Foreign Aid and Economic Growth in Ecuador:

A Test of the Harrod-Domar/Financing Gap Growth Model

Lotta Westerberg1

1 Swedish national with a Bachelor’s of Arts in Political Science from Stephen F. Austin State University, USA and a Master in International Development from the Josef Korbel School of International Studies, University of Denver, USA. She has lived and worked in Ecuador for more than two years.

I Introduction

For centuries, nobody paid much attention to the economic growth of the developing

countries. The League of Nations’ 1938 World Economic Survey, for example, included one

paragraph on South America, but paid not attention to the poor countries in Asia and Africa.2 All

this changed after World War II. All of a sudden, policy makers were called to solve the “urgent

problems” of the poor countries as everyone now agreed that the poor countries should

“develop.” 3 Scores of economists now rushed to give policy advice to the newly independent

poor countries. These economists had been influenced by two simultaneously events, (1) The

Great Depression, and (2) the industrialization of the USSR “through forced savings and

investment” (Easterly 1997:4).

The Harrod-Domar model, influenced mainly by the Great Depression, was one of the

first models used to analyze economic growth in developing countries, and still today, it is the

base of many economic development models in organizations such as the World Bank and the

International Monetary Fund (IMF). Essentially, the model calculates the investment required

for a target growth rate. The gap between the required investments and the available resources

will then be the ‘financing gap,’ which can be filled with foreign aid. Hence, the amount of

foreign aid a country receives will, based on the Harrod-Domar/Financing Gap model, have an

effect on its economic growth. However, several intervening factors can affect the outcome, and

hence question the models practical application. This paper will discuss the contemporary use of

the Harrod-Domar/Financing Gap model and summarize the discussion of real life issues that

can affect the outcome. The paper then evaluates the practical applicability of the model by

looking at the case of Ecuador.

II Theoretical Aspects of the Harrod-Domar Growth Model

The Harrod-Domar model was put forth in Evsey Domar’s article on economic growth

called “Capital Expansion, Rate of Growth, and Employment,” in 1946.4 Despite the fact that

the model was not intended to be a long-term growth model for developing countries, but rather

discussed the “relationship between short-term recession and investment” in the United States, it

2 Arndt, 1987, p.33.3 Arndt, 1987, p.49 quote from UN World Economic Report 1948.4 Roy Harrod had in 1939 published a similar article, hence the name of the model.

2

is the most widely applied growth model in economic history (Easterly 1997:2). It has been

argued that the model became popular because of its simplicity. According to the model, growth

of the Gross Domestic Product (GDP) will be proportional to the share of investment spending

in GDP. Hence, for economic growth, every economy must save a certain proportion of its

national income. While some of these savings may be used to replace worn-out or impaired

capital goods, the rest of the savings, in order for the economy to grow, must be used to make net

additions to the capital stock. Further, if we assume that there is a direct economic relationship

between the investment (I) in capital stock (K) and the total GDP (Y), for example, if $3 of

capital is always necessary to produce a $1 increase in the GDP, then net additions to the capital

stock will increase the GDP proportionally. This is known as the capital-output ratio, or k.

The savings (S) of an economy equals the proportion of the nation’s income (Y) not

consumed (C). Consumption, or expenditures on purchase of final goods and services, is

determined by the national income. Hence, the more you make (Y), the more you can spend (C),

and the more you will have left to save (S). Further we must assume, according to the Harrod-

Domar model, that the national savings ratio (s), is a fixed proportion of national output (for

example 6%), and the total new investment is determined by the level of savings. The savings

rate of the economy, or the savings as proportion of national income, is defined as S=sY, with

s=S/Y. The question then is; how do you determine investment in economy? According to the

Harrod-Domar model, this can be done by following a few simple steps:

1. Invest in the capital stock of the economy, or I=ΔK.

2. As discussed, ΔK/ΔY=capital out put ratio, or k.

3. Hence, ΔK=kΔY, i.e. I= kΔY

4. Since net national savings, S, must equal net investment, I, we can write this equality as

S=I

5. Hence, sY= kΔY

6. If we dived the above equation first with Y and then by k, we get the Harrod-Domar

Growth Model: ΔY/Y=s/k.

