The Gulf crisis and the suspension of U. S. bilateralassistance to Pakistan for 1990 threaten to have profound economic andpolitical consequences for the . country. These developments are boundto further exacerbate the traditional Balance of Payments difficultiesand the unemployment problem in the short run, and possibly the futurelong-run economic growth of the country. The termination of U. S.assistance for this year is more a reflection of the changing realitiesof the world today, rather than the alleged temporary measure by the U.S. designed to elicit Pakistan’s cooperation in nuclearnon-proliferation. It is highly probable that future U. S. assistance toPakistan is going to be curtailed and is likely to be on more stringentterms than before.l In such circumstances, an essential question thatneeds to be answered is that will a reduction in U. S. military andnon-military assistance to Pakistan affect significantly its defensecapabilities and/or weaken its economy?” Clearly, any objective answerrequires an understanding of how the allocation of resources by Pakistanamong defense, public non-defense, private investment, and privateconsumption goods and services is affected by U. S. foreign aid. It isonly through this understanding that policy-makers in Pakistan canformulate the requisite strategies to minimize the adverse impacts ofthe reduction in U. S. assistance. This paper is a step towardfurthering that understanding.