metadata: authors: 0: author: Ranaweera,Thilakaratna
docna: 0: docna: Foreign aid, conditionality, and ghost of
            the financing gap - a forgotten aspect of the aid debate
docty: Policy Research Working Paper
subtopic: Consumption,Fiscal & Monetary Policy,Economic Conditions and Volatility,Legal Institutions of the Market Economy,Inflation,Macroeconomic Management
teratopic: Poverty Reduction
abstracts: cdata!: Assessing Aid: What Works, What
            Doesn't, and Why (The World Bank, 1998) generated a new
            wave of controversy about foreign aid and policy
            conditionality that had seen several decades of intense
            debate. Much of the recent debate has focused on the
            aid-growth relationship and the role of "good"
            policies. While a great deal has been said about qualitative
            aspects of aid effectiveness (that is, fungibility, among
            other things), little attention has been paid so far to some
            important quantitative aspects. The author draws attention
            to this neglected aspect of the aid debate to show that the
            level of aid requirements of a country is an equally
            important and integral part of aid and aid effectiveness.
            The author compares the World Bank/IMF approaches to
            estimation of external assistance requirements of a country
            in quantitative terms with an alternative model, the
            "balance of payments constrained growth model"
            (based on the Harrod trade multiplier). He finds that the
            latter model is not a real alternative as it is an
            incomplete model. More important, he shows that
            international financial institutions use these quantitative
            frameworks in a very flexible and pragmatic way to carry on
            a meaningful policy dialogue with both donors and recipient
            countries, which has an important bearing on aid effectiveness.
repnme: repnme: Foreign aid, conditionality, and ghost of
            the financing gap - a forgotten aspect of the aid debate
display_title: Foreign aid, conditionality, and
            ghost of the financing gap - a forgotten aspect of the aid debate
listing_relative_url: /research/2003/04/2243834/foreign-aid-conditionality-ghost-financing-gap-forgotten-aspect-aid-debate
topicv3: Macroeconomic Vulnerability and Debt
            m1326057 1104,Inflation m1326709 0870F4727ACED1CF8525815C00471347,Balance of Payments m1326965 441,Macroeconomic and Structural Policies
            m1327380 439,Financial Institutions m1505015 3797
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Poverty Reduction
origu: Development Data Group (DECDG)
no_of_pages: 29
author_keys: 0: author_key: 123357
model_extractions: 2

# **Abstract**

The World Bank publication "Assessing Aid: What Works, What Doesn't, and Why" generated a new wave of controversy about foreign aid and policy conditionality that had seen several decades of intense debate. Much of the recent debate has focused on the aidgrowth relationship and the role of "good" policies. While a great deal has been said about qualitative aspects of aid-effectiveness (i.e. fungibility, among other things), little attention has been paid so far to some important quantitative aspects. The present study draws attention to this neglected aspect of the aid debate to demonstrate that the level of aid requirements of a country is an equally important and integral part of aid and aideffectiveness. The World Bank/IMF approaches to estimation of external assistance requirements of a country in quantitative terms is compared with an alternative model, the so-called "Balance of Payments Constrained Growth Model" (based on the Harrod trade multiplier). It is revealed that the latter is not a real alternative as it is an incomplete model. More importantly, it is shown that international financial institutions use these quantitative frameworks in a very flexible and pragmatic way to carry on a meaningful policy dialogue with both donors and recipient countries, which has an important bearing on aid-effectiveness.
3

**Introduction.**

The publication by the World Bank entitled "Assessing Aid: What Works, What Doesn't, and Why," (see, The World Bank, 1998,) has generated a great deal of debate among, academics, professional economists, and policy makers.2 The World Bank report asserted that aid does help to increase growth in countries with sound economic management. The main message of the report both to aid recipients as well as donors was that aid should be allocated to recipient countries in accordance with their policy environments. These ideas about aid effectiveness, future of development aid, and policy conditionality associated with the new approach to aid have come under considerable criticism (see for example, Dalgaard and Hansen (2001), Doombos (2001),Guillaumont and Chauvet (2001), Hermes and Lensink (2001), Hoeven (2001), Hansen and Tarp (2000), Lensink and White (2000).

