Description: External finance was long believed to be important in supplementing domestic resources in the process of development. The dismal experience of many developing countries with the use of large inflows of commercial bank loans and official development assistance in the 1970s and 1980s has challenged this view. This study provides a rigorous theoretical and empirical analysis of the international aspects of development finance. Credit-rationing rules set by bank managers and donor governments in combination with uncoordinated macroeconomic policies in the industrialized world tend to create unstable and inadequate external financing conditions for the developing world. Trade, finance and economic growth interact in a complex manner, but the global framework developed in this study provides some clear insights. It shows, among other things, how macroeconomic policies in the industrial countries influence the outcomes of these interactions. For instance, a doubling of aid flows may either benefit or be disadvantageous to the developing countries depending on the way this increase is financed. Additional public borrowing will push up global interest rates and affect economic growth in the North, thereby increasing the debt-service burden and lowering export earnings of the South. Tax-financing or public expenditure reductions could mitigate such potential negative side effects of enhanced aid flows. This study not only makes overly clear that a global framework is needed to assess the contribution of external financial resources for development, it provides one as well.

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