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Foreign aid vs. International trade Essay

Foreign aid vs. international trade is a long lasting debate as to which strategy leads to the greatest level of economic development. Foreign Aid is defined as any assistance that is given to a country not provided through normal market forces. There are numerous forms of aid, from humanitarian emergency assistance, to food aid, military assistance, etc. Development aid has long been recognized as crucial to help poor developing nations grow out of poverty. International trade is the exchange of goods or services across international borders. Economic development as defined by AmartyaSen, 1998 Nobel prize laureate, “requires the removal of major sources of unfreedom: poverty as well as tyranny, poor economic opportunities as well as systematic social deprivation.” (1)

In 1970, the world’s affluent countries agreed to give 0.7% of their GNI (Gross National Income) as official international development aid, annually. Since then, these rich nations have rarely met their actual promised targets. “The US is often the largest donor in dollar terms, but ranks amongst the lowest in terms of meeting the stated 0.7% target.” The two charts below, reproduced from the OECD publications (2012) shows aid granted in constant dollars and as a percentage of GNI. Both support the conclusion regarding the failure to meet agreed upon aid commitments and the level of decreasing donations. (2)Billions have been donated, but it appears that Africa which has received the most aid remains a continent impoverished.

As Dambisa Moyo in the Wall Street Journal writes “money from rich countries has trapped many African nations in a cycle of corruption, slower economic growth and poverty. Cutting off the flow would be far more beneficial…….the insidious aid culture has left African countries more debt-laden, more inflation-prone, more vulnerable to the vagaries of the currency markets and more unattractive to higher-quality investment. It’s increased the risk of civil conflict and unrest ….. Aid is an unmitigated political, economic and humanitarian disaster”. (3) Wall Street Journal, March 21st, 2009

Over the past 60 years at least $1 trillion of development aid has been granted to Africa. And unfortunately real per-capita income in 2014 is less than it was in the 1970s. “More than 50% of the population — over 350 million people — live on less than a dollar a day, a figure that has nearly doubled in two decades” (4) Wall Street Journal, March 21st, 2009

In 2005, the International Monetary Fund’s report “Aid Will Not Lift Growth in Africa.” concluded that governments, donors and campaigners should be more modest in their claims that increased aid will solve Africa’s problems. (5)

Historically Asia was underdeveloped too. Yet various policies by governments to enhance international trade have resulted in many Asian countries i.e. Korea, Taiwan, Malaysia, and Singapore achieving spectacular economic growth and along with it, higher standard of living for its citizens. Dato Kim Tan, the co-founder and trustee for the Transformational Business Network (TBN) wrote “growing up din Asia, I saw the Asian tiger economies that 30-40 years ago had a lower GDP than Uganda or Kenya, transform themselves through enterprise, not through aid and philanthropy.”

(3)Paul Kagame, President of the Republic of Rwanda and that country’s first democratically elected president wrote: “There is bad aid and there is good aid. The bad aid is that one which creates dependencies, as we’ve known for a long time now. But good aid is that which is targeted to create capacities in people so that they are able to live on their own activities.… In the long-term they have to depend on themselves rather than depend on aid.”(4)

Poverty Cure

The issue to be addressed is whetherforeign aid achieveslong-term growth and development – is it a positive or negative catalyst to economic well being. And the corollary to this statement is whether international trade is a better alternative to economic achievement.

Trade Theory:

The historical basis for concluding that there is gain from trade originates from David Ricardo’s work: Principals in Political Economy and Taxation. The historical context of the time was the protectionist English corn laws, restricting wheat imports. Ricardo’s conclusion, arrived at by his theory of comparative advantage, showed that countries could benefit if they specialized and promoted free trade.

Figure 1: Comparative Advantage

Country A has an absolute production advantage of both goods A and B because it can produce more of these goods. Since the PPC is not parallel we can presume that the opportunity cost are both different. As a consequence specialization and mutually beneficial trade can occur. Country A has a comparative advantage in the production of good B and Country B has a comparative advantage in the production of good A. Country B PPF curve has a lower slope therefore its comparative advantage of production is the good on the horizontal axis.

