Foreign aid, economic structure, and dependence

An inflow of foreign capital leads to structural changes in the economy. By lowering the relative price of tradable to non-tradable goods, it induces a decline of the relative share of tradables in the country's production. The effect on consumption shares is less obvious, since price and income effects may tend to be offsetting. The existence of foreign aid also establishes a dependence of the economy on the outside world. Estimates of the degree of such dependence, through the use of national-accounts aggregates, would be biased by the afore-mentioned effect on relative prices. Hence, specifically, estimates of time tends based on the use of current prices may lead to different conclusions from those which employ constant prices for comparison. The inferences of this paper are derived in a simple, two-sector, small-country model. The concreteness and probable relevance of the main propositions are then demonstrated by empirical illustrations.