Contents

Chapter 1 (Introduction) ................................................................................................................................................... 1

Introduction ............................................................................................................................................................................... 2
Context ......................................................................................................................................................................................... 3
Trends and Composition of Aid: ................................................................................................................................... 5
Chapter 2 ..................................................................................................................................................................................... 7
Generic definitions .................................................................................................................................................................. 8
Literature Review .................................................................................................................................................................. 11
Objective of the study .......................................................................................................................................................... 18
Significance of the study ..................................................................................................................................................... 18
Research Questions .............................................................................................................................................................. 18
Chapter 3 ................................................................................................................................................................................... 19
Methodology ............................................................................................................................................................................ 20
Type of study ...................................................................................................................................................................... 20
Inclusion criteria ............................................................................................................................................................... 21
Exclusion criteria .............................................................................................................................................................. 21
Ethical considerations .................................................................................................................................................... 21
REFERENCES ........................................................................................................................................................................... 22


1





Chapter 1
Introduction

2

Introduction
Controversies about aid effectiveness go back decades. Critics such as Milton Friedman,
Peter Bauer, and William Easterly have leveled stinging critiques, charging that aid has enlarged
government bureaucracies, perpetuated bad governments, enriched the elite in poor countries, or
just been wasted. They cite widespread poverty in Africa and South Asia despite three decades of
aid, and point to countries that have received substantial aid yet have had disastrous records such
as the Democratic Republic of the Congo, Haiti, Papua New Guinea, and Somalia. In their eyes,
aid programs should be dramatically reformed, substantially curtailed, or eliminated altogether.
Supporters counter that these arguments, while partially correct, are overstated. Jeffrey
Sachs, Joseph Stiglitz, Nicholas Stern and others have argued that although aid has sometimes
failed, it has supported poverty reduction and growth in some countries and prevented worse
performance in others. They believe that many of the weaknesses of aid have more to do with
donors than recipients, and point to a range of successful countries that have received significant
aid such as Botswana, Indonesia, Korea, and, more recently, Tanzania and Mozambique, along
with successful initiatives such as the Green Revolution, the campaign against river blindness,
and the introduction of oral rehydration therapy.
This study intends to explore trends in aid, the motivations for aid, its impacts on the
sovereignty of the recipient country (Pakistan), and discloses its interference and influence on the
policy initiations and policy making. It begins by examining aid magnitudes and who gives and
receives aid. It discusses the multiple motivations and objectives of aid, some of which conflict
with each other. It then explores the empirical evidence on the relationship between aid and
growth, which is divided between research that finds no relationship and research that finds a
positive relationship (at least under certain circumstances). It unfolds some of the tricks of using
3

aid more effectively to influence the governance of the country, including the principal-agent
problem and the related issue of conditionality, and concludes by examining some of the main
proposals for improving aid effectiveness and keeping the sovereignty of the country intact.
Context
Role of Foreign Aid in the Development of Pakistan:
Pakistan has been a recipient of foreign aid since its existence. This aid has been in the
form of grants, tied aid, project aid and huge inflows intended to keep the foreign exchange
reserves at a safe level to cope with industrialization related liberal import policy. Foreign aid
has played very important role in the economic development of Pakistan.
In the beginning Pakistan received very small aid from the rest of the world and international
monetary agencies like World Bank and IMF. Industrialization process began in Pakistan after
the late 50s and to fulfill the demand of intense development activity, increased reliance on
foreign resources became virtually inevitable. In the economic history of Pakistan five-year
planning scenario is also responsible for foreign aid. Government of Pakistan had to request for
the foreign aid for the completion of the five years targets and the volume of foreign aid
increased with the introduction of every five-year plan.
Many economists share the same views about the foreign aid and economic development. Many
third world countries received substantial foreign aid from the developed countries for the
economic stability and development but political considerations strategic alliances has been
partly responsible for the level of aid flows to different countries at different points of time.
Due to geo-political developments around its borders Pakistan received liberal assistance
packages during the decade of 60s and 80s. Pakistan has been closed ally of western world in
4

