Cambridge International AS and A Level Economics: International aid, trade and investment (9708)

This guide is aligned to the Cambridge International AS & A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. It covers sections 11.5.1 (international aid) and 11.5.2 (trade and investment) of topic 11, International economic issues. Topic 11 is A Level content; the syllabus says AS content is assumed knowledge. The other statements in 11.5 (multinational companies, foreign direct investment, external debt, the IMF and the World Bank) have their own pages and are not taught here. Every figure below is invented for illustration.

Use it with the revision notes, the practice set, the free diagnostics, the course checklist and the course home. For background, see protectionism, comparative advantage and free trade and the current account.

What the syllabus lists

Section	Outcome	How this guide treats it
11.5.1	Forms of aid	Table of forms, then the grant element
11.5.1	Reasons for giving aid	Humanitarian, developmental, self-interested
11.5.1	Effects of aid	Chains of reasoning, both ways
11.5.1	Importance of aid	Size measures and evaluation
11.5.2	Trade and investment	Terms of trade, access to markets, capital flows

The syllabus prints 11.5.2 as a heading with no bullet points. This guide reads it as trade and investment between countries at different levels of development, which is how the 11.5 heading frames it.

Forms of aid (11.5.1)

Aid is a transfer of resources (money, goods or expertise) to another country on easier terms than the market would offer, or free, to promote development or relieve an emergency.

Classification	Forms	Key point
By source	Bilateral (government to government); multilateral (pooled through an international body); non-governmental (charities)	Bilateral aid usually carries the donor’s political aims
By terms	Grants (no repayment); concessional loans (low interest, long repayment)	Loans add to the debt burden
By conditions	Tied (must buy from the donor); untied	Tying raises the cost of what is bought
By purpose	Project (a road, a clinic); programme or budget support; technical assistance (training, advice); emergency relief; food aid	Emergency aid meets short-run needs, project aid builds capacity

Grant element of a loan. A loan below market terms contains a gift. Take a loan of 100 at 2% a year, interest paid yearly, principal repaid after 10 years, discounted at an 8% market rate.

PV of repayments = 2 x (annuity factor) + 100/1.08^10 = 13.42 + 46.32 = 59.74

Grant element = (100 - 59.74)/100 = 40.3%

The recipient receives a gift worth about 40 units. At an 8% interest rate, a loan at 8% would have a present value of exactly 100 and a grant element of zero.

Reasons for giving aid (11.5.1)

• Humanitarian and moral. Relieving famine, disease and extreme poverty after disasters. This is the strongest case for emergency aid.
• Developmental. Many poor countries have low saving, so investment is limited (a savings gap) and imports of capital goods are hard to pay for (a foreign exchange gap). Aid can fill both gaps.
• Self-interest of the donor. Strategic alliances, political influence, access to resources and markets, and tied aid that supports the donor’s exporters.
• Shared problems. Disease, instability and migration cross borders, so donors gain from stability elsewhere.

Worked example 1: the savings gap

Country A is an illustrative low-income economy. Its GDP is 8,000 million units. It wants growth of 5% a year. Each extra unit of output needs 4 units of capital (capital-output ratio of 4). Domestic saving is 14% of GDP.

• Investment needed = 5 x 4 = 20% of GDP.
• Savings gap = 20 - 14 = 6% of GDP = 0.06 x 8,000 = 480 million.
• If aid of 480 were all invested, growth = 20/4 = 5%.

This is a simple model, not a syllabus formula. Its weakness is the assumption that every unit of aid is invested. Suppose only 70% is invested and the rest is spent on consumption. Investment = 14 + 0.7 x 6 = 18.2% of GDP, so growth = 18.2/4 = 4.55%, not 5%.

Effects of aid (11.5.1)

Possible benefits to the recipient

• Higher investment: aid funds roads, ports, power and schools, which raises productive capacity and shifts long-run aggregate supply right.
• Human capital: health and education aid raises productivity and labour force participation, so output per worker grows.
• Poverty relief and stability: emergency aid saves lives, and budget support can fund public services.
• Technology and skills transfer through technical assistance.

Possible harm

• Dependency. Governments may rely on aid and tax less, so institutions stay weak.
• Corruption and fungibility. Money for one purpose frees domestic funds for another, perhaps military spending or the wealthy.
• Exchange rate effect. A large inflow raises demand for the local currency. A stronger currency makes exports dearer and imports cheaper, which can hurt exporters and import-competing producers (similar to the “Dutch disease”).
• Distorted markets. Free food aid shifts the supply of food right, lowers local prices and weakens farmers’ incentives to produce.
• Tied aid and conditions. Tied aid raises costs. Conditions may force policies the recipient does not choose.
• Unpredictability. If aid arrives late or is withdrawn, budgets cannot be planned.

Worked example 2: tied aid

Country A receives a tied grant of 100 million. Donor suppliers charge 15% more than world prices.