One aspect of this debate that has not received a great deal of discussion until recently relates to the question of analytical models for determining the extent of aid requirements of a country. In his study on "The Ghost of the Financing Gap: How the Harrod-Domar Model still Haunts Development Economics" Easterly (1999, see also 1997) pointed out that the Harrod-Domar model is still being used by leading international financial institutions (IMF, WB, etc) and regional agencies to measure foreign resource requirements, to allocate aid, and to provide advice to developing countries on economic policy. He observed that the Harrod-Domar model was not intended as a growth model, and was in fact repudiated by one of its authors four decades

> 2 Scc also, the background studies to that report by Burnsidc and Dollar (1997 and 2000) and Collier and Dollar (1999)
4 ago. Easterly encouraged the academic/professional development comununity to closely evaluate the analytical models used by international financial institutions for determining foreign aid.

Picking up Easterly's challenge, in an article in the Journal of Post-Keynesian Economics (Fall 2001) titled "Exorcising the ghost: An alternative model for measuring the financing gap in developing countries", Nureldin Hussain (2001) presented an "alternative" approach to address "interrelated questions of how to predict growth, how to measure the financing gap, and how to allocate aid and measure its development effectiveness." Hussain stated that so far there has not been a credible alternative to the Harrod-Domar model and that this creates a dilemma for policy makers. In this view, the "dominant think tank of World Bank is now shifting from the aid-financed investment toward a new paradigm - good policies plus money," but "this new paradigm has no unifonn philosophy to address the interrelated questions" of aid and development. To address such questions, Hussain advocates the use of the so-called "Balance of Payments Constrained Growth Model" of Thirlwall and Hussain (1982) - referred to as the T-H model. According to Hussain, this latter model "introduces a convenient methodology backed by a growth model to estimate resource requirements, as well as providing "new" insights with regard to the fomnulation of development policies and assessing the effectiveness of development assistance." Hussain presented a very interesting form of the T-H model with actual applications for a number of African countries. While simplicity and clarity are virtues
5 that any user would appreciate, the T-H model, unfortunately, does not present a "credible alternative." In part, the problem seems to emanate from the particular presentation of the T-H model: it is not a complete model. Thus, the T-H model ends up with an incomplete estimate of the financing gap. It appears that Hussain has somewhat misunderstood the so-called World Bank model and Easterly's observations on the "ghost of financing gap". To clarify these issues, we first begin with a very brief description of a stylized version of the "standard" model used by the World Bank for country operations work, which Easterly took to task. Second, a comparison of this "standard" version with the T-H model reveals that the latter is almost an exact copy of one of the key relationships of the former. The T-H model leaves out other key relationship such as the investment-savings gap, the fiscal gap and the monetary implications of the balance of payments. Thus, the T-H model fails to address the fundamental question raised by Easterly, and cannot be considered an "alternative". Furthermore, it is also clear that both Easterly and Hussain have failed to appreciate how the World Bank and IMF models are used in practice: that is, how Bank/lMIF economists, policy makers, and donors have used these models in a very flexible way to overcome some of their well-known shortcomings. Thus, it appears that both Easterly and Hussain are ghost-busters chasing after elusive, if not almost non-existent "ghosts."
6