3

Hence, the growth rate of the GDP (ΔY/Y) is determined jointly by the national savings

ratio, s, and the national capital output ratio, k. More precisely, it says that, “the growth rate of

national income will be directly or positively related to the savings ratio and inversely or

negatively related to the economy’s capital-output ratio” (Todaro & Smith 2003:114). For

example, in a country with a savings ratio of 6% and a capital output ratio of 3,5 the GDP will

grow by 2% (6%/3) each year. However, in many developing countries, a GDP increase of 2%

is barely adequate to keep up with the population growth. Therefore, the net savings rate needs

to be increased to about 15-20%,6 through increased taxes, foreign aid, and/or general

consumption sacrifices. The difference between the required investment and the country’s own

savings is called the ‘financing gap,’ and, according to the model, private financing is assumed to

be unavailable to fill this gap. Hence, the international community thought that foreign aid was

the best way to fill the gap and attain target growth. At the beginning, development economists

were not clear about how long it would take aid to increase investment and in turn increase

growth. However, soon economists argued that the model was short-term, i.e. “this year’s aid

will go into this year’s investment, which will go into next year’s GNP growth” (Easterly

1997:5). Chenery and Strout further developed the Harrod-Domar/Financing Gap model in 1966

as the Two Gap Model, which essentially imply the same testable propositions: “(1) aid will go

into investment one for one, and (2) there will be a fixed linear relationship between growth and

investment in the short-run” (Easterly 1999:3).

III Theory meets application

Between the years of 1950 and 1995, Western countries gave one trillion dollars

(measured in 1985 dollars) in aid.7 As Easterly put it, “since virtually all of the aid advocates

used the Harrod-Domar/Financing Gap model, this was one of the largest policy experiments

ever based on a single economic model” (Easterly 1997:8). To test if the two propositions of the

5 A “normal” capital-output ratio is around 3.5 (Easterly 1999).6 Rostow, in “The Stages of Growth. A non-communist manifesto,” defined the take-off stage of an economy in this way. Countries that were able to save 15% to 20% of their GNP could grow (‘develop’) at a much faster rate than those that saved less.7 Foreign aid, or Official Development Assistance (ODA), comprises loans or grants to developing countries and territories provided by donor governments and their agencies for promoting economic development and welfare. If the assistance is provided in the form of a loan, it must be extended on concessional financial terms, that is, with a grant element of 25% or more, calculated as a net present value of the future payment stream discounted at 10% (As defined by OECD).

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economic model held true between the years of 1965-1995, Easterly (1999) ran two regressions,

first testing the aid-to-investment relationship (Table 1), and then the investment-to-growth

relationship (Table 2).

Table 1: Results of regressing Gross Domestic Investment/GDP on ODA/GDP country by country, 1965-1995

Coefficiant of Investement on ODA Number of Percent of Sample

CountriesTotal 88 100%Positive, significant, and >=1 6 7%Positive and significant 17 19%Positive 35 40%Negative 53 60%Negative and significant 36 41%

According to this table, the positive relationship between aid and investment, as

expected by the Harrod-Domar/Financing gap model, did not hold true for a majority of the

countries. For 36 countries, or 41% of the sample, there was even a significant negative

correlation between aid and investment. In his second table, spanning the years 1950-1992 and

testing the short-term investment-to-growth relationship, Easterly’s main goal was to examine

the predictive power of the model, i.e. if we can predict growth with a constant capital-output

ratio, with k being more than 2 and less than 5.8

Table 2: Results of regressing GDP Growth on Gross Domestic Investment/GDP with a constant, country by country, 1950-1992

Coefficient of Growth on Investment/GDP Number of Percent ofCountries Sample

Total Sample 138 100%Positive, significant, “zero” constant,9 and 2<k<5 4 3%Positive, significant, and “zero” constant 7 5%Positive and significant 11 8%Positive 77 56%

8 The average k is supposed to be around 3.5, and hence most countries, if not all, should fall in between the range of 2 and 59 A constant that is insignificantly different than zero.