Effective value = 100/1.15 = 86.96 million

About 13.04 million of the headline grant is absorbed by higher prices, so the real transfer is 13.0% smaller than advertised. If only 60 of a 200 million grant is tied, the effective value is 60/1.15 + 140 = 192.17 million, a loss of 7.83 million.

Importance of aid (11.5.1)

Judge importance by relative size, not headline amount.

Measure	Country A	Donor D
Aid	480 received	7,200 given
GNI	8,000	2,400,000
Aid as % of GNI	6.0%	0.30%
Population	12 million	not needed
Aid per head	40 units	not needed

Aid/GNI (A) = 480/8,000 x 100 = 6.0% and aid per head = 480/12 = 40.

A 6% share is large for Country A and tiny for the donor. Aid matters most when the recipient is small, has little tax revenue, cannot borrow from private lenders and has weak export earnings. It matters least to a large economy that is able to raise tax and attract private capital.

Real value also matters. If nominal aid is 480 and the price index of aid purchases has risen from 100 to 112, real aid = 480/1.12 = 428.57. Rising prices have reduced it by 10.7%.

Evaluation points. Does the recipient have the institutions to use it well? Is it grant or loan? Is it predictable? Is it spent on long-run investment or only consumption? What would be the alternative source of finance? The same aid can raise growth in one country and do little in another.

Trade between countries at different levels of development (11.5.2)

Many low-income countries export a narrow range of primary products and import manufactured goods and capital equipment. This creates three problems.

Terms of trade

Terms of trade = (export price index / import price index) x 100

A fall means each unit of exports buys fewer imports. Country A, base Year 1 = 100:

Year	Export price index	Import price index	Terms of trade	Export volume index	Income terms of trade
1	100	100	100.0	100	100.0
2	96	104	92.3	105	96.9
3	90	108	83.3	110	91.7
4	84	112	75.0	118	88.5

Year 4: ToT = 84/112 x 100 = 75.0, a 25% fall. Income terms of trade = ToT x volume/100 = 75.0 x 118/100 = 88.5.

Country A is exporting 18% more yet can afford 11.5% fewer imports. A long-run decline in the relative price of primary goods against manufactures is the Prebisch-Singer argument. It is a hypothesis, not a certainty: commodity prices have had upswings, and a producer that diversifies avoids the problem.

Price volatility

Primary products often have low price elasticity of demand and unstable supply (weather, pests). Suppose a bumper harvest raises supply and sales by 10% when PED is -0.4. The price falls by 10/0.4 = 25% (a linear approximation). Revenue changes by 1.10 x 0.75 = 0.825, a fall of 17.5%. A bigger harvest cuts export income, and that complicates planning and investment.

Access to markets

Rich-country barriers hurt developing exporters. Tariff escalation means low or zero tariffs on raw materials and higher ones on processed goods, which discourages processing.

Worked example 3. Country A exports a processed good at 140, made from a raw input worth 100 (value added 40). The rich market charges a 10% tariff. If buyers will pay no more than 140, the exporter receives 140/1.10 = 127.27.

• New value added = 127.27 - 100 = 27.27.
• Fall = (27.27 - 40)/40 = -31.8%.

A 10% tariff cuts value added by about 32%, which shows why escalation keeps developing countries as raw-material suppliers. Farm subsidies in rich countries also lower world prices and undercut poorer farmers.

Evaluate liberalisation. Trade lets countries use comparative advantage, import capital goods and technology, and sell to larger markets. Against that, a country with weak industries may need temporary protection for infant industries (see protectionism), and opening too fast can expose producers to sudden competition and price swings. Benefits also depend on whether workers can move to growing sectors.

Investment between countries (11.5.2)

Capital tends to be scarce in poor countries, so returns may be higher there, but risk is also higher. Flows from richer to poorer countries include portfolio investment (shares and bonds), bank lending and aid. Direct investment by firms is covered in its own pages.

Benefits. Foreign finance can raise investment above domestic saving, pay for capital goods and finance a current account deficit.

Risks. Portfolio flows can reverse quickly. If investors lose confidence, the currency can fall and the economy suffers.

Worked example 4: financing a deficit

Country A has a current account deficit of 250 and net private capital inflow of 300.

• Financial account surplus minus current account deficit = 300 - 250 = +50, which adds to reserves.
• If confidence falls and net inflows turn to -200, the gap is 250 + 200 = 450, so reserves fall or the currency depreciates.

Inflows that pay for productive investment are safer than inflows chasing short-run gains.

Common errors

• Giving aid’s headline amount instead of aid as a share of GNI or per head.
• Treating all aid as good or all as bad. Conclude by weighing the type, the recipient’s institutions and the alternatives.
• Reversing the terms of trade formula or calling a fall “worse” without saying that fewer imports are bought per export.
• Treating a fall in the terms of trade as a fall in export revenue (volume may rise).
• Describing tied aid without saying the cost is a price premium.
• Writing “trade not aid” with no evaluation of rich-country barriers.

Official syllabus

Cambridge International AS & A Level Economics 9708, syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment, sections 11.5.1 and 11.5.2.