Abstract
Many developing countries in the world are stuck in a vicious cycle of poverty; they cannot develop their economies as a result of this. They may need a push to spur development of their economies by way of aid; whether bilateral or multilateral. Foreign aid has in some instances proven to be very crucial in the achievement of economic growth in these countries. In other instances however, the aid has only served to enrich a few individuals but failed to rescue economies, as is the case of a great many Sub Saharan Africa countries and a big part of Latin America. Aid is meant for development purposes though some of it may come with attendant conditions. These are referred to as tied aid and are given on several strict conditions. Most of the aid directed towards Sub Saharan Africa may fall under this category.
This research will take a long look at the recipients of aid in the world, the effect of that aid on their economies and the extent of the impacts of aid in such nations. A look shall also be taken at the impact of aid on both the donor and the recipients with a special emphasis on the relationship created. The research will explore secondary data for this particular purpose.
Keywords: Aid, Vicious cycle, Savings, Bilateral, Multilateral, LDCs, Tied aid, FDI, Foreign aid, Millennium Development Goals (MDGs).
Contents
The Role of Foreign Aid in Economic Development 9
Conditions Attached to Foreign Aid. 11
The Adverse Effects of Foreign Aid. 12
How to Ensure Foreign Aid Facilitates Economic Growth and Development 13
Introduction
Aid refers to the conditional or unconditional lending of resources by a country, referred to as the donor, to another country, usually labeled the recipient. Aid provision has been a big issue in international organizations for over seven years. The first instance of aid was witnessed after the end of World War II when most European countries sought and received assistance to help rebuild their economies. Since then, the phenomenon of aid has become engrained in the collective conscience of the developed world, so much so that it forms a huge part of their foreign policy (Harmer, &Cotterrell, 2008).
Much of the aid offered by the donors to recipient nations is intended for economic use such as spurring growth and development in a bid to improve the general quality of life among the recipient country’s populace. It has emerged, however, that the donor-driven aid may not always lead to sustainable results (McGillivray, 2007).
Literature Review
Many literatures abound on the impacts of foreign aid on the recipient economies. Time and again, research into the phenomenon has been carried out with a whole variety of results emerging. Manning (2006) claims that low income countries, which are usually the recipients seem likely to have a wide range of financing options. The newfound wide range can be attributed to the emergence of new economic powerhouses such as the BRICS group of companies. The aid that the recipients receive is however likely to be lost.
The risk of loss is due to three critical factors; most of the aid reliant countries tend to prejudice their situation by borrowing on very inappropriate terms because of the urgent need for the monetary boost offered by foreign aid. These countries are also likely to use aid that is not hinged upon any conditionality in order to postpone mandatory adjustments. This may lead to diversion of the aid money. The low income, aid dependent economies may usually end up wasting or misappropriating aid resources on unproductive investments. Some money may also be lost through corrupt dealings (Manning, 2006).
In his writing, Boone (1996) notes that foreign aid offered to recipient third world countries would be more productive were it not for politics. He comments that politics creates too much bureaucracy around foreign aid money hence leading to restrictions in fulfillment of intended objectives.
According to him, poverty does not necessarily reflect government failure when it comes to foreign aid and its management. In his research, he found out that while aid does not necessarily increase investment levels, nor benefit the poor for whom it is meant, it does increase the size of the government. Aid does not always, in many cases where the government is not transparent, benefit the poor or improve their living standards as it is intended.
In a move to delink politics from aid and aid money management, Boone (1996) reveals that the impact of aid does not vary according to whether recipient governments are liberal democratic or highly repressive. The author, however, falls short of mentioning that democratic regimes are likely to utilize aid money better than repressive ones.
Boone (1996) claims that this may be due to the fact that democratic regimes are more likely to empower the poor for whom aid is intended than repressive regimes are. Even if the political elites continue to enjoy benefits of aid programs at the expense of the poor, liberal societies are likely to empower each individual through enlightenment. An implication is that short-term aid targeted to support new liberal regimes may be a more successful means of reducing poverty than current programs (Boone, 1996).
Harmer & Cotterrell (2005) assert that for most donor countries, economic growth has been a key determinant of the advancement of aid to recipient economies. They argue that aid relationships have been time and again viewed as a means of strengthening domestic economic growth in recipient nations. This is supposed to be achieved by reinforcing trade and export ties.
According to them, aid is most likely issued to donor countries after a major setback such as disaster that affects the economy of such recipient nations. To them, aid is supposedly earmarked for reconstruction and rebuilding. In their view, each country just needs a little push to recover, rebuild or regrow their economies after a setback is experienced. They therefore assert that the role of aid on the recipient economy is to spur growth and, or recovery. Harmer & Cotterrell (2005) also advance the claim that foreign aid may help the recipient country and its donor partner to reinforce trade and export ties.
McGillivray (2007) in his empirical survey on the macro level effectiveness of aid writes that official aid has time and again been criticized for not contributing to economic growth and poverty reduction in the recipient economies. He further notes that this is of great concern given the role aid is expected to play in the realization of the United Nations’ Millennium Development Goals (MDGs).
In the survey, he claims that there is overwhelming evidence that aid has helped increase the economic growth and reduction of other poverty related variables of the recipient nations. McGillivray (2007) therefore asserts that it can be inferred that poverty levels would be much higher and economic growth either stagnant or negative, were it not for foreign aid that is injected into the economies of donor-aid recipient nations.
