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Monday, 1 June 2009

Aid and Economic Growth

I promise that this is the last time we discuss this topic. I simply could not resist sharing the latest paper with you that provides the sort of empirical evidence that was appallingly absent from Dead Aid.  As my review indicated, there are many papers (not all) that shows aid can cause long term growth (and none that says aid causes poverty). The latest IMF paper (May 2009) is the case in point - key conclusions :
In this paper, we re-estimated the causal relationship between aid and growth in a large cross section of aid recipients, allowing for different kinds of aid to have distinct effects on growth. We attempted to disentangle the effects of two components of aid: a developmental component consisting of expenditures that could reasonably be anticipated to promote growth (DA), and a non-developmental component consisting of other expenditures (NDA). While we cannot directly measure DA due to data limitations, we construct proxies for it representing total bilateral aid from donor countries which are reputed to have development oriented programs or rank high according to formal aid quality indices. Our specifications allow for the effect of aid on economic growth to appear after long time-lags (possibly involving several decades).

We found that DA––as opposed to NDA––has a positive and robust effect on subsequent growth. The coefficient estimates show a sizable marginal impact: in cross-country regressions, an increase in average bilateral aid from Scandinavian countries by 1 percentage point of GDP over 1960–90 is associated with average per capita GDP growth rates in the 1990s that are higher by 1.2–1.3 percentage points. The effect is slightly smaller when bilateral aid from a larger number of donor countries is used as a proxy for DA. Panel regressions confirm the cross-sectional results: an increase in average bilateral aid from countries ranking highest according to the Aid Commitment to Development Index (CDI) of 1 percentage point of GDP is associated with average per capita GDP growth 15 years later that is higher by 0.2 percentage points. The deep lags considered in our specifications suggest that DA’s causal impact operates over several decades. This result is consistent with the view that DA may support investments in physical infrastructure, organizational development, and human capabilities, which bear fruit only over long periods.

Notwithstanding concerns about donor luck and skill in selecting recipient countries, the robust results uncovered here give rise to important policy implications. First, our findings help counter claims that aid is inherently ineffective and aid budgets should be reduced. On the contrary, an increase in aid and a change in its composition in favor of developmental aid are likely to create sizable returns in the long run. Further, by showing that donor characteristics may matter for aid effectiveness, the study calls into question the trend towards greater aid selectivity based on an exclusive focus on recipient countries’ characteristics (such as institutional characteristics and macroeconomic policies). At a minimum, the quality of the donor-recipient match may matter for aid effectiveness. More substantially, donor characteristics (and in particular, donor motives) may―through their effects on the nature of aid disbursed―have an effect on aid effectiveness which is independent of recipient characteristics (Kilby and Dreher, 2009).

Our finding that aid from specific donors promotes economic growth while aid from other donors does not raises an important question: What is it that makes aid from certain donors work? Data on sectoral allocations of aid at the donor-recipient level is incomplete and cannot serve as a basis for a conclusive analysis. For this reason, we remain agnostic as to the mechanisms which make aid from certain donors more growth-promoting than aid from others. For example, it could be argued that effective donors have more efficient administrations, face lower overhead costs, or are less bureaucratic so that more of each dollar of aid reaches the intended recipients (Easterly and Pfutze, 2008). A second possibility is that certain donors spend their resources better, by choosing priorities well and developing productive relationships with partners in the receipient country which ensure that official development assistance functions as intended. A third possibility is that aid from donors free of strategic preoccupations is more likely to facilitate politically costly, but growth enhancing economic reforms (Bearce and Tirone, 2008). According to this argument, the aid growth causal mechanism breaks down when the strategic benefits associated with providing aid are large for the donor government, as it cannot credibly enforce its conditions for desirable economic reforms in the recipient countries.

Despite a substantial aid effectiveness literature, we still know little about what makes some types of aid more growth promoting than others. Our analysis points to the need for further research aimed at identifying the growth effects of distinct categories of aid over relevant time periods and better understanding the strategies of the most effective donors, so as to isolate the channels through which development aid works.


  1. I am pleased to see the overall debate surrounding capital delivered as "Aid" becoming more nuanced, and moving away from binary yes/no thinking towards viewing inputs and outcomes according to the spectrum of their varied results. One of the few relative advantages to being "underdeveloped" is that we have the whole spectrum of previous human experience available to guide us in what not to try for ourselves. We can never follow their examples exactly, but there are few examples of things that went precisely as planned. There is a rich reservoir of mistakes to learn from however, which I suppose is the irony of science.

    It would be good if all donor states were to adopt such practices as the scandinavian countries described in the report do, such as maintaining accessible representatives in recipient countries, along with sufficient resources to confirm the use of donor funds as intended, and take direct feedback from the public as to effective delivery of project outputs.

    While it is terribly unfair to imply that without donor funding of the Health Ministry there would be less money available for public employees to steal, but nevertheless to a certain degree it is true. Corruption succeeds in the face of oversight, or lack thereof, and it is good to see certain donors truly do care what happens with their money. Presumably they hope that Zambians will recognize the difference between them and the more strategic-minded donors in choosing trading partners in the future.

  2. Bauer on Aid

    Even opponents of aid admit that aid sometimes achieves worthwhile results. This encourages the view that most aid succeeds, in whole or in part, and that it is therefore generally a plus, and hardly ever a minus.

    The following quotations from Peter Bauer’s 1996 lecture, ‘Foreign Aid: Abiding Issues’, published in his ‘From Subsistence to Exchange’, Princeton 2000, cast serious doubts on the validity of this view. Readers of ‘Moyo’s ‘Dead Aid’ will recall that it was dedicated to Bauer.