order to stop the onward march of communist menace. There was lavish foreign aid and military
assistance to Pakistan due war in Afghanistan. The inflows of generous foreign aid reached its
climax in the ear of Zia. With the end of war in Afghanistan, policy of isolation and lesser
interests of God Fathers Pakistan could not have economic and materialized aid on softer terms
(Kardar, 1995).
The composition and terms of foreign aid has changed considerably from grants and
grant like assistance to hard term loans over the years. The share of grants and grant like
assistance in the total commitments was 80% during the first five-year plan (1955-60). It was
dropped to 46% during the second five year plan (1960-65) and continued to decline thereafter,
averaging 31% during the third five year plan (1965-70) and 10% in the fourth five year plan
(1970-75). There were many geo-political aspects for that down ward trend in foreign aid in
shape of grant or grant like (Abbas, Brecher, 1992).
Foreign aid in shape of loans, and credit has been granted on easier conditions during the
1960s and the 1970s. During the 1980s and the first eight years of the 1990s (1990-98) the
source and availability of foreign aid has made very harder and difficult for Pakistan. The rate of
interest of foreign aid has been on the move during the last 50 years. Furthermore, the repayment
period of loans/credit has been reduced by the international monetary agencies and western
world (Qureshi, 1997).



5

Trends and Composition of Aid:
Trends and Patterns of Foreign Aid in Pakistan:
In Pakistan almost the earliest dispute, in the cabinet of the first Prime Minister (Liaquat
Ali), was over the principle of foreign aid. Three times in 1950 the Government of Pakistan
refused the proposed American Assistance. The cabinet also split in the same year over the
question of going to World Bank for loans. Ultimately it is the influence of Chaudhri
Mohammad Ali which persuaded the decision in the favour of taking aid and loans. The
Common Wealth aid, promised through the Colombo Plan, was however accepted. (Hasan:
1999)
Accordingly for the first time, Pakistan accepted the Common Wealth Aid under the
Colombo Plan in 1950s. And then in sixties, there was the emergence of the so called Growth
Man-ship, which suggests that there should be a high growth rate (minimum double of the
population growth rate).
In most of UDCs, (including Pakistan) the population growth rate was about 3%. Thus
the growth rate of 6% was assumed as a target for the rapid economic development. And
according to the Harrod-Domar Growth Model, to achieve the target of 6% growth rate the
6

savings (investments) must be equal to the 18-20%.


7










Chapter 2
Literature Review

8

Generic definitions
Foreign Aid
Aid (from the French word aide) also known as international aid, overseas aid, or foreign aid
Foreign aid is defined as when a country helps another country by: (a)Disater Relief,
(b)Military Support, (c)Education, (d)Economic Development
Foreign aid has been given different meanings by different schools of thought with
respect to its structure, its factors such as interest rate determination, repayment period and other
modalities.
Foreign aid takes place when a recipient country receives additional resources in foreign
currency over and above the capacity to import generated by exports. Foreign aid means those
additional resources, which are used to raise the performance of the recipient country above the
existing level.
Foreign aid is the transfer of resources from a rich country to a poor country. It is subject
to certain limitations, which generate various forms of foreign aid.
Financial Aid
The simplest form of capital inflow is the provision of convertible foreign exchange but
very little foreign capital indeed comes to the under-developed world so conveniently. If any
divergence from this form is described by saying that strings are attached then almost all
foreign public capital has strings. Financial aid is divided into different sub-forms i.e.
Untied Aid
9

