ABSTRACT
The traditional macroeconomic rationale for foreign aid is, as discussed in Chapter 4, that aid can help fill savings and trade gaps. In the next section, we therefore briefly review the simple gap approach. Nevertheless, it has become abundantly clear that the macroeconomic role and effect of aid are complex in a variety of ways which are not explicitly captured in gap models. Some of these complications are discussed, namely: (i) the effects of aid on government behaviour (including the tax effort of aid-receiving governments and the fungibility of aid), (ii) foreign debt problems and (iii) the relationship between foreign aid and the exchange rate (Dutch disease). Thus, aid does much more than fill gaps, and a major argument of this chapter is that aid should not be perceived simply as a measure to fill gaps in the short run. Instead aid should be given in such a way that the gaps will close over time so that growth and development can be sustained without aid. In the next to last section, we discuss the ways in which aid may be used to close both the external and fiscal gaps, considering both macro-level interventions and project-level activities. A final section concludes.