To establish a policy of international trade, governments need to develop programmes that require important changes in the society. For example, states must develop competitive market economies based on environmental sustainability, infrastructure, establish a stable currency, a transparent political framework and legal system, security, and educated populace as prerequisites.

Good A= Capital Goods
Good B= Consumer Goods
Figure 2: PPF curve with improved production via exports

Country A allocates its resources to mostly consumption. Country C allocates its resources towards investment/capital goods. Countries that allocate their resources mainly in investment/capital goods are greater to have long-term growth than those countries who are more focused on consumption who are using up more current resources. With respect to Aid, money that is allocated to current consumption will not improve future conditions where as aid money allocated for such production of infrastructure, health, etc. will in the long run exhibit economic growth.

Interestingly,South Korea’s economic growth from the early 1960s to the late 1990s was one of the world’s fastest, and South Korea remains one of the fastest growing developed countries in the 2000s.This experience is known as the Miracle on the Han River. Like many underdeveloped society’s, S. Korea possessesno natural resources and suffers from overpopulation.In addition, the Korean War destroyed much of its infrastructure. The solution was South Korea adapting an export-oriented economic strategy.Remarkably in 1980, the South Korean GDP per capita was $2,300, about one-third of nearby developed Asian economies such as Singapore and Japan. In 2010 South Korean GDP per capita advanced to $30,000 – almost thirteen times since 1980. (See two charts below on Korean Economic Growth and South Korean Economic Recovery after 1997.)

It is acknowledged that the Korean GDP per capita in 1960 was lower than some sub-Saharan African countries. The growth of the Koreanindustrial sector was the principal stimulus to economic development. It is true that initially some foreign aid was granted by the U.S. given the contentious communist threat, nevertheless, it was from strong domestic government support and a move toward competitive markets and international trade that resulted in the investment of modern technology and newly built facilities at a rapid pace. The export to foreign markets and the plowing of the foreign currency back into further industrial expansion was the strategy for growth.

In addition, this economic strategy suited South Korea given its poor natural resource endowment, low savings rate, and small domestic market. Labour-intensive manufactured exports, permitted South Korea to develop a competitive advantage. No doubt government initiatives were essential to this process. “The inflow of foreign capital was greatly encouraged to supplement the shortage of domestic savings. These efforts enabled South Korea to achieve rapid growth in exports and subsequent increases in income.”(5) Finally, the later development of a unique multinational firm known as the chaebol – family-controlled firms owning numerous international enterprises,enhanced Korean economic growth.

There is strong cooperation with government receiving financial support and guidance i.e. innovation and research. Today of these multinationals are Samsung, Hyundai, and LG. Thus, it is evident that South Korean expansion and wealth for its citizenry has derived from the adoption of a competitive market manufacturing economy, and the development of a high-tech commercethat emphasizes international trade. Foreign loans, supportive government policies, and not aid have been the critical catalyst to such a Han miracle.

Aid Theory:

Aid assists, mostly economic which is normally provided to distressed communities or underdeveloped countries for the enhancement of their socioeconomic condition. Aid is linked to need, is often not linked to the ability to enhance trade. Trade can result in inefficient distribution of income while if aid is mishandled the distribution of aid will be unfair, with people being deprived of the benefits of aid and effect economic growth of the country. Does Aid lead to the establishment of good infrastructure? Development aid is given by governments, i.e. the US being the largest aid donor in the world (As of 2010) and other organizations such as the World Bank. “Aid to all countries in the world declined” (2007, World Bank) An overview of a number of African countries that have been recipients of aid will consider the use and allocation of the foreign aid, and assess the outcome of these donations upon the populace of the continent.

One would note initially that there is a need for humanitarian aid to assist in emergencies and alleviate suffering but long term growth and development requires a different approach. Besides charity aid is a minimal portion of the over-all aid from governments. In the Democratic Republic of Congo, according to a report by Transparency International, the Zairian president Mobutu Sese Seko (1965-1977) is listed as having embezzled at least $5 billion form the nation. (6) Transparency International In 2009, the former president of Malawi – Bakili Muluzi was prosecuted for stealing $12 million allocated for aid. And Zambia’s former president, Frederick Chiluba is under investigation for taking millions from money that was set aside for health, infrastructure, and education.