5

Negative 61 44%Negative and significant 10 7%

Hence, only four countries have a positive and significant relationship between growth

and investment and a capital-output ratio between 2 and 5. It needs to be reiterated though, that

Easterly is testing the short-term relationship, there is generally a robust long-term relationship

between investment and growth (Levine & Renelt 1992).

Easterly points out, that despite these results (and the overall critique of the model in the

academic world), that the Harrod-Domar/Financing Gap model is still being used by the IMF and

the World Bank, and other regional agencies to measure “foreign resource requirements, to

allocate aid, and to provide advice to developing countries on economic policy” (Ranaweera

2003:3). The use of this model, Easterly and others argue, is partly to blame for the indebtedness

of developing countries. As the misconception inherent in the Harrod-Domar/Financing Gap

Model, that foreign aid would go one and one into investments, which would in turn lead to

economic growth and the ability to pay back the loans, did not materialize as planned. Already in

1966 did Bhagwati warn about the excessive indebtedness to donors, with Turkey already having

developed debt servicing problems on its past aid loans. In 1972, Bauer noted that “foreign aid

is necessary to enable underdeveloped countries to service the subsidized loans…under earlier

foreign aid agreements” (Bauer 1972:127). These issues have led to the development of the use

of the Harrod-Domar model (i.g. The Two Gap Model etc); however, the base of investment to

savings to growth is still the same. To evaluate why this basic assumption have lead to increased

indebtedness, instead of growth, let us look at what endogenous and exogenous forces might

impact the effectiveness of foreign aid, i.e. its impact on economic growth.

IV Foreign Aid and endogenous and exogenous forces

The effectiveness of foreign aid and its impact on economic growth has been widely

debated in the recent years. A 1998 publication by the World Bank entitled “Assessing Aid:

What Works, What Doesn’t, and Why,” assert that aid does help to increase growth in countries

with sound economic policy, while Easterly (see tables above) asserts that only seventeen of

eighty-eight countries show a positive statistical association between aid and investment (and

hence having marginal effect on economic growth). The difference between the two statements is

6

the base line it is trying to test. While the World Bank report is trying to test actual aid

effectiveness, Easterly is testing the underlying hypothesis of the Harrod-Domar/Financing Gap

model, he is asking whether “investment and aid jointly evolved the way the users of this model

expected” (Easterly 1997:17). This is also the purpose of this paper; to test whether the

theoretical baseline of the Harrod-Domar/Financing Gap model can hold true at all when it is

practically applied. To do this, however, a summary of the endogenous and exogenous forces

that can affect aid will be summarized, as to demonstrate the real world scenarios that affect the

theory of Harrod-Domar. Several scholars (Mulligan & Sala-i-Martin 1993, Easterly and Levine

1997, Easterly 1997, Temple 1998, Burnside & Dollar 2000, Hansen & Tarp 2000, Collier &

Dollar 2001, Moriera 2003) have tried to identify these endogenous and exogenous forces.

Endogenous Forces

Other than the World Bank, Burnside and Dollar (2000) focused on the effect of policy

on aid effectiveness. They came from a neoclassical perspective and argued that the “impact on

growth will be greater when there are fewer policy distortions affecting the incentives of

economic agents.” (Hansen & Tarp 2000:3). Shaw and Kim (2003) have further argued that a

strong policy environment will be able to better deal with aid allocations and will therefore foster

growth and reduce poverty. Especially, they argue, a strong policy environment is vital when

dealing with large amounts of aid. How then can one define “sound economic policy”? Collier

and Dollar (2001:5) argue that it, conceptually, “measures the extent to which government policy

creates an environment for broad-based growth and poverty reduction.” The World Bank

measures this through its Country Policy and Institutional Assessment (CPIA), which can be

divided into four categories (Collier and Dollar 2001):

1) Microeconomic policies: whether fiscal, monetary, and exchange rate policies provide a

stable environment for economic activity.

