FOREIGN AID AND AFRICA

Outline

1. What is Aid? 
2. Aid and Poverty 
3. The Vicious Cycle of Aid 
4. Aid and Corruption 
5. Aid and Social Capital 
6. The Economic Limitations of Aid 
7. Aid vis-à-vis Savings and Investments 
8. Aid and the Export Sector 
9. Aid and absorption capacity 
10. Aid and aid-dependency

•What is Aid?

Broadly speaking there exist three types of aid:

Ø    humanitarian or emergency aid, which is mobilized and dispensed in response to catastrophes and calamities - for example, aid in response to the 2004 Asian tsunami, or monies which targeted the cyclone-hit Myanmar in 2008;

Ø   charity-based aid, which is disbursed by charitable organizations to institutions or people on the ground; and

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Ø systematic aid - that is, aid payments made directly to governments either through government-to-government transfers (in which case it is termed bilateral aid) or transferred via institutions such as the World Bank (known as multilateral aid).

•Aid and Poverty

•The idea that large donations can remedy poverty has dominated the theory of economic development — and the thinking in many international aid agencies and governments — since the 1950s. And how have the results been? Not so good, actually.

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•Millions have moved out of abject poverty around the world over the past six decades, but that has had little to do with foreign aid. Rather, it is due to economic growth in countries in Asia which received little aid. The World Bank has calculated that between 1981 and 2010, the number of poor people in the world fell by about 700 million — and that in China over the same period, the number of poor people fell by 627 million.

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•In the meantime, more than a quarter of the countries in sub-Saharan Africa are poorer now than in 1960 — with no sign that foreign aid, however substantive, will end poverty there. In 2013, perhaps the most striking illustration came from Liberia, which has received massive amounts of aid for a decade. In 2011, according to the OECD, official development aid to Liberia totalled $765 million, and made up 73 per cent of its gross national income.

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•The sum was even larger in 2010. But in 2013 every one of the 25,000 students who took the exam to enter the University of Liberia failed. All of the aid is still failing to provide a decent education to Liberians.

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•One could imagine that many factors have kept sub-Saharan Africa poor — famines, civil wars. But huge aid flows appear to have done little to change the development trajectories of poor countries, particularly in Africa. Why? Poverty is created by economic institutions that systematically block the incentives and opportunities of poor people to make things better for themselves, their neighbours and their country.

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•The people in poor countries have the same aspirations as those in rich countries — to have the same chances and opportunities, good health care, clean running water in their homes and high-quality schools for their children. The problem is that their aspirations are blocked today — as the aspirations of black people were in apartheid South Africa — by extractive institutions.

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•The poor don’t pull themselves out of poverty, because the basic ability to do so is denied them. This was evident in the protests behind the Arab Spring: those in Cairo’s Tahrir Square spoke in one voice about the corruption of the government, its inability to deliver public services and the lack of equality of opportunity. Poverty in Egypt cannot be eradicated with a bit more aid. As the protestors recognised, the economic impediments they faced stemmed from the way political power was exercised and monopolised by a narrow elite.

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•Recognising that poor countries are poor because they have extractive institutions helps in understanding how best to help them. It also casts a different light on the idea of foreign aid. Even if a huge amount of aid is siphoned off by the powerful, the cash can still do a lot of good. It can put roofs on schools, lay roads or build wells. Giving money can feed the hungry, and help the sick — but it does not free people from the institutions that make them hungry and sick in the first place.

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•It doesn’t free them from the system which saps their opportunities and incentives. When aid is given to governments that preside over extractive institutions, it can be at best irrelevant, at worst downright counter-productive.

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The vicious cycle of aid

•With aid's help, corruption fosters corruption, nations quickly descend into a vicious cycle of aid. Foreign aid props up corrupt governments - providing them with freely usable cash. These corrupt governments interfere with the rule of law, the establishment of transparent civil institutions and the protection of civil liberties, making both domestic and foreign investment in poor countries unattractive. Greater opacity and fewer investments reduce economic growth, which leads to fewer job opportunities and increasing poverty levels. In response to growing poverty, donors give more aid, which continues the downward spiral of

     poverty. This is the vicious cycle of aid.

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•The cycle that chokes off desperately needed investment, instills a culture of dependency, and facilitates rampant and systematic corruption, all with deleterious consequences for growth. The cycle that, in fact, perpetuates underdevelopment, and guarantees economic failure in the poorest aid-dependent countries.

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Aid and corruption

•The donor community has publicly aired concerns that development assistance earmarked for critical social and economic sectors is being used directly or indirectly to fund unproductive and corrupt expenditures (UNDP's Human Development Report, 1994). At a hearing before the United States Senate Committee on Foreign Relations in May 2004, experts argued that the World Bank has participated (mostly passively) in the corruption of roughly US$100 billion of its loan funds intended for development. 