Foreign aid, which is not tied to any project or nation, is called untied aid. It is in all
respects, better than the tied aid because it offers more efficient use of foreign resources.
Untied aid is much desired because the recipient country is not bound to spend foreign resources
on specific projects in the donor country.
Loans
It is borrowing of foreign exchange by a poor county from a rich country to finance short
term or long term projects. These are sub-divided into two types subject to this criterion:
i. Hard loans
Hard loans are given in order to finance industrial imports and are given usually
for a period of five years or less. It contains no concessional elements but interest rate is
usually lower than the prevailing rate in international market. The grace period is very
much limited, penalty is paid after expiry of stipulated time period.
ii. Soft Loans
Soft loans are normally given for 10-30 years. Interest on these loans is less than
hard loans and often these loans involve a grace period. Concessional elements are
comparatively greater.
Grants
A grant is that form of foreign aid, which does not entail either payment of the principal
or interest. It is a free gift from one government to another or from an institution to a
government. It is much desired because it increases internal expenditure and generates income. It
10

is given on a humanitarian basis, especially in times of emergencies, earthquakes, floods, wars or
other special purposes.
Commodity Aid
It is another type of tied aid, which relates to commodities such as agricultural products,
raw materials and consumer goods. It helps in controlling famine and maintaining the tempo of
industries by providing raw materials to the industrial sector. It would be more helpful if it is
provided in cash form because a country can then buy more commodities from cheaper sources.
Commodity aid sometimes has a depressing effect on agriculture prices in a recipient country, so
it serves as a disincentive for the agriculture sector. The donor country may have much political
influence on a recipient country.
There is no unique source of foreign aid. It may be from a single country or from a group
of countries. On the basis of the kind of donor study may divide foreign aid in two types:
Bilateral Aid
Aid that is given from the government of one donor country to a recipient country is
called bilateral aid. It is basically a one to one relationship of two states. It depends upon the
political and economic relationships of the two countries coupled with the will of the donor
country.
Multilateral Aid
Multilateral aid is given by certain international financial institutions, agencies or organizations
to the governments of developing countries. It is distributed in a fair manner in order to raise the
pace of economic development.
11

Literature Review
Researchers coming from the west, the east, and the center (Asia) have all concluded that
aid as traditionally practiced has not had systematic, beneficial effects on institutions and policies
[Mosley, Harrigan, and Toye (1995); Rodrik (1996); Ranis (1995); Collier (1997); Dollar and
Svensson (2000); Devarajan, Dollar, and Holmgren (2000)]. In particular, there is broad
agreement that giving a large amount of financial aid to a country with poor economic
institutions and policies is not likely to stimulate reform, and in fact may retard it. More
generally, study agree with Acemoglu, Johnson, and Robinson (2001) that there is little
agreement about what determines institutions and government attitudes toward economic
progress. Their works, and the work of Engerman and Sokoloff (1997), indicate that
institutions are often quite persistent, but there are historical examples of significant reforms.
Given that institutions and policies are important for growth and that aid has had little
systematic effect on institutions and policies, study introduced the hypothesis that the impact of
aid on growth is conditional on these same institutions and policies. To investigate this
empirically study created a policy index based on several variables used in the empirical growth
literature (and in a follow-up paper, Burnside and Dollar (2000a), study added a rule of law
measure to the index), and found that aid had a positive effect on growth in developing countries
with significantly better than average institutions and policies, whereas aid had no positive effect
in countries with average policies. It is useful for the non-technical reader to provide a simple
graphical representation of these findings, which studyhave updated in Burnside and Dollar
(2003a). Study regress growth, policy, and aid on the other variables (reflecting initial
conditions) on the right-hand side of the growth regression, and extract the unexplained
(residual) component of each variable. Study then sort the data into 9 groups using the 33.3 and
12