2) Structural policies: the extent to which trade, tax, and sectoral policies create good

incentives for production by households and firms.

3) Public sector management: the extent to which public sector institutions effectively

provide services complementary to private initiative.

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4) Social inclusion: the extent to which policy ensures the full participation of society

through social services that reach the poor and disadvantaged, including women and

ethnic minorities.

This definition, Collier and Dollar (2001) argues, offers a very close relationship between

policy and the actual improvements in living standards of the poor. This, of course, is not the

only definition; different scholars will define the expression “sound economic policy”

differently. However, as long as they all do agree that a country’s policies have an impact on aid

effectiveness, they all agree that policy is an endogenous force, which either is affected by, or

effects, many other endogenous factors.

Country specific characteristics are other factors that can affect aid effectiveness

according to Easterly and Levine (1997) and Temple (1998). More specifically, Alesa and

Rodrick (1994) and Persson and Tabellini (1994) analyzed the relationship between inequality

and growth, and points out that “some policy variables depend on the distribution of income” (in

Hansen & Tarp 2000:7). In addition, other scholars (Hansen & Tarp 2001, Moriera 2003) argue

that cultural and socioeconomic characteristics are country specific aspects that affect the

relationship between aid and growth. Hansen and Tarp (2001) also make the argument,

however, that a country’s natural endowments affect the relationship. Further, already in 1993

did Mulligan and Sala-i-Martin argue that internal human capital will impact the propensity for

investment to translate into growth.

The nature of these endogenous factors, except for natural endowments, is gravely

affected by political stability. Hence, the political situation in a country is the overarching factor

that will have the principal impact on the aid to investment to growth possibility. The internal

characteristics of many developing countries have unfortunately lead to irresponsible and corrupt

political leaders who are able, or unwilling, to control the flow of aid into the country. While

foreign aid can be allocated for the very purpose of policy reform to increase its effectiveness,

the governmental structure can make this effort close to useless. Collier and Dollar (2001) did a

cross-country study regarding this aspect and concluded that while in some countries (Burkina

Faso, Honduras, and Slovakia) donors can work through the government, in other countries

(Peru, Colombia, and Malaysia) it is simply more suitable for donors to work around the

government.

8

Exogenous forces

In any given country, there could be an adverse shock like drought, which would cause

aid to increase but investment to fall. Hence, during special circumstances, it is not logical to

assume that a country is able to invest all the foreign aid it is allocated. In addition, despite the

fact that many developing agencies use the Harrod-Domar/Financing Gap model to asses how

much foreign aid that should be funneled to the country, the conditionality of the foreign aid

forces the recipient to invest not only in its own economy, but in the economy of the donor by

buying its goods. Hence, the status of many developing countries in the international political

economy order puts limits upon the ability for the country to invest the money to increase its

economic growth. Of course, this is a contradiction to the whole idea of the

Harrod-Domar/Financing Gap model, but many developing countries will argue that this is the

reason for the lack of economic growth in their countries, rather than endogenous forces. In

addition, developing countries might argue, there is no incentives for them to invest the aid in

increasing their net capital stock, as they still faces such an disadvantage in the international

trade order that this is merely a waste of money. The trade opportunities for these countries can

also be affected by the political situation in the countries surrounding it and international

commodity prices. Additionally, as mentioned earlier, nowadays developing countries have to

use some of its foreign aid to pay back earlier loans.

The application of cross-country regressions to test aid effectiveness is common. However, as

Moreira (2003) suggests, future research should focus on in-depth, country-specific, case studies,

as the affect of aid will change according to the recipient country and the type of aid allocated.

