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The Role of Foreign Aid and the foreign exchange Constraint in Growth : Some Extensions

  • Goyal, A.

An analytical framework that draws both upon the two-gap models and work on non-market clearing short-run constrained equilibria, and its application to long-run growth, is applied to find out when the contribution of foreign resources to growth is maximum. A theoretically consistent treatment of foreign inflows, starting from consumer and firm decisions, shows that foreign inflows need not have a negative coefficient in a behavioural savings function. A model with a saving function, an investment function and an import constraint generates a demand constrained short-run equilibrium in addition to savings and trade and capacity constrained equilibria. Considerations of dynamics and long-run persistence of constraints and equilibria, show foreign inflows make the maximum contribution, when the resource and trade constraints are binding, since rise in output and domestic savings results in the maximum increase in investment. Simulations show such a virtuous growth path was reversed in the sixties and seventies in India. A sudden fall in inflows reduced the slope and intercept of the investment function and the economy shifted to a stagflationary trajectory.

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Paper provided by Indira Gandhi Institute of Development Research- in its series Papers with number 70.

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Length: 28 pages
Date of creation: 1992
Date of revision:
Handle: RePEc:fth:indgan:70
Contact details of provider: Postal:
INDIRA GANDHI; INDIRA GANDHI INSTITUTE OF DEVELOPMENT RESEARCH, GEN.VAIDYA MARG.GOREGAON (E) BOMBAY-400 065 INDIA.

Phone: (022) 840 0919/20/21
Fax: (022) 840 2752/2026
Web page: http://www.igidr.ac.in/
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  1. Grinols, Earl & Bhagwati, Jagdish N, 1976. "Foreign Capital, Savings and Dependence," The Review of Economics and Statistics, MIT Press, vol. 58(4), pages 416-24, November.
  2. Bacha, Edmar L., 1990. "A three-gap model of foreign transfers and the GDP growth rate in developing countries," Journal of Development Economics, Elsevier, vol. 32(2), pages 279-296, April.
  3. Weisskopf, Thomas E, 1972. "An Econometric Test of Alternative Constraints on the Growth of Underdeveloped Countries," The Review of Economics and Statistics, MIT Press, vol. 54(1), pages 67-78, February.
  4. Gersovitz, Mark, 1982. "The estimation of the two-gap model," Journal of International Economics, Elsevier, vol. 12(1-2), pages 111-124, February.
  5. Bruton, Henry J, 1969. "The Two Gap Approach to Aid and Development: Comment," American Economic Review, American Economic Association, vol. 59(3), pages 439-46, June.
  6. Morisset, Jacques, 1989. "The impact of foreign capital inflows on domestic savings reexamined: The case of Argentina," World Development, Elsevier, vol. 17(11), pages 1709-1715, November.
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