After a decade of aid fatigue and dwindling development assistance, foreign aid is once again at centre stage. Recent years have seen a flurry of new aid initiatives – the UN Millennium Development Goals, the Monterrey Consensus, the UK’s Commission on Africa, and the G8 pledge to double the amount of aid, to mention only the most significant ones. And before 2010, governments’ spending on aid, as measured by the OECD, is projected at well above $100bn a year.
Much as these initiatives should be applauded for shining the spotlight on many neglected issues of poverty and human hardships in developing countries, they also need to be judged against a backdrop of our accumulated knowledge of what works and what does not. That has yet to happen. Indeed, there has been widespread neglect of the knowledge and experience we have gained from aid-giving over the last 50 years, and this constitutes a key problem in the new drive for aid. There is a discrepancy between the rush to increase foreign aid and the general lack of interest in the quality of aid, meaning its effectiveness. This not only suggests a mismanagement of public resources but also an absence of curiosity about establishing which are the best methods of helping poor countries to develop.
This is not to say that we already have the answers to all the mysteries of poverty, welfare and foreign aid. But we do know a lot and have garnered enough experience to say over the last 50 years aid has failed overall to deliver the sort of economic growth and development we had hoped for. And the prospects for the future don’t look much better.
Of the researchers who have studied the links between aid and economic growth, few have found conclusive evidence that aid gives a major boost to growth. On the contrary, most research suggests a negative correlation between the two. This doesn’t mean that receiving developing aid is the cause of a country’s low growth. In both cases, a cause-and-effect relationship is difficult to find through broad statistical cross-country analysis; several researchers have employed advanced analytical techniques but the results have varied from a weak negative effect to a weak positive effect (the latter after adjusting for the type of aid and the policy milieu in recipient countries). The sad overall conclusion that has to be drawn is that development aid does not have the stimulatory effect on growth that donor countries have always intended.
A case in point is development aid to Africa that has amounted to more than $1 trillion since 1950. Between 1970 and 1995, aid to Africa increased rapidly, with aid dependency (measured as the aid-to-GDP ratio) standing at nearly 20% in the early 1990s. Measured another way, the mean value of aid as a share of government expenditures in African countries was well above 50% during the 20-year period up to 1995. During the same period, per capita GDP growth in Africa decreased, so that many countries in Africa are actually poorer today than they were when they gained their independence.
This sad truth does little to support the idea that development assistance is the flywheel that starts the motor of economic activity. But the argument continues to be that aid is an essential part of the process of attracting new investment and fuelling sustained growth. Because poor countries lack the resources to finance investments, runs this argument, there is a financing gap between domestic savings and the resources needed to finance the level of investments required to achieve growth. If the financing gap theory of aid (yes, it is merely a theory) had been true, investment levels would have risen considerably and long-term growth would have resulted. In that case, using the models applied by the World Bank and other donor organisations, per capita GDP in most African countries should be at the same level as in New Zealand, Spain or Portugal. Instead, it has declined overall in Africa.
Now a new version of the financing gap theory is being used as the motif for the present gearing-up of aid spending. The leading economist Jeffrey Sachs, together with others involved in the highly influential UN Millennium Project, is advocating a “big push” in public investments with the idea of producing a knock-on effect on economic growth in developing countries. But the really poor countries, according to Sachs, are stuck in a savings trap and do not have the resources needed to make this development push. The claim is that an additional $75bn in development assistance could fill the gap.
This breathtakingly naïve view of aid and economic growth in poor countries defies basic economics and our acquired knowledge of what works and what does not. The history of aid clearly shows that this type of assistance has been strikingly inefficient and at times has proved more a hindrance to development than a help.
So why is it that aid has failed to deliver higher economic growth for developing countries? There is no single answer; one has to take several aspects of aid into account to understand what has gone wrong, and how our aid should be re-designed if it is ever to achieve its targeted goals.
As a general rule, development aid has not been spent in the way that was intended. Instead of gearing-up investments, the money has more often than not been frittered away on current spending and public consumption. Not only is it difficult to find any positive effects as a result of investment aid spending, but worse the evidence suggests that aid has actually had a negative effect on domestic savings, and has thus weakened poor countries’ ability to finance investments.
Several aid studies have also looked into the issue of what economists call fungibility; when aid intended for investment was used for that purpose recipient governments then reduced their own investment spending in that area and transferred those resources to additional consumption, with the end-result of there being no increase in a country’s net investment. This pattern of fungibility has also applied to aid that was intended for spending on education and healthcare.
Aid has also contributed to corruption in many developing countries. That is clearly not the intention of aid, but the unintended consequence of supporting corrupt governments has been precisely that. Furthermore, by supporting many state-owned and para-statal enterprises, aid has boosted corruption in more direct ways. These enterprises have become arenas of rampant corruption, and this has then spread to other parts of society. The tragedy of aid that has been revealed in a number of independent evaluations and by World Bank research, is that donors become part of corruption problem by supporting regimes that erode the governance structure. In those African countries that have received a high level of aid over time, this has become painfully obvious.
It has been sound economic policy, not aid, that in recent decades has lifted billions of Asians out of poverty and provided the resources to combat, and in some countries eradicate, starvation and many of the most ravaging diseases. While Asian countries were starting to open themselves up to trade and foreign investment with the policies that created the “Asian Tigers”, many African countries were heading for a model of economic autarky by closing their borders and regulating the domestic economy to an absurd degree. It is hardly surprising that this was a development strategy that has failed utterly. Yet western aid donors supported these policies, and many of them are still pouring money into countries whose economic policies are detrimental to growth.
The good news, though, is that countries are poverty-stricken because of bad policy, not because of geography, an inferior culture or any other deficiencies. Bad policies can be changed; not by aid, but by people insisting on change.