V Foreign Aid and Economic growth in Ecuador: 1961-2002

With over 50% of the population below the poverty line (less than $2/day), Ecuador is

one of the poorest countries in Latin America, and with a total debt of over $14 billion, it is also

one of the most indebt (counting per capita). However, out of the countries in its closest vicinity,

including Peru and Colombia, it is also considered relatively stable. Therefore, it will provide a

good example of a developing country with a relatively stable history in the most “prosperous”

9

developing region of the world. Hence, if the Harrod-Domar/Financing Gap Growth Model

were to work anywhere in the developing world of today, it should work there.

Despite its relative stability, several endogenous and exogenous forces affected its

economic development. This led to that Ecuador’s growth rate during the twentieth century was

rapid, in comparison to other Latin American countries, however erratic. Essentially, three

major phases of export-led economic growth demarcate Ecuador’s economic history up until the

debt crisis and the adoption of neoliberal stabilization and adjustment policies in the eighties:

cacao (roughly 1860-1920), banana (1948-1972), and petroleum (1972-1982). Since the Harrod-

Domar model was not put forth until 1948, the first phase is of lesser importance for the purpose

of this paper. As could be expected, it was during the banana boom that the UN Economic

Commission for Latin America (ECLA) inspired the doctrinal formation of the Ecuadorian

‘developmentalist state’ (Carlos & North 1997:4), with assistant from US government programs,

especially following the Cuban Revolution, and international lending agencies. It was during the

petroleum boom however, that the “aggressive borrowing” began after business elites in 1976

managed to replace the reformists in the military government with officers more responsive to

their demands (Carlos & North 1997:6). This increase in borrowing, or more specifically, the

responding debt, is illustrated in figure 1 below.

(Fig. 1)

Ecuador's Total External Debt:1970-2002

1970197219741976197819801982198419861988199019921994199619982000

Year

To

tal

Ext

ern

al D

ebt

Source: World Bank, Global Development Finance.10

10 Total external debt is debt owed to nonresidents repayable in foreign currency, goods, or services. Total external debt is the sum of public, publicly guaranteed, and private nonguaranteed long-term debt, use of IMF credit, and short-term debt. Short-term debt includes all debt having an original maturity of one year or less and interest in

10

This resulted in the debt crisis in the 1980s, from which the country has not to this day

totally recuperated, this partly because of the endogenous and exogenous forces that have

affected this small country since then, adding to the endogenous and exogenous forces of the

past.

Endogenous forces

To evaluate what negative endogenous forces exist in Ecuador, an examination of the

policy environment is essential. During the banana boom, the political elite invested profits and

aid into the banana industry, but failed to redistribute it, and invest it, into the entire economy.

As a result, there was an increased concentration of profits in the hands of the banana companies,

many of them foreign companies, “who did not invest or consume locally” (Carlos & North

1997:5). Hence, the first foreign aid that reached the country during this time did not fulfill the

first testable proposition of the Harrod-Domar/Financing Gap Model; that aid will go into

investment one for one. During the petroleum boom, money was invested into the own

economy, into the manufacturing industry. However, the manufacturing industry was “highly

dependent on imported inputs and capital stocks, thus contributing to the indebtedness of the

country; lacked vertical integration; focused on the production of non-essential goods for high

income urban groups; displayed high degree of inter-sectoral and regional concentration; and

was capital intensive, generating little direct employment” (Carlos & North 1997:6). As a

result, the foreign aid that reached the country during this time did not fulfill the second testable

proposition, that there will be a fixed linear relationship between investment and growth in the

short-run. Figure 2 illustrates that with exception for a slight increase in GDP per capita during

the first year of the boom, the GDP per capita remained rather stagnant during the years 1975-

1994.

(Fig. 2)

arrears on long-term debt. Data are in current U.S. dollars.