    ‘To call official wealth transfers “aid” promotes an unquestioning attitude. It disarms criticism, obscures realities, and prejudices results. Who can be against aid to the less fortunate? The term has enabled aid supporters to claim a monopoly of compassion and to dismiss critics as lacking in understanding and compassion.’ (Note: Bauer preferred to describe large scale aid as ‘government to government transfers’)

    ‘A…pervasive consequence of aid has been to promote or exacerbate the politicization of life in aid-receiving countries.’

    ‘having capital is the result of successful economic performance, not its precondition. Economic performance depends on personal, cultural and political factors, on people’s aptitudes, attitudes, motivations, and social and political institutions. Where these are favourable, capital will be generated locally or attracted from abroad.’

    ‘Poverty or riches, personal and social satisfaction, depend on people, on their culture, and on their political arrangements. Understand this sequence, and you understand the most important cause of wealth or deprivation.’

    ‘Development aid is thus clearly not necessary to rescue poor societies from a vicious circle of poverty. Indeed, it is far more likely to keep them in that state. It promotes dependence on others. It encourages the idea that emergence from poverty depends on external donations rather than on people’s own efforts, motivation, arrangements, and institutions.’

    ‘….external subsidies raise the real rate of exchange in the receiving country and thereby impair foreign trade competitiveness.’

    ‘By maintaining a minimum level of consumption, the subsidies avert total collapse and conceal from the population, at least temporarily, the worst effects of destructive policies. These subsidies also suggest external endorsement of damaging policies. These results in turn help the governments to remain in power and to persist in these policies without provoking popular revolt.’


  3. A Trillion US$ is a Large Sum,

    Of that there is no doubt. However, like any number it lacks meaning without context. One context in which the $trillion figure is being frequently used lately is within the Dead Aid debate, to describe the seemingly huge amount of development aid which has presumably been squandered by African governments and self-serving NGOs over the last five decades. Then again, there are more than fifty African nations, or 2500 total nation-years over which that $trillion was distributed. That gives an average of $400 million per nation per year. Still a lot of money in the African context, but a pittance compared to what developed nations have and are investing in their own development. I find the assertion questionable that somehow this trickle of external funding was ever enough to develop African economies to a level comparable with nations on other continents even before the depredations of the corrupt and opportunistic.

    Another way to look at this big number in context is per capita. Over a billion people over the last fifty years have or are living in Africa, so again our $trillion boils down to not that much investment by Western standards, less than $1000 per African. Of course there has been a lot of currency inflation over the course of five decades, so that should stretch our $trillion significantly farther (because the older $'s were worth more). However, that same inflation should be taken into account when we allow ourselves to be persuaded by the sheer size of this $trillion figure. Put in the context of US economic activity for example, our $trillion translates into about three weeks of business as usual. Even if we apply generous inflation adjustments to this, we are still looking at the entire African continent over five decades sharing the equivalent of a few years of US economic output with which to "catch up". Add in the Cold War aspirations of the Super Power Blocs, which were seldom compatible with productive development of civilian infrastructure, almost certainly amplifying the "Resource Curse", and the recipe does not seem to contain sufficient ingredients for healthy economic growth.


  4. The current growth in Aid from the West to African nations is in part a guilty, too-little-too-late response to their selfish Peace Dividend policies toward spending in the developing world during the 1990's. I recall personally being loudly shouted down every time I tried to raise the point that since the US had fought the Cold War in places like Africa, Central and Southeast Asia, Latin America and the Middle East, it made sense to use whatever funds were being diverted from military posturing against the Soviets to invest and rebuild in those areas. Oh no, that money was to go for all their own hopes and dreams, the battle was over better schools and health care or massive tax cuts, that America couldn't afford to increase spending in other countries. The "Third World" should be just be celebrating the death of the Soviet Union and thanking the US for defeating Communism. Democracy was going to peacefully transform places like Timor, Cambodia, Afghanistan, Yugoslavia, Somalia, Congo, etc. because the Cold War was over, and in the parlance of US propaganda, had never been "Hot", therefore had never been fought, therefore required no reconstruction effort or further sacrifice by American taxpayers. I think that recent history has demonstrated these policies to have been sadly misguided and short-sighted.

    Likewise the assertion that aid is effectively a subsidy by the poor of developed nations to the rich of developing nations is rather specious, given that the poor of developing and developed nations alike have unquestionably been used to the benefit of the rich of developed nations for centuries, and the degree to which aid drawn from taxpayer contributions affects the poor in the developed world is entirely due to the progressive or regressive nature of their own tax systems, and has nothing to do with how the aid is spent in the targeted nation. We should disabuse ourselves of the notion that somehow Western taxpayers have "poured money into African development" over the last fifty years, I submit that it is more accurate to say that they have occasionally and grudgingly condescended to toss back a few scraps from tables laden in large part with the fruits of African labor and natural bounty. Having destabilized much of the continent for generations, that same instability is used to inflate the perception of risk on investments made, and thus the level of return demanded and received by the capital investors (as opposed to the African contribution of land, labor and material). To whatever extent that aid to governments increases stability, the cessation of that aid would presumably increase the return on investment demanded by foreign investors.

    There are many important aspects to discuss and reform about how African governments solicit and use aid funding and direct investment from rich nations, so let us not be distracted by large sums out of context or other hyperbolic generalizations which appeal more to emotion than to calm assessment of where genuinely effective development can be achieved and with which of the resources available. Development needs to be measured more according to specific project outcomes for individual Africans and communities, instead of potentially misleading macro-economic indicators like national GDP or continental averages.

  5. Millennium Challenge Corporation expansion plans:


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