**The "standard" framework of the "Three-Gap"**<sup>**modelof the World Bank3**</sup>

In the following paragraphs, a description<sup>of the WorldBank's model isgiven</sup> with the variables expressed in level tenrs.<sup>Whilethismodel canbe giveninmore</sup> compact fonn to show its properties,<sup>we optto give a descriptionof the actualworking</sup> model used by the country economists<sup>in theWorld Bank.The "standard"modelusedby</sup> many World Bank country management<sup>units (knownas theRevisedMinimum</sup> Standards Model Extended - RMSM-X)<sup>belongstoa classof "three-gap"modelswidely</sup> used by developing countries (see<sup>Bacha (1990), Iqbal(1997),Khan(,Sepehri, Moshiri</sup> and Doudongee (2000),Taylor(1990))<sup>thatis an extendedversionof the "two-gap" model</sup> introduced by Chenery and Strout (1966).<sup>It consistsof two modules:the flow of funds</sup> module that sets the accounting identities<sup>andafew behavioralequations (FOF), anda</sup> external debt module that brings<sup>ininformationof externaldebt relatedtransactions</sup> (DM). The basic version contains<sup>foureconomic agents or "sectors":Central</sup> Govenunent, the Monetary System<sup>(CentralBankand Deposit Money Banks),the</sup> "Private" Sector<sup>4</sup> ("Rest of the Economy"<sup>includinghouseholdsand private firms,non-</sup> central govermment agencies, parastatal<sup>enterprises, and non-monetaryfinancial</sup> institutions) and the Foreign Sector.

# **Equations of the "standard" model**<sup>**5**</sup>

The savings-investment gap:

> Thc "standard" three-gap model has<sup>**conic**tindcra grcatdcal of criticismfrom WorldBankeconomists,and therc had been a number</sup> of attempts to find altematives that arc<sup>capablcof handlingold issucsandncwdcmands,including povcrty-relatedwork (see,</sup> Dcvarajan **ct** al (1994), Agesior,<sup>etal (2000).</sup>

> 4The so-called 'Private Sector' should<sup>bc interpretedas a residtialsector,i.e. whateversector theuscr does not specify scparatelywill</sup> be in this 'Private Sector.'

> s For **the** symbols used. see appendix<sup>1.</sup>
7 Y - (Cg + Cp) - ( Ig + Ip) = X - IM (1) The foreign exchange gap: X - IM + NFY + NCT + KTfg + DFI + POR + NLT + NST + dRES = GAPF (2) The fiscal gap: NTXpg + Td + (Ti - Sub) + NCTfg + NFfg + NFgp + Krev - Ig - NKTRgp = The monetary sector flows are summarized by equation (4) below: L,l,p + Lnlig + dRES = dM + dNOL (4) Ignoring many sectoral details, this stylized version of the model can be summarized to consist of 4 equations and 33 variables.<sup>6</sup> A particular version of this consistency framework in summary form is given in the appendix 2. To obtain a numerical solutioni (33-4) variables should be assigned values. In this process, a number of important variables are "endogenized" by specifying several appropriate behavioral equations. Some of these are discussed below in the section on typical behavioral structure of the model. For the remainder, several different methods of exogenously specifying the expected values for the variables are adopted. These, in fact, could also be considered as sub-models depending on the degree of details accommodated.

# **Typical behavioral equations of the model**

The money demand function: M = P y / v _(5)_ 6The **5s** equation of thc system, i.e. that for **thc** private scetor is redundant according to Wairas' law.
|Theinvestment/outputrelation:||
|---|---|
|l(t)=ICOR(t+l)*[y(t+1)- y(t)]|(6)|
|Privateconsumptionfunction:||
|Cp=c*(Y-T+NCTR+NFY)|(7)|
|Importfunctions:||
|IMi=f(yC,RERi)|(8)|
|Manufacturingexportsfunction:||
|Xm=f(yf,RERm)|(9)|
|Otherexports:||
|Xi=(I+gxi)*Xi(t-1)|(10)|

The model can be solved using one of several approaches. First, all resource flows could be specified exogenously and the model could then be solved for the implied growth and inflation rates.<sup>7</sup> Second, resource requirements (including the additional foreign exchange needs) could be estimated for given growth and inflation assumptions. Most users of the model adopt the latter approach for computational convenience. Either approach could be considered as a first step in an iterative process that converges to a feasible solution to the model.8 To evaluate the extemal sustainability of the country, a module that incorporates external debt infonnation supplements the flow-of-funds framework. This enables the calculation of the debt servicing capacity of the country taking into account the existing

> In World Bank terminology this is called the "availabilities" approach to model solution.

