Question

How important is foreign aid for developing countries in relation to their other sources of foreign exchange receipts? What are the potential costs and risk to the recipients and how could they be reduced?

Answer 1

Answer:

Foreign aid can be defined as, financial or technical help given by on country's government to another country to assist social and economic development or to respond to a disaster in a receiving country. Foreign aid is important is how it fosters a conducive diplomatic realtionship between the donor and the recipient. Impoverished nations receiving aid can eventually become independent and move towards democratic fundamentals with the help of donor countries. Foreign aid is important to impoverished countries as it provides specifically the materials needed to build effective infrastructure and expand educational programms and the access to schools. Additionally, it provides efficient responses to humanitarian emergencies.

Tied aid has a tendency to reduce aid effectiveness, value for money and sustainale development is developing countries. By forcing aid money to spent on the donors' goods, competition in the market for the provided goods is eliminated, hence allowing firms to charge noncompetitive prices, resulting in excess costs of between 15-30%

The developing country in the process is also denied any decision making on resource allocation, inhibiting the enhancement of addministrative skills.Tied aid also encourages dependency and wasteful spending. Goals of poverty eduction and sustainable development are in these ways hampered.

To overcome all these problems we can apply a new approach based on a CAPM to calculate the deadweight loss from aid volatility. Such approach provides a simple quantitative measure of the costof aid volatilty in a framework that differentiates between good and bad volatility for each recipient country and that is decomposible inn terms of thecontribution of each donor country to volatiity.