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•When the corruption associated with loans from other multilateral development banks is included, the figure roughly doubles to US$200 billion. Others estimate that of the US$525 billion that the World Bank has lent to developing countries since 1946, at least 25 per cent (US$130 billion) has been misused. Vast sums of aid not only foster corruption - they breed it.

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•Aid supports rent-seeking - that is, the use of governmental authority to take and make money without trade or production of wealth. At a very basic level, an example of this is where a government official with access to aid money set aside for public welfare takes the money for his own personal use.

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•Obviously, there cannot be rent-seeking without a rent. And because foreign aid (the rent) is fungible - easily stolen, redirected or extracted - it facilitates corruption. Were donor conditionalities remotely effective, this would not be the case. But, as described previously, conditionalities carry little punch.

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•In 'Do Corrupt Governments Receive Less Foreign Aid?', Alesina and Weder conclude that aid tends to increase corruption.  Further, aid fosters corruption by reducing public spending; that by increasing government revenues, aid lowers the provision of public goods (things that everyone benefits from, but no one wants to pay for - for instance, a lamppost).

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•In a similar vein, foreign aid programmes, which tend to lack accountability and checks and balances, act as substitutes for tax revenues. The tax receipts this releases are then diverted to unproductive and often wasteful purposes rather than productive public expenditure (education, health infrastructure) for which they were ostensibly intended. In Uganda, for example, aid-fuelled corruption. In the 1990S was thought to be so rampant that only 20 cents of every US$r dollar of government spending on education reached the targeted local primary school.

•Aid and social capital

•Social capital, by which is meant the invisible glue of relationships that holds business, economy and political life together, is at the core of any country's development. At its most elemental level this boils down to a matter of trust. Among development practitioners there is increasing acknowledgement that 'soft' factors - such as governance, the rule of law, institutional quality – play a critical role in achieving economic prosperity and putting countries on a strong development path. But these things are meaningless in the absence of trust. And while trust is difficult to define or measure when it is not there the networks upon which development depends  break down or never even form.

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•Foreign aid does not strengthen the social capital - it weakens it. By thwarting accountability mechanisms, encouraging rentseeking behaviour, siphoning off scarce talent from the employment pool, and removing pressures to reform inefficient policies and institutions, aid guarantees that in the most aid-dependent regimes social capital remains weak and the countries themselves poor. In a world of aid, there is no need or incentive to trust your neighbour, and no need for your neighbour to trust you. Thus aid erodes the essential fabric of trust that is needed between people in any functioning society

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The economic limitations of aid

•Any large influx of money into an economy, however robust, can cause problems. But with the relentless flow of unmitigated, substantial aid money, these problems are magnified; particularly in economies that are, by their very nature, poorly managed, weak and susceptible to outside influence, over which domestic policymakers have little control.

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•With respect to aid, poor economies face four main economic challenges:

–reduction of domestic savings and investment in favour of greater consumption;

– inflation;

–diminishing exports; and

–difficulty in absorbing such large cash influxes.

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Aid reduces savings and investment

•As foreign aid comes in, domestic savings decline; that is, investment falls. This is not to give the impression that a whole population is awash with aid money, as it only reaches relatively few, very select hands. With all the tempting aid monies on offer, which  are notoriously fungible, the few spend it on consumer goods, instead of saving the cash.

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•As savings decline, local banks have less ) honey to lend for domestic investment. Economic studies confirm this hypothesis, finding that increases in foreign aid are correlated with declining domestic savings rates.

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•Aid has another equally damaging crowding-out effect. Although aid is meant to encourage private investment by providing loan guarantees, subsidizing investment risks and supporting cofinancing arrangements with private investors, in practice it discourages the inflow of such high-quality foreign monies.

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•Indeed, in some empirical work, it is shown that private foreign capital and investment fall as aid rises. This may in part reflect the fact that private investors tend to be uncomfortable about sending their money to countries that are aid-dependent.

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•An outgrowth of the crowding-out problem is that higher aid: induced consumption leads to an environment where much more money is chasing fewer goods. This almost invariably leads to price rises - that is, higher inflation

 

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Aid chokes off the export sector

•The IMF has stated that developing countries that rely on foreign capital are more prone to their currencies strengthening. Accordingly, aid inflows would strengthen the local currency and hurt manufacturing exports, which in turn reduces long-run growth. IMF economists have argued that the contribution of aid flows to a country's rising exchange rate was one reason why aid has failed to improve growth, and that aid may very well have contributed to poor productivity in poor economies by depressing exports.

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•In other work, their research finds strong evidence consistent with aid undermining the competitiveness of the labour-intensive or exporting sectors (for example, agriculture such as coffee farms). In particular, in countries that receive more aid, export sectors grow more slowly relative to capital-intensive and non-exportable sectors.