66.7 percentiles of aid and policy. The average growth rate for each group appears to depend on
the interaction between aid and policy (Figure 1). To us this graph shows that
institutions/policies matter (something that is not in dispute). But the graph also shows that the
effect of aid on growth also appears to depend on the level of policy. When policy is bad, the
level of aid seems to have little impact on growth; if anything, a slightly negative impact. But for
countries with good policies, giving sufficiently more aid seems to have a very positive impact
on growth. The key statistical question is whether the impact of aid on growth is different for the
poor-policy observations than for the good-policy observations.
Foreign aid is an important source of income in developing countries and carries potential
to play a key role in promoting economic growth. The traditional literature on economic growth
emphasizes the positive role of foreign aid in the process of economic development. Foreign aid
inflow influences the process of growth by reducing the saving-investment gap, increasing
productivity and transferring the modern technology. However, in the neoclassical growth
framework the benefits of foreign capital inflows are of temporary nature. Like many other
developing countries, Pakistan has heavily relied on foreign borrowings to finance its economic
development. This strategy increased its dependency on external resources. Pakistan has received
around US$73.14 billion in the form of foreign aid from 1960 to 2002 [Anwar and Michaelowa
(2006)], but the benefits of this aid flows have not stretched to the whole society, which means
that foreign aid has failed to improve the economic conditions in Pakistan. The literacy rate is
still around 50 percent and other social indicators, such as employment, health and education
etc., also do not present an encouraging picture. Saving rates have remained low, and the trade
gap has widened [Husain (1999)]. Foreign aid has not been utilized for development of the
economy; rather aid has served the vested interests of influential people. During 1990s, the
13

foreign loans at commercial rate of interest have exacerbated the foreign debt problem of the
country. The overall situation depicted above cast doubts about the effectiveness of foreign aid
as a tool for economic growth.
The impact of foreign aid on economic development has always been a controversial
issue. In 1950s, 1960s and 1970s rich countries used foreign aid to fill the gaps in resources,
encouraging domestic investment and industrial development under the belief that foreign aid
could help developing countries to accelerate the takeoff into self-sustained growth by
generating new domestic investment [Rostow (1960) and Waterson (1965)].
Many economists assert that foreign capital inflow is necessary and sufficient condition
for economic growth in developing countries. They claim that there exist a positive correlation
between foreign aid and economic growth because it complements domestic resources and also
supplements domestic savings to bridge saving-investment gap and provides additional financial
resources which helps to achieve the short-term growth targets. Besides, it is also held that,
foreign aid assists to close the foreign exchange gap, provide excess to modern technology and
managerial skills and allow easier excess to world markets [see for example, Chenery and Strout
(1966); Papanek (1973); Gulati (1975); Roemer (1989); Islam (1992) and Thirlwall (1999);
among others].
Mosley (1980) observes a positive relationship between foreign aid and economic growth
for UK aided countries and negative for French and Scandinavian aided countries. However, he
concludes that aid could not improve the economic conditions in Bangladesh, India and countries
like Korea, Malawi and Kenya.
14

Another strand of literature asserts that external capital exert significant negative effect
on the economic growth of the recipient countries. According to this view, foreign aid is fully
consumed and substitutes rather than complements domestic resources. It is argued that foreign
aid is used to import inappropriate technology, distorts domestic income distribution and
encourages a bigger, inefficient and corrupt government in developing countries Foreign aid is
also thought to displace domestic savings, which in turn retards investment and economic growth
[Griffin and Enos (1970); Weisskoff (1972)].
Boone (1996) finds that aid has no effect on investment and growthhis estimates show
that the marginal tendency to consume from foreign aid is insignificant and marginal tendency to
investment was zero. Easterly (2001) finds no empirical relationship between foreign aid and
economic growth and between aid and investment. He concludes that aid has not delivered the
expected results and may create the wrong economic incentives. Many studies confirm negative
correlation between foreign aid and economic growth. Negative correlation between aid and
growth is the outcome of factors such as economic policies, government intervention, business
cycle and instability of foreign aid flows in the recipient countries [Levy (1984)]. Singh (1985)
concludes that state intervention in the economy generate negative impact on economic growth
and makes the aid-growth relationship statistically insignificant. Burnside and Dollar (2000) find
that the relationship between foreign aid and economic growth may depend on whether the
recipient countries have been pursuing sound economic policies. Gounder (2001) and Lloyd, et
al. (2001) find that foreign aid contributes to long-term growth in private consumption and
policy reforms enhance the effectiveness of economic growth.
Mavrotas (2002) finds that policies impact aid effectiveness in case of India. Lensink and
Morrissey (2000) analyze the impact of aid uncertainty on economic growth in developing
15