Thus, these examples of corruption pervert the opportunity for aid to assist the average African improve their conditions. Economic theory will emphasize that inefficiency will result from government intervention and in particular ‘free’ funds. Bad government worsens the situation as they are often bureaucratic in addition to corrupt. The civil service is inefficient and vulnerable to cronyism which has consequence for responsible governance. Economic incentives are nullified and governments need not respond to citizen needs. Investors require transparency in government and business but such a prerequisite is not required when donations are the source of funds. Policies such as taxation can be deferred since donations flow in to the country. The priority is to remain in power. Africa continues to be the most unstable region. There are numerous examples of civil strife as exemplified by the current war in Southern Sudan and The Congo.

According to the Stockholm International Peace Research Institute, Africa had a greater number of wars than elsewhere in the world. Obviously, such strife has immense impact upon daily life and thwarts any possibility of private investment. Aid thus fills the vacuum. As stated in his book, Dead Aid: Why Aid Is Not Working and How There is a Better Way for Africa, by D. Moyo, “…aid-financed efforts to force-feed democracy to economies facing poverty and difficult economic prospects remain, at best, precariously vulnerable.” (7) Further evidence of endemic problems is observed in Nigeria. This government is one of the most mismanaged in Africa.

For example, during the World Economic Forum of 2005 in Davos Switzerland, four state governors were being investigated in the U.K. for money laundering. Large amounts of aid are looted. “Speaking at the New Partnership for African Development (NEPAD) meeting in Abuja, Nigeria, in December 2003, the former British secretary of state for international development, Lynda Chalker, noted that 40 percent of the wealth created in Africa is invested outside the continent.” (8)

Advantages and Disadvantages to Trade:

Trade provides development countries with an important base for their own improvement. Countries can develop their own strategies and outcomes to achieve their development objectives i.e. focusing on agriculture of manufacturing services. Countries are the determinants of their own economic destiny. One difficulty of trade is the international economic system imposes impediments i.e. trade barriers. The global market is not an international free trade market i.e. tariffs, taxes and subsidies, regulations and such restrictions operate to the disadvantage of the developing countries. The donor country puts restrictions on the recipient country i.e. the requirement for government transparency, human rights, political support at the UN or Ideological support. Japan gains support from small countries on whale killing/harvesting using trade.

Developing countries have weak economic power to challenge economic injustices i.e. EU and USA have large program of subsidies and economical protectionism.One argument states that trade is a foundation for international cooperationi.e. one country is the resources base and the other importing country is the manufacturing base. Trade would benefits those countries who are engaged in trade (based on the market). Trade relationships would result in a more equitable partnership and thus might be a catalyst for investment and growth.

Developing country could receive direct foreign investments and the benefits that would sue from that, technology, employment etc. The result of this would lead to lower prices, greater choice, more efficient allocation of resources, foreign exchange and idea flowing between countries. Once getting passed trade impediments it can seen as long-term development strategy for a developing country. A summary of the advantages and disadvantages:

A country may import things which it cannot produce
Maximum utilization of resources
Benefit to consumer
Reduces trade fluctuations
Utilization of surplus produce
Fosters international trade
Import of harmful goods
It may exhaust resources
Over specialization
Danger of starvation
One country may gain at the expensive of another
It may lead to war

Advantages and Disadvantages to Aid:

Aid has been said to decrease the development for countries with their own improvement. Aid has many advantages but as it can be seen using examples such as African countries it can be seen that aid has decreased the development for countries. Countries can be giving aid for ethical reasons, if there was a natural disaster and were in need of assistance. Aid is based on need, aid permits to countries to retain their dignity because aid if often perceived as condescending. There are different types of aid, tied and untied. Tied aid is foreign aid that must be spent in the country providing the aid or in a group of selected countries. Untied aid is assistance given to developing countries, which can be used to purchase goods, and services in virtually all countries.

Jeffery Sachs (UN advisor) argued that aid is important, it is essential to break the poverty cycle and a determinant of long term growth. His argument stated that poor countries are not wealthy because of diseases such as malaria, they need to remove problems such as disease because the free market will not due this.

