Forex: The U.S. Foreign Aid factor

A major share of U.S. long-term investment abroad is a direct investment in capital plant and equipment of foreign subsidiaries.

When this type of investment involves the building of new production facilities, these foreign subsidiaries buy a considerable portion of their capital equipment from U.S. suppliers.

Thus, a part of the negative effect of the capital outflow is immediately offset by the positive effect of an increase in exports.

Once the foreign subsidiary is producing, it may take over a part of world markets (in the country receiving the investment)which had heretofore been supplied by exports from the United States, thus reducing U.S. exports and adding to the overall negative impact of the investment.

But, finally, and this applies to all U.S. investment abroad, the foreign investment will return interest and divided payments to the United States over its lifetime, thereby increasing total foreign receipts in the future.

In any normal foreign investment, direct or portfolio, the investor expects to receive more in return (both principal and interest) than the original investment, since the normal expectation of investment is gain.

Thus, over the lifetime of an investment, the impact on the balance of payments must be positive, i.e., total receipts as a result of the investment must exceed the payments involved in making it.

Under the normal course of events, aid to underdeveloped countries will be spent on imports within a very short period some of which will be U.S. exports.

Further, the U.S. aid program has attempted to minimize the negative impact on the balance of payments by increasingly 'tying' the aid to the U.S. exports since 1960.

That is, as a condition for receiving the aid, the recipient country must spend the dollars in the United States.

Theoretically, of course if all aid were 'tied', the balance of payments impact would be zero, since the added receipts from U.S. exports would be equal to the amount of the aid.

However, such cannot be the case in practice. The foreign exchange received by the recipient country as a result of U.S. aid will, indeed, be spent in the United States, but one can assume that some of these expenditures on U.S. goods would have occurred anyway.

Thus, the aid actually releases other foreign exchange which the country can now spend of which may be spent in the United States.

Calculations based on past experiences estimate that a dollar of U.S. aid will result in a net increase of U.S. exports of between 5 cents and 60 cents, depending on the country receiving the aid.

Thus, a reduction in U.S foreign aid will have an immediate favorable impact on the balance of payments, but not to the full extent of the actual reduction in aid expenditure.