You are on page 1of 11

Introduction: In the build-up to the Group of Eight (G8) summit, in Gleneageles, Scotland mid2005, where the issue of foreign

aid was a central discussion point in their agenda the debates regarding foreign aid were highlighted in the media, although stated briefly and in a polarised fashion. Before the summit the Sunday Telegraph stressed that foreign aid can do harm as well as good.and the balance is on the side of harm (Riddle, 2007, p. 165). On the contrary the Tablet, the international Catholic weekly, in its editorial highlighted that there is a welter of evidence that much aid has been beneficial and more aid was vital (Riddle, 2007, p. 165). Aid comes in different forms such as general budget or balance of payments support, technical assistance, project finance, emergency assistance and more recently debt relief (Weiss, 2011). As can be seen from the theoretical frameworks discussed later in this essay, the focus of aid has been on economic growth, i.e. growth in GDP, up until 1990s. However, the focus has shifted to poverty reduction in 1990s, as reflected in the United Nations Millennium Development Goals (MDGs) with poverty reduction being its first goal. The ideas surrounding the mechanisms to achieve these goals have been dominated by a paradigm with three interconnected principles i.e. economic growth, good governance and social development (Weiss, 2011) It is worth mentioning that measuring the impact of aid at national and international level requires accurate, reliable and consistent time series and cross country data as to the amounts of aid given and the different variables against which the effectiveness of foreign aid is to be measured (Weiss, 2008). Weiss argues that, despite having clearly defined goals and having sophisticated estimation techniques at our disposal, yet quantifying poverty at national and global level with accuracy remains challenging, due to the debates about poverty data, discrepancies between alternative measures (household surveys or national accounts) and technical problems with conversion rates for international comparisons. Riddle (2007) points out that existing data gaps and methodological challenges make tracing overall relationships between foreign aid and its impact and effectiveness somewhat difficult.

Since the scope of this paper is very limited and extent of the discussion and debates surrounding foreign aid are voluminous, furthermore, taking the micro-macro divide into account, this essay will discuss the following: we will briefly discuss the theoretical justification of foreign aid and debates as to its effectiveness, then at macro level we will analyse the impact of aid on economic growth and governance and at micro level we will look at arguments regarding project aid. Economic Growth Theory and the Case for Foreign Aid In the 1930s as a solution to the great depression Keynes emphasised on failures of the market and argued for the role of state in stimulating the economy by adopting two approaches 1 reducing the interest rate, 2 government investments in infrastructure (Keynes, 1936). Subsequently, Harrod-Dommar model (Harrod, 1939) (Domar, 1946), further developed the idea that related an economys rate of growth to its stock of capital. In 1956 1957, building on the neo-classical production function framework, Solow and Swans model became dominant approach in analysis of growth. Their model highlights the impact of savings, technological

progress and population growth on economic growth in a closed economy (Snowdon & Vane, 2005). Later other economists such as (Gerschenkron, 1962) and (Chenery & Strout, 1966, p. 680) argued that amongst other things a rise in the level of investment and saving will transform a poor and stagnant economy into one whose normal condition is sustained growth. Hence the two-gap model, which suggested

that to expedite the process of growth and if the gap between foreign exchange earnings is larger than the domestic investment-savings gap, given that domestic and foreign resources are not substitutable, then foreign aid and borrowing can be used to bridge the gap. The two-gap model was the standard theory based on which initial justification for aid was provided. The argument is that aid fills the larger of the savings or balance of payments gaps. Therefore, according to this analysis growth is generated by the level and efficiency of investment (Weiss, 2011). g=(I/Y)/v

g = growth rate, I = investment, Y = GDP, v = capital output ratio (a measure of investment efficiency). As aid is assumed to supplement domestic savings,

