirical Tests of some Savings Hypotheses for African Countries", Financial Journal, Vol.2, N°2 (1981).
_12/ G.F. Papanek, "The Effect of Aid and Other Resource Transfers on Savings and Growth in Less Developed Countries", Economic Journal, Vol.82, (1972), pp.934-950,
H
public social services. Yet another explanation may be that aid has naturally flowed into countries which are relatively poorer and therefore with lower savings propensities. —13/ The most recent evidence of this is the fact that
because of the current declining growth trends in Africa, a call has been made to the donor community to increase its aid substantially to these countries. A recent study by the Economic Commission for Africa (ECA) also shows an increase in aid flows to African agriculture in the face of declining production in this sector. —14/ It might also be mentioned in this context that 60.2 per cent of
the African Development Bank Group cumulative lending went to the poorest member countries as at the end of 1983. —
Other studies indicate that in economies with fluctuating export receipts, foreign finance has been found to play a role of smoothing the consumption path over time. — When export receipts are rising due to a boom in commodity prices, for instance, governments naturally increase total expenditures to satisfy increasing social needs. During the slump periods, revenues and savings decline and in order to maintain the irreversible expenditure levels, internal and external borrowing is resorted to: the short-run current public consumption is said to be subject to the 'ratchet
effect'. ^— Thus, the observed negative correlation between domestic savings
and foreign finance can be regarded as a result of quite rational behaviour on the part of borrowing countries - particularly on the part of the much poorer countries.
These observations seem to indicate that that foreign finance flows where it is needed most - that is, where it is meant to raise the growth rate in income to a higher level than that achievable by domestic savings alone.
13/ G.F. Papanek, 1972, Ibid. ■ n
14/ ECA, Apparent Discrepancy between Increasing Resource Allocation to Food J
and Agriculture in Africa and the Declining Performance of the Sector.
UN/E/ECA/CM.10/21 (February 1984) " H
15/ ADB, Two Decades of Development Financing (Abidjan, 1984) p.18. Poorest
countries are those whose per capita GNP is below or equal to US $400. Fl 16/ D.C. McDonald, "Debt Capacity and Developing Country Borrowing: A survey
■ u
of the Literature." IMF Staff Papers Vol.29, N°4 (December 1982) ^
pp. 603-646. ;
17/ This means that public consumption expenditures tend to be rigid down wards. See P. Wonnacott, Macroeconomics (Homewood, Richard D. Irwin,
Inc., 1984) U
29
-Thus, the apparent negative relationship between domestic savings and foreign finance does not necessarily imply that the latter causes the former to decline. The case, therefore, remains strong for increased aid to those economies which need it most.
j In summary, foreign finance (including debt) has a crucial role to play in development. With respect to debt finance, as long as the loans are j i employed in projects yielding sufficient return in foreign exchange to service
the debt, such finance should be employed.
1
2. External Debt Trends and Structure