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•Aid inflows have adverse effects on overall competitiveness, wages, export sector employment (usually in the form of a decline in the share of those in the manufacturing sector) and ultimately growth. Given the fact that manufacturing exports are an essential vehicle for poor countries to start growing (and achieving sustained growth), any adverse effects on exports should in the first instance be a cause for concern.

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•Moreover, because the traded goods sector can be the main source of productivity, improvements and positive spillovers associated with learning by doing that filter through to the rest of the economy, the adverse impact of aid on its competitiveness retards not just the export sector, but also the growth of the entire economy.

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Aid causes bottlenecks: absorption capacity

•Very often, poor countries cannot actually use the aid flows granted by rich governments, At early stages of development (when countries have relatively underdeveloped financial and institutional structures) there is simply not enough skilled manpower, or there are not enough sizeable investment opportunities, to put the vast aid windfalls effectively to work.

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•Economic researchers have found that countries with low financial development do not have the absorptive capacity for foreign aid. In countries with weak financial systems, additional foreign resources do not translate into stronger growth of financially dependent industries.

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•What happens to this aid money that can't be used? In the most honest of outcomes, if the government did nothing with the aid inflow, the country would still have to pay interest on it. But given the policy challenges of large inflows (for example,  inflationary pressure, Dutch disease effects i.e. Negative consequences arising from large increases in a country's income-in this case resulting from large increase in foreign aid, policymakers in the poor country must do something.

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•Since they cannot put all the aid flows to good use (even if they wanted to), it is more likely than not that the aid monies will be consumed rather than invested (as before, thereby raising the risk of higher inflation).

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•Since they cannot put all the aid flows to good use (even if they wanted to), it is more likely than not that the aid monies will be consumed rather than invested (as before, thereby raising the risk of higher inflation).

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•To avert this sharp shock to the economy, African policymakers have to mop up the excess cash; but this costs Africans money. In addition to having to pay the interest on the aid the country has borrowed, the process of sterilizing the aid flows (again, issuing local-country debt in order to soak up the excess aid flows in the economy) can impose a substantial hit to the government's bottom line. Uganda offers a telling example of this. In 2005, the Ugandan central bank issued such aid-related bonds to the tune of US$700 million; the interest payments alone on this cost the Ugandan taxpayer US$IIO million annually.

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•Naturally, the process of managing aid inflows is particularly painful when the interest cost of the debt the government pays out are greater than the interest it earns from holding all the mopped-up aid money

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Aid and aid-dependency

•Corruption, inflation, the erosion of social capital, the weakening of institutions and the reduction of much-needed domestic investment: with official aid to the continent at 10 per cent of public expenditure, and at least 3 per cent of GDP for the average country, Africa's continual aid-dependency throws up a host of other problems.

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•It engenders laziness on the part of the African policymakers.  This may partly explain why, among many African leaders, there prevails a kind of insouciance, a lack of urgency, in remedying Africa’s developmental woes. Because aid flows are viewed (rightly so) as permanent income, policymakers have no incentive to look for other, better ways of financing their country's longer-term development.

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•Relatedly, in a world of aid-dependency, poor countries' governments lose the need to pursue tax revenues. Less taxation might sound good, but the absence of taxation leads to a breakdown in natural checks and balances between the government and its people. Put differently, a person who is levied will almost certainly ensure that they are getting something for their taxes!

•Aid Effectiveness

•In 2005, this worrying lack of empirical support for aid effectiveness led to the Paris Declaration on Aid Effectiveness, in which over one hundred countries, international agencies and development banks agreed to change the way donors and developing countries do business together by emphasising principles of  partnership, improved coordination between donors and transparency (OECD, 2005, 2008).

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•The Declaration can be seen as a reaction to a period when, rightly or wrongly, the IMF and World Bank were criticised for using conditionality to impose their preferred policies on less developed countries. To rectify this, the Declaration emphasised that donors should respect the right of recipients to set their own development objectives and support them in achieving those objectives.

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•However, it is debatable whether any real progress has been made in achieving the goals set by the Declaration (Woods, 2008; OECD, 2010) and there is still no incontrovertible evidence of a positive relationship between aid and growth.

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•The Paris Declaration (2005) is a practical, action-oriented roadmap to improve the quality of aid and its impact on development. It gives a series of specific implementation measures and establishes a monitoring system to assess progress and ensure that donors and recipients hold each other accountable for their commitments. The Paris Declaration outlines the following five fundamental principles for making aid more effective:

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   1. Ownership: Developing countries set their own strategies for poverty reduction, improve their institutions and tackle corruption.

2. Alignment: Donor countries align behind these objectives and use local systems.

3. Harmonisation: Donor countries coordinate, simplify procedures and share information to avoid duplication.

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4. Results: Developing countries and donors shift focus to development results and results get measured.

5. Mutual accountability: Donors and partners are accountable for development results.

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