therefore ( I ) represents the sum of domestic savings ( S ) and Aid ( A ). Therefore: g = ((S/Y) + (A/Y))/v This implies that if we increase the share of aid in GDP, ceteris paribus, will generate higher investment and higher growth. Likewise, to meet the target growth (g) and if domestic savings are not sufficient to fund the required investment to achieve it then aid can step in to fill the gap (Weiss, 2011). In the1980s, structural adjustment lending, promoted by the World Bank, with the objective of adjusting the economic structures and policies in LDCs, in a bid to direct them towards economic development, became dominant (Erixon, 2005). From the 1990s, in theory and in practice, the emphasis was on selectivity, aid conditionality, and the policy environment in the recipient countries (Fine, Lapavitsas, & Pincus, 2001) . However, irrespective of which idea of foreign aid has been the conventional wisdom that informed the actions of the aid community (Erixon, 2005, p. 7) in estimating the aid requirements and in campaigns calling for more aid, the gap theory, although fundamentally flawed (Erixon, 2005, p. 3), remained the core justification applied by all donors. Effectiveness of Foreign Aid The Debate The effectiveness of aid is debated at both micro and macro levels. At micro level, aid agencies and donors repeatedly claim that their programmes and projects have been successful to a large extent. However, at macro level evaluations normally fail to find positive impact or at best the findings are ambiguous (Mosley, 1987). In the year 2005, an academic review of foreign aids effectiveness maintained that in Less Developed Countries (LDCs) aid has neither had a positive impact to increase welfare nor to enhance growth, thus it should not be increased (Erixon, 2005). Similarly Nicolas van de Walle in his book Overcoming Stagnation in AidDependent Countries (Walle, 2005), has concluded that aid has had a very limited impact on economic growth and development of 26 aid dependent countries studied in his book.

However, Jeffery D. Sachs, a special adviser on the Millennium Development Goals (MDGs) of the United Nations (UN) and director of Millennium Development Project, in his book The End of Poverty (Sachs, 2005) has argued that because of compelling evidence of its undoubted success aid should be increased UNCTADs estimates, published in its LDCs 2011 report, show that by 2015 the number of people living under extreme poverty in LDCs will be 439 million; however, if the MDG targets are met it would reduce only to 255 million. The report further suggests that, in 1990, China and India accounted for 61% of the people living in extreme poverty in all developing countries. However, by 2007, this figure had reduced to 42%, largely due to the number of poor people in China more than halved in 20 years (UNCTAD, 2011). The Same report suggests that, on the other hand the global share of people living in extreme poverty in LDCs has increased from 18 % in 1990 to 27 % in 2000, and by 2007 reached 36 %. Given current trends and the continuation of business as usual, it is clear that, over time, LDCs will become the major locus of extreme poverty in the world (UNCTAD, 2011, p. 4). Taking this debate into account the next section looks at the effectiveness of aid at macro level. Aid and Economic Growth (Macro Level) Studies have presented conclusive evidence that economic growth does not automatically result in improvements in social standards. This is based on the fact that in most countries, excluding Sub-Saharan Africa, progress towards achieving the MDGs, in particular achieving income poverty targets, are reportedly on track. However, social indicators such as infant mortality rates, gender equality measures and access to basic services such as clean drinking water and sanitation lag behind (Weiss, 2008). Furthermore, UNDP has developed Human Development Index

(HDI) which measure human wellbeing by combining GDP per capita (in terms of purchasing power parity) with health and education indicators. From cross-country analyses it is evident that pro-poor expenditure in those areas has had little direct impact (Weiss, 2008). Taking into account that since 1990 the international community have focused on poverty reduction as their primary objective, it would be fair to ask the question that if

it is accepted that aid has had some effect on poverty reduction what has been achieved in this regards and what are the transmission mechanisms through which aid will achieve this goal. There is voluminous literature on aid and from reviewing some of it one can safely conclude that GDP growth, with more refined versions of the foregoing two-gap model, governance and social development have been accepted as the main channels through which the objectives can be achieved. The logic behind this is of a cumulative progress where improvements on one front positively affects the others (Weiss, 2008). Therefore, for the purpose of this essay due to its limited scope, we will focus on the question what has been the impact of aid on LDCs growth. Economists have argued that even if we accept that aid increases growth, it may not result in a reduction in poverty. GDP may grow and more wealth may be created, as long as gains of the rich or middle class are higher than the losses of the poor, yet the poor may become poorer (Bigsten & Levin, 2004). Moreover, the poor are