> Since no explicit objectivc function is used, the solition is best described as a feasible one. The importance of iteration in this process cannot be overemphasized.
9 stock of external debt and changes in that stock as a result of the projected balance of payments outcomes as given by the flow-of-funds part of the model. In other words, the interaction of the infonnation on external debt flows and the flow-of-funds facilitates the mapping of the implications of alternative profiles of aid-financing to the balance of payments.

# **Investment-Savings Behavior and the Calculation of "financing gap".**

For the last two decades, the Harrod-Domar specification embodied in equation (6) above had been under challenge by numerous academics, World Bank/IMF economists and other users of this type of "standard" model9. However, Easterly added a new dimension to that challenge by alluding to the "ghost of financing gap" by emphasizing the implications to an important outcome of the model, namely foreign aid allocation. And this important variable has also an equally significant bearing on the lending programs and policies of the World Bank/IMF, other multi-lateral and bilateral donors. After a critical evaluation of the "financing gap" model in light of growth theory, Easterly (1999) concluded that "...in the short run, there is no theoretical reason in standard neoclassical and endogenous growth models to expect the ICOR to be a measure of investment quality, to be the derivative of growth with respect to investment, or to be constant during transitions." Considering a number of specific country experiences, Easterly (1999) then went on to assert that the "financing gap" model has little empirical validity. From a fairly rigorous viewpoint, these indeed were very valid criticisms of the type of models in question. Unfortunately, however, Easterly did not propose any

> 9 Some have in fact opted to drop the relationship between investment and growth and have instead adopted an output adjustment mechanism in the Keynesian tradition (see, Bacha, 1990 and Taylor, 1994)
10 alternative models that the international financial institutions could possibly use in the given context.

# **Comparison of "three-gap" and T-H models.**

The "standard" model can easily be presented in such a way as to conform to the T- H model by appropriately aggregating variables so as to retain only those that are used by T-H. and expressing the results in growth rate **fomi.** However, by retaining the details that actually are considered within the framework of the "standard" model, we also want to emphasize the fact that a great deal of information and empirical work goes into the use of the framework than appears at first sight. For example, a function may be developed for direct foreign investnent into the particular country under study or the value assumed may be based on already approved projects (such as oil pipelines, hydroelectric dams, etc) from available reports etc..

The important point to note is that by considering a subset of variables in equation (2), one can easily arrive at the result showni by the T-H model's equation (5) in growth rate form (see, Hussain (2001)). It is clear that the sub-set of the variables considered by Hussain in his equations (2), (3), and (4) - and therefore, in the resulting equation (5) - is the sum of the current and capital account transactions of the balance of payments. Hence, of course, the origin of the term "balance of payments constrained growth." Ignoring the richer details in the World Bank presentation, it appears that the T-H model is based on the same aggregative import/export elasticities that underpin the World Bank's balance of payments equations. However, while focusing on the balance of
11 payments gap is unavoidable, it is not the same thing as asserting that the external gap is the only constraint and that it is the "dominant constraint on output growth". In some developing countries, this may not be the case. It is precisely because of this reason that Chenery and Strout (1966) laid emphasis on the "two gap" approach and the inter-related nature of the savings-investment and foreign exchange gaps.