11

Ecuador:GDP per capita 1961-2002

19611964196719701973197619791982198519881991199419972000

Year

GD

P p

er c

apit

a

It should be noted, however, that the social conditions of the country improved during the

petroleum boom, as the state also invested in the expansion of the educational system and public

services (Carlos & North 1997:6). However, despite the fact that these investments certainly

helped the poorer communities, the question when evaluating the Harrod-Domar/Financing Gap

model is not the goodwill of the then government to make these investment, but rather to

examine if these investment resulted in the growth of the economy, which it does not appear to

have done. Maybe this is because the investments only improved the conditions marginally for

the poor, and inequalities in relation to social, economic, and political power remains.

The extreme increase in the GDP per capita in the early nineties can be accredited to

sound monetary policy. In 1992, the Government adopted a Macroeconomic Stabilization plan,

supported by the IMF. Inflation decreased from 60.2% in 1992 to 31% in 1993 and 25.4% in

1994, international reserves increased from a low of US$ 224 million in August 1992 to US$ 1.2

billion in December 1993 and US$ 1.7 billion in December 1994 (www.ecuador.org).

However, the political situation in the country has not been stable during the last ten

years, and corruption has been rampant. In 1995, Vice President Alberto Dahik resigned and

fled Ecuador to avoid arrest on corruption charges. In 1997, President Abdala Bucaram, a

populist know as El Loco, or “The Crazy One,” became so unpopular, mainly due to his erratic

behavior, that the National Congress dismissed him for “mental incapacity” (World Almanac &

12

Source: World Bank national accounts data, and OECD National Accounts data files.

Book of Facts 2002:791). This incident forced a reconstruction of the Ecuadorian constitution,

with the new constitution coming into force in August of 1998. This lead to relative calm for a

couple of years, but in 2000, Ecuador saw the ousting of yet another president when Indigenous

Organizations and Union leaders lead the campaign against then President Jamil Mahuad and his

monetary policies. In 2003, Lucio Guitierrez won the presidential bid with promises to focus

especially on the plight of the indigenous population. However, due to his unpopular tactic of

ousting some Supreme Court justices and his failure to fulfill his campaign promises to the

strong indigenous movement, he was ousted in the a popular uprising during the spring of 2005.

A transition government took over and in 2007, the current president, the right-left Rafael Correa

was elected. During his tenure he has managed to oust all of the members of congress in order to

form a constitutional assembly that yet again re-wrote the constitution of this politically unstable

country.

Exogenous forces

Exogenous forces in general, and international commodity prices in particular, have

affected the macroeconomic performance in a country that remains highly dependent on primary

product exports (mainly oil). This reliance on one primary product has left Ecuador very

sensitive to fluctuating world oil prices and natural disasters affecting its production. From 1982

to 1987, Ecuador experienced a slowdown in economic growth, this partly due to exogenous

forces. The collapse of the world oil prices in 1986 reduced Ecuador’s oil export revenues by

half, and a year later, an earthquake destroyed a large stretch of Ecuador’s main oil pipeline and

left 20,000 homeless. This lead to that, in 1987, Ecuador had to suspend interest payments on its

then $8.2 billion foreign debt (www.ecuador.org). In 1995, a border war with Peru flared up, the

so-called Cenepa War, which included military confrontation that affected the performance of

the economy.11

In 1999, Ecuador underwent its worst economic crisis, mainly as a result of a

combination of exogenous forces (drop in oil prices, the effects of the phenomenon of "El Niño",

the Asian and Brazilian financial crisis). The economy shrank by 7.3% and the national

11 The Cenepa War (January 26 – February 28, 1995) was a military conflict between Ecuador and Peru, fought over control of a disputed area on the border between the two countries. The indecisive outcome of the conflict — with both sides claiming victory — along with the mediation efforts of the United States of America, Brazil, Argentina, and Chile, paved the way for the opening of diplomatic negotiations that ultimately led to the signing of a definitive peace agreement in 1998, putting an end to one of the longest territorial disputes in the Western Hemisphere.