affected in many different ways by different causes of growth. Therefore, only the growth impact of aid alone does not tell enough as to how it impacts poverty (Hansen & Tarp, 1999). This implies that economic growth alone does not

necessarily result in poverty reduction if not supplemented by good governance and social development. Moreover, Paul Mosley has concluded that due to the issues of fungibility and leakages of aid, into unproductive public expenditure in less developed countries, it is impossible to establish any significant correlation between aid and growth. Some attribute the failure to the political climate and policy environment in the LDCS. It has been argued that there is some evidence that aid works in good policy environment (Burnside & Dollar, 2000), however, others (Clemens et al, 2004) (Dalgaard, Hansen, & Tarp, 2004) have found that good policy environment does not necessarily increase the effectiveness of aid. Moreover, on the governance front, Deborah Brutigam (2000); argues that in the academic community regarding the impact of aid in Sub-Saharan Africa there is an increasing convergence of opinion that aid has dramatically failed to achieve its intended objectives. She argues that high aid intensity is associated with erosion in the quality of governance (Brutigam, 2000).

Therefore, to conclude this section, it is fair to say that aid has had little, if any, impact on the economic growth of LDCs, based on what we reviewed in this section, for several reasons including: a) quality of governance of LDCs (which incorporates complacency of government officials, corruption, inefficient institutional arrangements etc.); b) the possibility that aid monies have not been properly utilised to increase investment and thus it financed consumption instead (fungibility and leakages) which somehow overlaps with a) (however not necessarily due to corruption and misappropriations but due to low capacity in the ranks of LDC governments to manage aid monies); and c) the amount of aid was too little to have an impact. On the other hand aid may exacerbate the issue of quality of governance as argued by Brutigam (2000). Therefore, one can argue that it is unlikely for aid to spur economic growth as advocated by its proponents. Firstly, aid is mostly channelled through the

governments of the recipient countries, therefore, its impact and efficiency to a large extent depends on the capacity and motivations of the recipient countries government. Secondly, assuming fair capacity and good intentions on the part of the recipient government, the amounts they receive may not be large enough to fund the countys all or major interconnected investment priorities to generate further investment to achieve sustained growth. Finally the increase in government

expenditure may have a crowding out effect on private investment; therefore, the country will require further intervention and more aid in order to keep up the growth process. Project Aid and Economic Growth (Micro Level) While at macro level aids impact is evaluated through empirical studies and regression analysis, at micro level, however, assessment and evaluation of the effectiveness of aid, in particular project aid; relies on observational studies, historical records, experiments and anecdotes. There are many different types of activities included in the project aid, however, major channels of intervention include the following: rural development (including agriculture), education, health, water Development projects have specific and

supply and sanitation (Riddle, 2007).

tangible and intangible outputs, however, the main objectives are to fill the resources, skills and systems gaps prevalent in the recipient countries. For almost all aid funded projects a project completion report is normally compiled. The project completion reports generally record the results achieved and overtime hundreds of thousands of project completion reports have been written up. However, only the larger agencies, such as DFID, USAID, AusAid etc.., publish aggregate reports so the likelihood is that they reflect the overall performance of all aid projects (Riddle, 2007). The success rate recorded by these organisations

ranges from 75 % to 85 % (based on a review of 1,400 project reports DFID post 1990, USAID and AusAid 2004). Similarly UNDP reported the overall performance of around 400 projects 1999 2002 and recorded 84 % success. A 28 % increase in efficiency compared to 1992 1998 (Riddle, 2007). Taking this into account the next section looks at some success stories attributed to aid and assesses its overall impact on poverty reduction and growth. Firstly consider the story from World Health Organisation (WHO). In 1955, there were approximately 10 15 million cases of smallpox reported in more than 50 countries and each year 1.5 to 2 million died of the disease. In 1965 WHO launched a campaign to eradicate the disease and by 1980, it declared the smallpox as the first disease in history to have been eradicated, with the last endemic case recorded in Somalia in 1977. Between 1967 to 1979 the annual cost of the smallpox campaign was USD 23 million; therefore a sum of approximately USD 298 million was required. The project was partially funded by aid monies (USD 98 million) and the rest (USD 200 million) came from endemic countries (Levine et al, 2004, p. 13). Another success story comes from Australian Aid (AusAID) regarding its contribution to education in Papua New Guinea (PNG). It has been claimed that AusAID played a major role in expanding the quality and quantity of education in PNG whereby the number of children attending school increased from 510,000 to one million in the 10 year period from 1992 2002. AusAID has argued that in general its aid played a major role in improving the quality of education through transfer of knowledge and skills, producing and distributing educational material and production of the curriculum to replace the previous Australian based curriculum (AusAID, 2003).