In contrast to the World Bank's model that incorporates three inter-related gaps, the T-H model is focused exclusively on one gap: the balance of payments constraint. The T-H model has no explicit savings-investment gap, which is given in equation (1) above. Neither does the T-H model contain a fiscal gap. In the T-H model, therefore, one has to assume that the savings-investment gap and the fiscal gap are actually implicit. To claim that the T-H model is indeed an "alternative" in the context under consideration, it is necessary to explicitly show how the balance of payments constrained growth is related to the investment-savings gap and the fiscal gap. As can be seen from the World Bank's model, this can be done only **in** a consistent accounting framework that is based on behavioral relations explaining aggregate growth, savings and investment that are consistent with the balance of payments (or vice-versa) and the fiscal variables. The essence of Easterly's criticism was that the Harrod-Domar based simple investment/growth behavioral relation assumed in the World Bank model was neither theoretically satisfying nor empirically valid, especially in the short-run. Easterly was well disposed to make that statement as he had substantially contributed to the evolution of the current form of the World Bank's model. Sweeping this problem under the carpet
12 in the T-H model is not a satisfactory solution as the savings-investment gap and the fiscal gap cannot disappear into thin air.

The T-H estimate of foreign exchange requirements to achieve a given target rate of growth (see, his equations 8 and 9) is only a partial representation of the total foreign exchange needs of a country. Considering the more comprehensive balance of payments account given in equation (2) above, it is clear that the T-H model does not explicitly show the foreign exchange requirements relating to the maintenance of a desired (or target) level of foreign reserves (dRES), which is a very important variable in a policy dialogue. It is possible to argue that the change in reserves is somehow embedded in the two parameters of the T-H model relating to the proportions of the total import bill financed by export earnings and capital flows. If this is the case, it is a somewhat confusing way to take account of this factor and is bound to cause problems in practical implementation of the T-H-n model. The desired or target level of net foreign assets is a key element of the IMF financial programming framework, which is underpinned by the monetary model of the balance of payments. Maintaining an adequate level of foreign assets to meet import payments is a crucial foreign exchange requirement facing many developing countries. Thus, the foreign financing gap estimate of the T-H model is only a partial estimate of requirements as it fails to account for the total foreign exchange requirements of a country, including the need to build up external reserves.

Considering the T-H model in the context of explaining growth rate differences by demand constrains associated with the balance of payments, Elliot and Rhodd (1999)
13 came to the conclusion that the T-H model "to be less than complete because it omitted the effect of debt servicing." Elliot and Rhodd demonstrated that the simple Harrod multiplier will over-predict growth if the rate of change in debt servicing is greater than the rate of capital inflows, and the model will under-predict if the rate of capital inflows is greater than the rate of change in debt servicing.

Furthermore, an important shortcoming of the T-H model is that it fails to trace the monetary implications of the balance of payments outcomes, which is at the heart of the IMF's financial programming framework. The Fund's framework integrates monetary, income and balance of payments analysis, and is also the basis for credit allocation to member countries (see, Polak (1997), Khan and Montiel (1989), Khan, Montiel, and Haque (1990), Bolnick (1999), JMF(1977), IMF(1987)). Unlike the T-H model, the World Bank's "standard" model is roughly comparable to the IMF's financial programming framework as both these models are built on the same accounting framework. More importantly, both the Fund and Bank models explicitly address the important policy problem of maintaining a target level of foreign exchange reserves and the implications of that target to the monetary/credit variables in the given country. The monetary model of the balance of payments is the theoretical underpinning of the domestic credit ceilings (especially the credit to govermment sector) that are part of IMF conditionality. Unfortunately, the T-H model does not address these questions explicitly.
14

# **Practical applications of models in macroeconomic policy work**

Why the macroeconomic framework needs to be explicitly treated in an integrated manner can also be considered from a very practical point of view. In their work, donors, policy makers at country level, and country economists at international organizations have to be concerned with an integrated view of macroeconomic developments. That is, they consider the three gaps (the savings-investment, the foreign exchange and the fiscal balance) in a consistent manner. All the parties in a policy dialogue demand to see the basic infonnation regarding growth, inflation, the balance of payments, the fiscal gap, the external debt indicators (the standard external exposure indicators as well as details about concessionary financing availabilities etc). Even if the T-H model is used, it would be necessary to present the implications of a macroeconomic scenario in terms of all three gaps. More specifically, it would be necessary to translate the growth and financing gap arrived at by T-H to their private and public components of investment and savings. This is particularly important for tracing the implications of a balance of payments outcome on the public investment and budgetary financing situation of the country under consideration. This is a point missed by both Hussain and Easterly. In Hussain's case, it results in a mistaken claim that he has found an "alternative" model. Ignoring this real life process makes the T-H model more of an academic exercise.

