4 of the generally accepted, even if minimal, role for government in promoting economic development by investing in the activities which the private sector would not otherwise undertake. Such activities tend to use labor and local funds intensively: rural infrastructure; rural health service; environmental quality; education and diffusion of technological knowledge; and an effective system of public administration.

# **_III._** _Development Spending and Local Funds_

_5._ This section builds on the conventional national income accounts framework to formulate a three-gap model for examining the nature of the local financing gap. Eql expresses a familiar identity: (G-T) is the fiscal deficit; G is government expenditure; T is revenue; Sp and Ip represent private savings and private investments respectively; (M-E) is the current account balance; M represents imports, and E is exports.

## (G-T) = (Sp-Ip) + (M-E)

## Eql

6. Eql provides a basis for the "two-gap" thesis; it envisages the economy as constrained by a savings-investment gap and a foreign financing gap (Chennery and Strout, 1966). Given a growth target, if internal savings were to constrain investments, or if the trade gap were to limit imports required for production, foreign aid will, in each case, bridge the financing gap and help to accelerate economic growth. While the proponents of the two-gap model were aware of other constraints on economic growth, the model was focused on the foreign financing gap, and was applied in quantifying the foreign resource requirements for achieving planned growth targets in the LDCs.

7. Various critics have queried the two-gap thesis. J. C. Fei and G. Ranis (1968), and H. Bruton (1969) questioned its theoretical basis and empirical relevance. They queried the conceptual distinction between the two gaps as well as the meaning of the aid requirements for growth that the model generated. They contended that aid, without policy reforms, could perpetuate the financing gaps and impede growth. More recently, C. Burnside and D. Dollar (1997) also raised doubt about the effectiveness of aid; they argue that good policies - particularly good fiscal, monetary and trade policies - are critical to have the desired impact of aid on economic growth. Willaim Easterly (1997) traced the evolution of the financing gap idea: from Harrod-Domar's concept of the incremental capital output ratio (ICOR), to Rostow's stages of growth, to Chennery and Strout, and to others. Easterly raised doubts about the empirical validity of the ICOR concept that underlies the two-gap thesis. In addition, according to Lance Taylor (1993), the two-gap model does not convey the nature of the development financing problems of the LDCs. He proposed that at least a third gap, the fiscal gap, should be added to the two-gap model to account for the "linked fiscal and foreign transfer limitations" on policy reform and development financing plaguing the LDCs today.

8. The advocates as well as critics of the two-gap thesis glossed over the importance of the local resource gap, though they were aware of the problem. Chennery and Strout, for example, discussed the limits to aid absorption and aid productivity posed by factors, such as education and skills, an efficient public administration, and an effective