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

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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).

4
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


Countries
Total 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 of


Countries 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 5
9
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

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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.

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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”

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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


Total External Debt

70

72

80

90

98

00
74

76
78

82

84
86

88

92
94

96
19

19
19

19
19

19
19

19
19

19
19

19
19

19
19

20

Year

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.

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GDP per capita Ecuador:GDP per capita 1961-2002
61

76

88

00
64

67

70

73

79

82

85

91

94

97
19

19

19

19

19

19

19

19

19

19

19

19

19

20
Year

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

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 &

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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).

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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


ODA (current US$)

61

76
64
67
70
73

79
82
85
88
91
94
97
00
19
19
19
19
19
19
19
19
19
19
19
19
19
20

Year

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

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
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.

Bibliography

16
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