Giving of aid is perceived as an inducement to behave or support certain policies. Aid can be used as blackmailing or getting the upper hand on another country in order to gain their vote in the UN.

William Easterly (Professor of economics, NY university), aid does more harm than good, its often wasted, it inhibits peoples inventiveness, devising their old solutions. Aid is corrupt because its given to corrupt officials and often its fragmented that there is many donors and misallocations of the funds. Aid often comes with a lot of preconditions. Furthermore, aid has often come with a price of its own for the developing nations.

Aid is often wasted on conditions that the recipient must use overpriced goods and services from donor countries. Most aid does not actually go to the poorest who would need it the most. Aid amounts are dwarfed by rich country protectionism that denies market access for poor country products, while rich nations use aid as a lever to open poor country markets to their products. Large projects or massive grand strategies often fail to help the vulnerable as money can often be embezzled away.


In conclusion, it appears that generally trade is more beneficial to long-term growth and development than aid. African examples discussed are proof that aid is counterproductive and the road to economic failure. The opposite appears true. Those countries able to divorce themselves from aid dependency are more likely to succeed as evidenced by China, India, and even South Africa. A strategy of transparent government, efficient civil service to meet social needs i.e. education, incentives, entrepreneurship, the rule of law, patent protection, institutions to attract foreign direct investment by creating attractive tax structures and reducing the red tape and complex regulations for businesses.

Private capital investment into sustainable companies, with aid directly to community based non-profitable organizations is recommended. African nations should also focus on increasing trade, but there have been cases where rapid growth in international trade has led to bottlenecks and impediments to growth and development. There appears to be no panacea but one does conclude that in order to achieve economic, social, and political progress there are essential non-economic and economic prerequisites – cultural (i.e. individualism, attitudes of personal achievement, hard work, etc.) political (i.e. transparent governments, stability, the rule of law,) and economic (i.e. infrastructure, communications network, merit goods i.e. education and health etc.).

Each nation is unique with regard to trade and aid. The answer is not either or – aid or trade .but accountable and transparent aid in conjunction with sustainable trade and honest and efficient government.

Bibliography: (Complete bibliography after check by Ms. Kerr)

1. Amartya Sen. 1999. Development as Freedom. Oxford university press 2. http://www.globalissues.org/article/35/foreign-aid-development-assistance 3. wall street journal
4. wall street journal
5. http://www.povertycure.org/voices/kim-tan/
6. http://www.povertycure.org/voices/president-paul-kagame/
7. http://books.google.ca/books?id=_adMWevoEq0C&pg=PA137&dq=The+inflow+of+foreig
n+capital+was+greatly+encouraged+to+supplement+the+shortage+of+domestic+savings.+These+efforts+enabled+South+Korea+to+achieve+rapid+growth+in+exports+and+subsequent+increases+in+income.%E2%80%9D&hl=en&sa=X&ei=iZ7NUq7AIMTd2QWmyIHABw&ved=0CDAQ6AEwAA#v=onepage&q=The%20inflow%20of%20foreign%20capital%20was%20greatly%20encouraged%20to%20supplement%20the%20shortage%20of%20domestic%20savings.%20These%20efforts%20enabled%20South%20Korea%20to%20achieve%20rapid%20growth%20in%20exports%20and%20subsequent%20increases%20in%20income.%E2%80%9D&f=false 8. OECD Development Statistics Online, last accessed April 7, 2012 9. http://www.bbc.co.uk/news/uk-20405140

10. http://www.guesspapers.net/1593/advantages-and-disadvantages-of-international-trade/ 11. http://www.moeasmea.gov.tw/ct.asp?xItem=72&CtNode=263&mp=2 12. http://www.globalissues.org/article/35/foreign-aid-development-assistance 13. http://www.ryanallis.com/sustainable-capitalism-and-the-role-of-aid-vs-trade-in-prosperity-creation/ 14. http://www.cato.org/publications/economic-development-bulletin/african-perspectives-aid-foreign-assistance-will-not-pull-africa-out-poverty

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