On the other hand, critics have argued that project aid has had a negative impact on the economic growth and recovery (after a period of recession caused by natural disasters for instance). In particular it has been argued that in some instances aid has had a detrimental impact on the employment and job creation which are the main pillars of economic growth. For example, consider an anecdote provided by David Schmidtz (2000). He recalls from his travel to Zambia through Zimbabwe and says When I crossed the border from Zimbabwe into Zambia, I saw a large sign prohibiting importation of secondhand clothing from Zimbabwe into Zambia. I was wondering whether second-hand clothing might carry some disease, when I passed through the town of Livingstone I asked what the sign was about. I was told by three different sources that Livingstone had until recently been the hub of Zambias textile industry. Cotton was grown, processed, and woven into cloth there. However, a few years ago, in the wake of a severe and highly publicised drought, international relief agencies decided that what Zambia needed was planeloads of second-hand clothing. Livingstone manufacturers could not compete with free clothing, though. Today, the unemployment rate in Livingstone is ninety per cent (Schmidtz, 2000, p. 2) The conclusion is that aid monies and WHOs intervention contributed to eradication of smallpox which the endemic countries would not have been able to tackle on their own. Although these success stories are undoubtedly difficult to challenge,

nevertheless, it is important to note that the majority of the evidence regarding the performance of the projects are almost exclusively provided by the agencies funding the projects. It is fairly obvious to conclude that eradication of diseases or improvements in educational standards and quantity indicate social improvements, however, for their overall impact to be noticeable on the economy as a whole, in particular on economic growth, poverty reduction and development it certainly requires a longer period of time. Furthermore, there is an issue with sustainability of the projects, particularly the education project. For instance the AusAID report does not specify what would happen to the project if the aid by the Australians are stopped (exit strategy) and what would be the implication for the school children. This scenario implies that the project will result in creation of a dependency syndrome, where the host nation

becomes so aid dependent that it would not be able to sustain the project without external support and intervention. However, assuming that the Australians had never started and funded the project what would have been the implications for the almost half a million out of school children who are now receiving quality education should we accept AusAIDs claims. Moreover, as recalled by Schmidtz (2000), projects that are not well thought out can have detrimental effect on economic recovery and growth. Conclusions When it comes to lifesaving operations (emergency response in the wake of disasters) one can agree that aid can play a major role. However, considering the anecdote by Schmidtz, this should be planned properly and carefully thought out as to its impact on the economy as a whole. For instance, instead of importing

planeload of second hand clothing the aid monies could have been invested to subsidise local production. This would have saved jobs and would have been more effective. At macro level as argued earlier in this paper, considering the case from China and India, one can conclude that aid is not the best solution to address growth issues in LDCs. Moreover, even if it is accepted that aid can have some impact on economic growth the sustainability of the growth and its impact on poverty alleviation is somewhat questionable. It has been argued by numerous economists that aid

widens the gap between the rich and the poor. On the other hand, aid may exacerbate the problem of governance and erode the quality of LDCs governments further as in LDCs the policy will be oriented towards what gets more aid than what helps the poor. Finally, due to crowding out issue of private investment as a result of excessive government expenditure it is safe to conclude that aid may not have a positive impact to increase the productive capacity of the recipient country.