countries. They find that the impact of foreign aid on economic growth depends on the aid levels
and the stability of aid flows. Pallage and Robe (2001) explain empirical regularities in the
foreign aid flows to developing countries. They reveal that aid flow is a major source of income
in the majority of recipient countries and aid flow is highly volatile and overwhelmingly pro-
cyclical. This means that even if foreign aid helps foster economic growth, serious problems
would nevertheless stem from the fact that aid disbursement pattern intensify volatility of
developing countries disposable income which affects growth negatively. Hansen and Tarp
(2001) conclude that aid increases growth via capital accumulation and it does not depend on
good policy. They note that growth regressions are sensitive to choice of control variables and
choice of estimators and that much more theoretical work is needed before drawing policy
insights. Pack and Pack (1994) asserts that foreign aid is fungible. They claimed that because of
the fundability of foreign aid, the increase in government income in the form of aid will be
crowded-out.
On the other hand, Cassen (1994) argues that the relationship between aid and growth is
rather weak, and it can be either positive or negative, depending on the countrys absorption
capacity of aid, economic and political structure and the time period chosen. Studies based on
time series data conclude that foreign aid has been an important determinant of economic
growth. Feyzioglu, et al. (1998) concludes that sectoral concessional loans are highly fungible.
An alternate strand of literature points out that foreign economic assistance displaces
processes of institutional maturation that is essential to promote economic development. Thus,
foreign aid promotes aid-dependency [Friedman (1958) and Bauer (1971)]. Foreign assistance
represents a side payment to elites in recipient countries, design to buy compliance in
maintaining the economic and political dominance of the industrialized countries [Frank (1966)].
16

Brautigam and Knack (2004) point out that poor quality institutions, weak rule of law,
absence of accountability, controls over information and high level of corruption have distorted
the benefits of foreign aid in most African countries. Similarly, Wolfensohn the president of
World Bank in 2002 observed that We have learned that corruption; bad policies and weak
governance will make aid ineffective. However, selective foreign aid has helped to improve per
capita income and lower infant mortality rate in under-developed nations [Easterly (2003)].
Selective foreign aid means that donor nations put some conditionalities in the form of low
inflation and budget deficit, non-interference with market prices, privatization and openness to
international trade [Easterly (2003)]. Svensson (1999) concludes that foreign aid has a positive
long-term impact in democratic countries, but in countries with authoritarian regimes, aid has
often dissipated into unproductive activities. Ranis and Mahmood (1992) claims that foreign aid
retard a countrys ability to adhere to responsible economic policies.
The bulk of theoretical and empirical literature has so far produced inconsistent and
elusive results regarding the relationship between foreign aid and economic growth. Empirical
findings are also mixed with respect to the impact of foreign aid in Pakistan. For instance,
Chishti and Hasan (1992) conclude that 28 percent of the domestic borrowings go towards
financing the public sector non-development expenditures. Their results also indicate that foreign
aid in the form of grants has a modest impact on public investment while loans do not seem to
have a significant impact on public investment. Shabbir and Mahmood (1992) conclude that net
foreign capital inflows, disbursement of grants and external loans have a positive impact on
economic growth of Pakistan. Ali (1993) points out that there is no significant relationship
between inflow of foreign aid and economic growth. Khan and Rahim (1993) conclude that
foreign aid has negative relationship with domestic savings and it has no significant impact on
17