In Easterly's case, it appears that he was carried away by the lack of rigor in the Harrod-Domar specification that underlies the World Bank's model and he missed the importance of the procedure that leads to the identification of the so-called "financing
15 gap." The World Bank's model is not a rigorous tool, but rather a "back of envelope" calculation (as Easterly mentioned) that enables a dialogue among different partners: the country-specific policy makers, the country economists in the World Bank and/or IMF, and the donor countries' representatives. The World Bank'and/or the IMF's models and projections provide a consistent framework within which a meaningful dialogue on the growth, inflation, balance of payments, and fiscal implications of several external sector developments and policy scenarios can be carried out. One such important instance is the Special Program for Africa (SPA) where the "financing gap" is a crucial indicator for the dialogue between the donors and the country officials. Another is the Country Assistance Strategy (CAS) of the World Bank. As mentioned before, a large volume of information is utilized to draw up "high", "'most reasonable" and "low" case scenarios, which are presented for consideration. In identifying the relevant "financing gaps", country economists are not solely guided by the Harrod-Domar model as Easterly would want us to believe (Easterly (1999). As mentioned before, they take into account a large number of factors such as possibly lum-lpy investments, productivity, and emerging opportunities for export-diversification etc.. The resulting growth model, however, may be cast in the Harrod-Doinar framework, more as a convenient way to summarize the scenarios and results than to be "dogmatic". In his quest of rigor, Easterly seems to have overlooked this procedural aspect, which actually, in a sense, does not rely that much on the formal Harrod-Domar specification of growth.'<sup>0</sup> In this sense, it is hard to see where the "ghost" is in the "financing gap."

> '° For a very pragmatic description of **the** usc of **the** financial **programming iimodel** of **the** IMF for stabilization policy, sec Mussa and Savastano (1999).
16 As pointed out above, ignoring the savings-investment relation within the framework under consideration has resulted in the T-H model taking an incomplete view of the interrelations under consideration. Thus, the T-H model has not only failed to address the investment-savings gap issue treated by Easterly but also has grossly underestimated the importance of the iterative procedure that is used in the World Bank and related organizations to arrive at "financing gaps." This iterative procedure essentially concerns the identification of balance of payments financing requirements and fiscal deficits that are mutually consistent in the "three gap" framework shown above.

Referring to the savings-investment gap, Hussain states that "...measuring the resource gap as the difference between planned investment and planned savings does not mean that capital inflows to fill the gap will automatically be invested or that they are predestined for investment. The T-ll approach does not imply such presumptions." Neither do the World Bank/lMF models or their country economic work carry such presumptions. Besides, the World Banlk and the 1MF, after 50 years of experience, do not seem to carry any illusions about the implementation capacities in member countries. The question here is not so much about presumptions as about practical implications of capital inflows to finance public and private investment. In the World Bank/IMF frameworks, the relative magnitudes of resource flows have an important bearing on both the time path and the nature of the policy package that is designed for implementation. When shortfalls in implementation occur, the targets for resource flows as well as implementation schedules are revised. Given this iterative process of aid-related work at
17 the international financial institutions, it is hard to believe Easterly's assertion that these institutions assume that "aid will go into investment one for one" (Easterly, 1999).