13

currency, Sucre, plummeted. For the first time in history, an extended banking holiday was

decreed and deposits frozen to prevent a run on banks, yet over 60% of banking assets ended in

the hands of the State.  Ecuador was forced to default on its payments to private international

creditors and was unable to reach an agreement with the IMF. During the year, Ecuador became

to first country to default on the Brandy Bonds. The rapid decline in the value of the Sucre, led

to that in March of 2000, the Ecuadorian parliament ratified a law to dollarize the economy. In

April 2000, an agreement was reached with the IMF that secured US$ 2 billion in loans from

international financial institutions to Ecuador.  In August of 2000, private creditors

overwhelmingly accepted a bond-exchange offer and Ecuador became current on its obligations.

VI Conclusion

While foreign aid certainly helped the Ecuadorian economy, it has not been the main

reasons for its growth spurts. This is not an argument against the practice of giving foreign aid

to developing countries, rather an argument against the reliance on the Harrod-Domar/Financing

Gap model. As this case study of Ecuador has demonstrated, the underlying assumptions of the

model, that aid will go into investment one-to-one and that there is a linear relationship between

investment and growth, does not hold true because of the interference of endogenous and

exogenous forces.

The forces operating in Ecuador are by no means unique for a developing country, and

hence demonstrate that the application of the Harrod-Domar/Financing Gap model on

developing economies will do nothing else than illustrate the limitations of theory. While a

theoretical model may be the start of a new way to reach economic growth, it is by no means the

end of the process, and should not be treated as such. When it comes to the

Harrod-Domar/Financing Gap model however, the theory has been used to guide practical

application long after that academics, and Domar himself, doomed it too inadequate. The real

issue here is therefore not the Financing Gap, but rather the wide gap that has developed between

academic growth literature and the applied economists trying to get real economies to grow.

Some argue (Ranaweera 2003) that Easterly, and others, have failed to appreciate how

the World Bank and the IMF used the model in practice, that is, they have used the model “in a

very flexible way to overcome some of its well-known shortcomings” (Ranaweera 2003:5).

14

However, if these shortcomings are so well known, and flexibility has to be so widely applied,

has not the model lost its simplicity that once made it so popular? Would it not be easier to come

up with other methods to allocate aid? Easterly (1997) suggests, for example, that donors could

allocate aid per capita to poor countries “according to which countries have the best track records

on economic policies…[and] country economists could project growth subjectively using world

average growth, the country’s historical average growth, country policies, and external

conditions” (Easterly 1997:24).

In the case of Ecuador, it is obvious that sound economic policies, the current oil price,

and exogenous forces have affected the growth of the economy much more substantially than the

allocation of aid to the country. The comparison of the growth of GDP per capita (see graph

earlier in the reading) and the amount of Official Development Assistance allocated (Fig. 3) will

illustrate this.

(Fig. 3)

ODA To Ecuador: 1961-2002

19611964196719701973197619791982198519881991199419972000

Year

OD

A (

curr

ent

US

$)

However, to say that ODA has to lead to economic growth to be effective is a

misrepresentation of the very definition of aid, as aid merely has to “provide support for or relief

to”12 a circumstance. The basis for giving aid should be altruism, not profit making by attaching

conditionality to loans. Of course, economic growth can lead to more sustainable solutions for

12 As defined in Random House Webster’s College Dictionary, 1996.

15

Source: Development Assistance Committee of the Organisation for Economic Co-operation and Development.

the poor in the developing countries. However, nowadays countries spend so much money

paying back interest on previous “aid” that it has no money left for the poor. Hence, the aid

system, the way it is set up right now, many times has a negative impact on the poor. Ecuador’s

reliance on aid has left the country with one of the highest per capita debts in Latin America, and

the economic reforms of the last decade might be too little too late, and, as usual, the poor will

suffer the most.

Hence, advice given to developing countries should not be based on the

Harrod-Domar/Financing Gap model, as the model is a just a way of encouraging developing

countries to take out additional loans, which they have to pay back, with interest, to the

developed countries. Instead of giving developing countries the illusion that additional aid will

solve their problems and lead to economic growth, more emphasis should be put on aiding these

countries to develop the capital (financial, social, and human) which already exist in the society.

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16

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