economic growth. Iqbal (1997) is of the view that foreign capital that flows into the public sector
has strong positive impact on social and non-development expenditures and has little effect on
development spending. He further suggests that foreign loans and aid are largely consumed
rather than invested productively and foreign assistance cause a strong shift of public domestic
resources from development projects to non development expenditures. Khan (1997) has also
pointed out that aid has a robust negative impact on economic growth. Similarly, Ishfaq and
Ahmed (2005) conclude that foreign aid has not contributed favourably to GDP growth rate of
Pakistan. This ineffectiveness of aid is attributed to diversion of aid funds to non-productive
activities and inefficiency in resource allocation especially in the public sector. Husain (1999)
argues that foreign aid exerts positive impact on growth if the macroeconomic policies are
correct, microeconomic incentives are not distorted and the supporting institutions are in place.
In the absence of these preconditions foreign aid helps to postpone the tough decisions required
for prudent economic management. Under these circumstances, foreign aid is curse rather than
blessing and should be avoided.
These conflicting views have motivated study to reinvestigate the role of foreign aid in
determining economic growth. This paper seeks to answer the question whether foreign aid is
affecting the sovereignty of Pakistan? Specifically I hypothesize that Pakistan should concentrate
on those internal resources that are stable, sustainable and are largely within the policy control of
the authorities, rather than continue to depend on those resources which are more volatile, less
stable and controlled by the external policymakers.


18

Objective of the study
This study will evaluate the foreign aid policy of Pakistan in terms of public
administration issue rather than an economic issue. This study intends to unfold the reality of
foreign aid and the deep and harsh consequences of foreign agenda and policies on our system
and public administration.
Significance of the study
Over the past half century, the U.S assistance to Pakistan has been transactional and
intermittent. Not surprisingly, this on-again, off-again history of U.S. assistance has left the
Pakistani people and their leaders with serious concerns about the depth and reliability of the
U.S. commitment to their wellbeing. This study will unveil the intention of donors of foreign aid
and will also identify the flaws in the forced policies and agendas attached with the foreign aid
which will lead us to understand the reality of foreign aid and policy of Pakistan regarding aid.
Research Questions
1. Does foreign aid effects the sovereignty of Pakistan?
Guiding questions
2. Does it help recipient country or hurt her and in either way what is the impact? How
important is foreign aid in fostering economic growth in Pakistan?
3. Does the foreign aid have any impact on the policies implemented in Pakistan?
4. Are the policies backed by foreign aid in compliance with the true betterment of Pakistan and
their people?

19







Chapter 3
Methodology

20

Methodology
The purpose of this chapter is to delineate the methodological approach employed in this
research. To recap, the goals of this research are to: 1) analyze the foreign policy in terms of
influencing or damaging the sovereignty of Pakistan; 2) evaluate the foreign aid policy of
Pakistan in terms of public administration issue rather than an economic issue; 3) unfold the
reality of foreign aid and the deep and harsh consequences of foreign agenda and policies on our
system and public administration. Given the primary objectives of the research and the dense
amount of existing research on foreign aid affecting the public policies initiated or implemented
in Pakistan interpretive research methodology will be used utilized. The research methodology
includes a pre-study comprised of secondary data obtained from the history of Pakistan written
or noted by authentic sources and the researches of the researchers of countries like Pakistan
India, America, England and Europe. In each case the data will be interpretively analyzed
First, a discussion of the pre-study, consisting of an analysis of secondary data from above
mentioned sources. This analysis of secondary data supports evolving a priori themes identified
from earlier research and provides a foundation for the development of the interview guide for
further research.
Type of study
Study will seek if any relationship exists between the foreign aid and the sovereignty and public
policy initiated. For this purpose qualitative secondary data will used which can explore the
reality and then can explain the prevailing situation in terms of what is the dependent and what is
the independent factor. ANOVA will be run on the gathered qualitative secondary data to
analyze the findings of the secondary research.
21

Inclusion criteria
Primary and secondary researches of the researchers from all over the world published in
English language only.
Researches highlighting or proving any relationship between foreign aid and sovereignty
of the country.
History of Pakistan from the authentic sources of historical books published, international
journals.
Researches published in international journal, local journals, academic journals and
online.
Exclusion criteria
Discrimination on any basis will not be entertained either on race, cast, religion etc.
Non English research thesis, research papers, articles and finding will not be included.
Research focusing on economic factors solely will be avoided.
No time period is set for researches.
Ethical considerations
No attempt of plagiarism will made
No results of other researchers will be copied of reproduced
No manipulations will be made to the empirical evidence deducted from the study



22

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