During the post-war years Marshall Aid from USA funded the recovery of Europe. So when the developing countries which were then designated ‘less developed ‘ came to embark on development programmes they were advised by economists about two factors that would limit their development projects.

One was the ‘savings’ gap or the lack of sufficient domestic savings to fund all the investment that was required to build the infrastructure by way of roads, power plants, dams and irrigation works. It was argued that these countries had only about 15-17% of the GDP by way of savings and that 12% of the GDP was required to fund the public administration and another 5% to maintain and preserve the economic infrastructure of roads, bridges, power plants and the social infrastructure of hospitals and schools. So these countries have to engage in a deliberate mobilization of savings from already low per capita incomes by reducing consumption if they are to develop. The former colonial countries with some sense of guilt perhaps suggested the developed world should provide foreign aid to these countries to supplement their national savings.

Economists pointed out that these countries also lacked sufficient foreign exchange to import the required capital goods for development projects. So they talked about a foreign exchange gap as well. To tide over the savings gap and the foreign exchange gap they advocated foreign aid.

But Sri Lanka in the fifties did not lack foreign exchange since we exported tea, rubber and coconut products and earned considerable foreign exchange which could be used to finance the capital goods for investment. The savings gap could be met from government revenue. The plantations were taxed to provide the income of the government and fund the development programme. But by the end of the 1950s, the terms of trade - the balance between the import costs and export earnings - had turned adverse. The prices of our commodity exports were stagnant while the prices of imported industrial goods increased. So we actively sought and obtained foreign aid to meet the savings gap and the foreign exchange gap.

The amount of foreign aid increased dramatically after 1977. In 1977 it was Rs. 1,255 million while in 1978 it jumped to Rs. 3,953 million. Thereafter it increased with the Mahaweli Project. Foreign aid became an important item in the financing part of the budget.

The projects funded by foreign aid cost too much - much more than would have if funded locally. This is partly because a lot of foreign aid comes with conditions imposed by the donor countries. These countries insist that the goods and technical expertise required for the project should be obtained from them and these often cost much more than in the world market. Foreign contractors pad up foreign aided projects to pay kickbacks to ministers and bureaucrats. Some estimate that the cost of the project goes up by about 30% owing to such corruption.

International institutions like the World Bank and the Asian Development Bank as well as the International Monetary Fund give foreign loans. The advantage of foreign aid is that the terms of the loans are non-commercial from the donors’ point of view. The rate of interest is very low often about 2-3% and the terms of repayment are long, being over 15-20 years

Foreign aid can take several forms. It can be military aid, debt relief, and economic development assistance, and even disaster assistance money. We have benefited by way of a debt payment freeze this year. The US Government has granted a debt repayment freeze of $110 million according to a recent report attributed to the Minister of Finance. All these are with "strings attached". The donor institutions want human rights to be upheld. Greece which had passed an Anti-Conversion Law was required to suspend its implementation and later agree to rescind it before US aid could be given. The donors want an Interim Administration for the North & East because they can’t give aid directly to the banned LTTE. But they are keen to give aid to the areas under Tiger control. Foreign aid doesn’t include tariff preferences. The future of our garment industry depends on duty free and quota free access to the EU but these are conditional on observance of human rights, which continue to be violated all the time.

Foreign aid is also associated with "fraud, waste, and abuse." In fact it has been estimated that about 30% of aid proceeds are siphoned into the pockets of ministers and their cronies. Without foreign aid such grand corruption has no scope for our state is cash-strapped. There are many people who feel that foreign aid is the main cause for the culture of corruption that pervades our society. The fraud and failure of foreign aid is now so obvious that it has ended up in the pages of the prestigious American Economic Review. Economists Alberto Alesina and Beatrice Weder ask the simple question, "Do Corrupt Governments Receive Less Foreign Aid?" in the September 2002 issue, (quoted in the Ludwig Von Mises Institute website).

They found no evidence that nations and multinational institutions direct their foreign aid to less corrupt governments and away from more corrupt governments. In fact some others say the US Government prefers to give foreign aid to highly corrupt governments because they will do their bidding more willingly. They prefer highly corrupt democracies to dictatorships. The Ludwig Von Mises Institute has raised the question whether there is a correlation between democracy and high corruption in developing countries. The American Economic Review authors tentatively conclude that foreign aid over time increases government corruption in beneficiary nations. We qualify having had foreign aid for fifty years. They say "government-to-government "gifts" actually make government worse over time in terms of both government corruption and economic growth and creates what the authors call a "voracity effect" in recipient countries.

These authors’ brief review of the academic literature on foreign aid points out that:

If we consider the use to which foreign aid has been put by our governments most of these points are borne out. Aid money goes into projects, which do not necessarily promote good governance or economic growth.

Some economists argue that the big players in foreign aid, the International Monetary Fund and the World Bank, are more likely to bring about economic meltdown and social calamity than economic stability. Why do they say that? Because foreign aid came to be linked with what the IMF called ‘stabilization programs’ and structural adjustment programs.

Over the longer term foreign aid prevents the political leaders from taking the hard economic decisions required for self-sustainable growth. Instead they are tempted by foreign aid to indulge in an orgy of extravagant consumption for themselves and for the country. They don’t realize that there is a cost to their extravagance. The foreign aid enables money, which would otherwise have to be mobilized for investment to be used for the day-to-day spending of the government including expenditure on the war effort. If there were no foreign aid the political leaders would have been forced to economise on public expenditure and the country’s expenditure in foreign currency.

Under foreign aid the political establishment has grown and become too costly with MPs and ministers enjoying duty free limousines, and other perks all casting a heavy burden on the budget. They enjoy foreign funded jaunts, which bring no benefit to the country. Politicians with extravagant perks are not only at the centre but also at the provincial and pradeshiya level. Although the Provincial Councils are on paper vested with a variety of functions they have no fiscal autonomy. They don’t have powers of taxation to raise money to cover their expenditure budget. Instead they get grants from the central government snapping the connection between expenditure and taxation which alone exacts a sense of financial responsibility. Foreign Aid in short makes our political leaders blind to economic realities and make them irresponsible spendthrifts.

But the bills have to be paid even they fall due even after a long period. The massive foreign aid in the form of loans taken over the last twenty-five years are now falling due for repayment. This year’s budget provided for $500 foreign debt repayment which has been frozen by the creditors. If new foreign aid stops it is very likely that the government will have to default on foreign debts falling due for repayment next year and years thereafter. The carnival will then be over for the politicians.

Foreign aid has not stimulated a higher growth rate and has also adversely affected the creation of jobs. We have a large army of unemployed and need a labour intensive economic strategy to solve the unemployment problem. But foreign aid promotes capital-intensive growth. So bulldozers and heavy-duty tractors and power driven concrete mixers will be utilized instead of labour intensive methods for construction of buildings or dams or roads. Foreign aid is music to the ears of our political leaders. But the UPFA will soon realize that the music has stopped.