A NOTE ON FOREIGN ASSISTANCE AND THE CAPITAL REQUIREMENTS FOR DEVELOPMENT,
RAND CORP SANTA MONICA CALIF
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This memorandum assumes that the sole purpose for extending foreign assistance is to further economic development in the recipient countries, and that economic development in the recipient countries can be measured solely in terms of increases in real national income properly valued. The memorandum is essentially an exercise in optimization, given the need to conserve resources in the donor and given the objective of raising real national income in the recipient. Foreign assistance extended by the donor can be converted into a grant equivalent, the amount that the donor in effect actually gives away as pure foreign aid. Using a similar technique, a grant equivalent can be defined for the recipient by taking the present discounted value of the foreign assistance and all future debt servicing associated with it. So long as the rate of discount for the recipient exceeds that for the donor, the grant equivalent for a given capital flow will typically be higher for the recipient than it is for the donor. Analysis shows that in the case of straightforward lending maximization is accomplished by lengthening the maturity of the loan indefinitely and raising the interest rate charged on the loan just enough to leave the grant equivalent from the donor unchanged. Optimizing terms for other forms of assistance are more complicated. As illustrations, two recent proposals are examined using the tools of grant equivalents the investment tax credit proposal and the proposal to subsidize interest rates on flotations by less developed countries in the bond markets of donor nations.