One important consideration worth mentioning in the policy dialogue in programs such as the SPA is the explicit treatment of the external indebtedness of a country. The external debt module (DM) attached to the "standard" models facilitates this analysis. External loan disbursements, repayments, and interest payments are considered from the point of view of donors as well as receivers. The donors are classified according to multilateral, bilateral, private-guaranteed, and private non-guaranteed while the borrowers are categorized by central government, monetary sector, or private sector (including public sector organizations). This enables a reasonably accurate mapping of resource supply and identification of specific resource needs within say a medium-term adjustment framework under consideration. As such, "financing" gaps are not just a matter of an estimate based on investment demand determined by an incremental-output ratio. Rather, they are the result of a common-sense dialogue, which takes into account all possible information available on expected external and domestic developments, the emerging resource needs and available finance.

Given the pragmatic way the World Bank/lMF models have been used in the recent past as tools for a policy dialogue with member countries, it is somewhat inappropriate to state that these models are used to "prescribe policies" for developing member countries (see Hussain, 2001). It is equally inaccurate to say that these models
18 are used to "make growth projections..." Rather, the models are used essentially to explore resource implications of different macroeconomic scenarios.

These points have been brought into focus by Mussa and Savastano (1999) when they analyzed the IMF experience with stabilization programs. They observe that: ... the intellectual doctrine associated with IMF financial programming is primarily a recognition of basic accounting identities supplemented with a small number of behavioral relationships and forecasts of key economic variables, the latter two being subject to revision as new evidence becomes available. This is topped with a reasonable discretion in judging both the size of the required macroeconomic adjustment and the relative effectiveness of the policy instruments available to the authorities to undertake it."

# **Data and Estimation Issues**

Comparing the T-H and the Hairod-Domar models, Hussain refers to the problems of estimating the parameters and the "inaccuracy of the lCOR approach in measuring the financing gap and in predicting growth perfonnances." He claims that "in contrast, the basic parameters of the T-H-l approach are the price and income elasticities of demand for exports and imports ......... these elasticities.....are, therefore, fairly constant and largely exogenous, and hence more reliable to use for predictive purposes." Economists at the country level and in international organizations are well aware of the difficulties associated with economic data. There is no empirical evidence to show that
19 trade data in developing countries are in anyway "better" or more "reliable" than investment or consumption data. Furthermore, Bairam and Ng (2001 ) who investigated the stability of export and income elasticities embodied in the T-H model found that the export and import demand functions for Canada and UK were unstable during the period 1973-95. The sample of countries studied by Bairam and Ng included Canada, New Zealand, and the UK, where statistics are better developed than in most developing countries. Thus, there seems to be no guarantee of the stability of the elasticities in question for most of the developing countries. If these parameters are not stable the, T-H model is bound to yield biased results.

# **Concluding remarks.**

The brief examination of the World Bank and the T-H models reveals that the latter is a somewhat of a partial representation of the former. The T-H model lays emphasis on the balance of payments constraint only and has not taken into explicit consideration the aggregative saving-investment behavior that is implicit in the balance of payments picture. Thus, the exposition has missed the important point made by Easterly regarding the theoretical and empirical weaknesses of the investment/growth relationship underlying the World Bank model. Both Easterly and Hussain, however, fail to realize the practical ways in which these theoretical and empirical weaknesses are overcome in practical applications of these models. The World Bank's model is only a starting point of a policy dialogue between donors and developing countries that
20 eventually converges to agreements on the magnitude and time path of resource flows. In this sense, both Easterly and Hussain seem to be chasing after non-existing "ghosts".

It may be pertinent to quote what Paul Krugman said recently ( Krugman, 2000) when he considered the question how complicated a model has to be: "... what we know pretty well, from decades of trying to give micro-foundations to macro, is that logical completeness and intellectual satisfaction are not necessarily indications that a model will actually do a better job of tracking what really happens. For many purposes, the small, ad-hoc models are as good as or better than the carefully specified, maximizing intertemporal model." Considering Krugman's observation, although made in another context, and what Mussa and Savastano have said about the pragmatic use of IMF' financial programming model, one might be tempted to conclude that the "ghost of the financing gap" after all may not be a bad ghost to live with, until a credible alternative is found.