Bibliography: AusAID. (2003). The Contribution of Australian Aid to Papua New Guinea s Development 19752000. Canberra: The Australian Agency for International Development (AusAID). Bigsten , A., & Levin, J. (2004). Growth, Income Distribution, and Poverty: A Review. In A. Shorrocks, & R. Hoeven, Growth, Inequality, and Poverty. Oxford: Oxford University Press. Brutigam, D. (2000). Aid Dependence and Governance. Washington, D.C: Expert Group on Development Issues. Retrieved November 20, 2011, from http://www.sti.ch/fileadmin/user_upload/Pdfs/swap/swap404.pdf Burnside, C., & Dollar, D. (2000). Aid, Policies and Growth. American Economic Review, vol. 90, pp. 847-868. Chenery, H. B., & Strout, A. M. (1966, Sept.). Foreign Assistance and Economic Development. The American Economic Review, Vol. 56,, 679 - 733. American Economic Association. Retrieved November 20, 2011, from http://www.jstor.org/stable/1813524 Clemens et al, M. (2004). Counting Chickens When They Hatch: Timing and the Effects of Aid on Growth. CGD Working Paper 44. Washington, D.C: Center for Global Development. Retrieved 11 20, 2011, from http://www.cgdev.org/content/publications/detail/2744 Dalgaard, C.-J., Hansen, H., & Tarp, F. (2004, June). ON THE EMPIRICS OF FOREIGN AID AND GROWTH. The Economic Journal, 114, F191F216. Domar, D. E. (1946, Apr). Capital Expansion, Rate of Growth, and Employment. Econometrica, Vol. 14(No. 2), pp. 137-147. Erixon, F. (2005). Aid and development: will it work this time? London: International Policy Network. Fine, B., Lapavitsas, C., & Pincus, J. (2001). Development Policy in the Twenty-first Century: Beyond the post-Washington Consensus. London & New York: Routledge,. Gerschenkron, A. (1962). Reflections on the Concept of 'Prerequisites of Modern Industrialisation, Ch.2 in Economic Backwardness in Historical Perspective,. Cambridge. Hansen , H., & Tarp, F. (1999). Aid Effectiveness Disputed. CREDIT Research Papers.

Harrod, R. F. (1939). An Essay in Dynamic Theory. The Economic Journal, Vol. 49, No. 193, pp. 14-33. Retrieved November 10, 2011, from http://links.jstor.org/sici?sici=00130133%28193903%2949%3A193%3C14%3AAEIDT%3E2.0.CO%3B2-7 Keynes, J. M. (1936). The General Theory of Employment, Interest and Money. New York: Macmillan Cambridge University Press. Levine et al. (2004). Millions Saved: Proven Success in Global Helath. Washington DC: Centre for Globald Development. Mosley, P. (1987). Foreign Aid: Its Defense and Reform. Kentucky: University Press of Kentucky. Riddle, R. C. (2007). Does Foreign Aid Really Work? New York: Oxford University Press. Sachs, J. D. (2005). The End of Poverty: Economic Possibilities for Our Time. New York: Penguin Books. Schmidtz, D. (2000, November). Islands in a Sea of Obligation: Limits of the Duty to Rescue. The Moral and Legal Limits of Samaritan Duties. Netherlands: Kluwer Academic Publishers, Vol. 19, No. 6 (Nov., 2000), pp. 683-705 . Retrieved November 22, 2011, from http://www.jstor.org/stable/3505071 Snowdon, B., & Vane, H. (2005). Modern Macroeconomics: Its Origins, Development and Current State. Cheltenham: Edward Elgar Publishing Ltd. UNCTAD. (2011). THE LEAST DEVELOPED COUNTRIES REPORT 2011. New York: UNITED NATIONS PUBLICATION. Walle, N. v. (2005). Overcoming Stagnation in Aid-Dependent Countries. Washington DC: Centre for Global Development. Weiss, J. (2008). The Aid Paradigm for Poverty Reduction: Does It Make Sense? Development Policy Review, Vol. 26(No. 4), 407 - 426. Weiss, J. (2011). Official Development Assistance: does it reduce poverty? In H. B. Dulal , Poverty Reduction in the 21st Century: Challenges and opportunities. New York: NOVA Science Publishers.

You might also like