In his assessment, some critics have gone so far as to claim that aid is harmful, a failure and is counterproductive in the criteria of poverty reduction. He analyses the possible links between foreign aid and national economic growth per capita. McGillivray (2007) finds evidence that aid is associated with higher public expenditures that would otherwise have not prevailed.
This increased public expenditure tends to spur economic growth and open up avenues for economic expansion through increased employment opportunities, increased service delivery and the construction of basic factors of production. There is evidence that the impact of aid, and its effectiveness, is contingent on the policies and priorities of the recipient nations; aid, despite working in all recipient economies, tends to work better in economies whose governments have better policy regimes (McGillivray, 2007).
The report by the Commonwealth of Australia (2011) notes the fact that the total volume of aid in the world has grown dramatically driven by the huge increases in aid funds from traditional donors, the emergence of new non-governmental donors and global funds, and the rapid growth in aid from the emerging non-traditional donors. In the independent review on the effectiveness of aid, the report notes that aid can play an important role in promoting development of recipient nations.
Aid can specifically target the poor, help to stabilize fragile nations, promote innovations and inventions to help tackle global challenges, and spur production in the recipient economies (Commonwealth of Australia, 2011). The review notes that for most countries, in most times, the policies that are adopted by the authorities and the practices that attend to such policies are far more important than the aid itself in determining the success or failure of such aid.
In the report, the Commonwealth of Australia (2011) advances the view that many factors are responsible for determining the effectiveness of aid. The report groups the factors into three broad categories- the capabilities and policies of the recipient economy, the performance of the donor country, and the quality of relationship between donor and recipient.
For aid to be effective, the recipient economy need to have in place very strategic policies that enable the adequate and proper use of aid money for the exact intent (Commonwealth of Australia, 2011). This is in line with the sentiments expressed by McGillivray (2007) among many other scholars.
Ranis (2006), in his study of how to enhance the effectiveness of aid proceeds to propose the establishment of a new modus operandi for foreign aid, based on a much more passive, banker-like posture by donors, leaving the initiative for defining what reforms are feasible, plus the establishment of self- conditionality, to the recipients before they approach the international community of donors.
In his view, if the use of aid money and the policies that guide such use were left for the recipient, the effectiveness of aid would be greatly enhanced. Ranis (2006) seems to take a bottom up approach in the use of aid money. He views aid as able to perform better if donors do not interfere in the planning process.
In his opinion, Ranis (2006) claims that the most serious handicap in the way of all aid donors has been the phenomenon of disbursement dilemma which he aptly describes as the overwhelmingly strong need to lend, accompanied by a long list of conditions. The list, Ranis (2006) notes, is often insufficiently differentiated to reflect specific local institutional political and economic realities.
The list, he goes on to assert may be frequently drawn up without a clear idea of what is critical to an economy. He insists that for aid to be effective, the number of conditions attached to it must be reduced. Citing the example of the world bank’s decision to reduce the number of conditions tied to aid, that had the effect of increasing economic growth, Ranis (2006) proves that aid is much more effective when left largely to the discretion of the recipients albeit with a little guidance from the donor.
The Role of Foreign Aid in Economic Development
Towards the end of the Cold War, as the champions of the two economic ideologies looked to further their global influence, aid stopped being about increasing their reach but more and more about alleviating poverty in the world and promoting development of client states (McGillivray, 2007).
As the Cold War ended, the countries that were in direst need of help and wallowed in extreme poverty became the top most priority. This is how the international movement for the effectiveness of foreign aid began taking shape in the mid to late 1990s. Foreign aid is used to help alleviate human suffering in the donor countries, specifically tied aid.
The money obtained from donors and aid partners is used to improve critical social and economic sectors of human life such as education, healthcare and social services. The donor aid received by poor countries helps to fund projects that empower humans living in the recipient states and therefore help them overcome extreme poverty.
Through increasing the access to basic services such as education and healthcare, aid helps to strengthen human capacities in the recipient economies and empower the individuals to be more productive and thereby climb out extreme levels of poverty (Ranis, 2006). In light of this, therefore, it is true that aid helps reduce and even alleviate extreme poverty levels.
Foreign aid helps to spur government spending in the recipient economies. The inflow of foreign currency helps to fund investment in critical sectors such as development of infrastructure, construction of healthcare and educational facilities, among other development projects. This increased government spending leads to increase in the employment levels in the economy and hence the improvement of living standards in the recipient economies (Harmer & Cotterrell, 2005).
The effect of the increase in government spending also helps boost other indirect sectors and therefore expand the economy through the multiplier effect. The use of the aid money in the improvement of critical infrastructure such as schools and healthcare facilities helps to improve the living standards in the economy coupled with economic growth due to increased productivity of the population. The construction of basic factors of production such as roads also leads to improved productivity levels.
Through foreign aid, increased linkages are established between the donor nation and the recipient economy. These linkages, as Ekanayake (2010) notes, serve as avenues for the transfer of technology and technical know-how in the form of expatriates who are seconded by donor economies to the recipients.
The transfer of technology and technical know-how to the recipient economy helps improve the way daily activities and chores are carried out hence contributing to an overall increase in the productivity of the recipient nation’s population (Ekanayake, 2010). The transfer of the technology and technical know-how to the aid recipient nations helps bridge the technological gap between the developed and the developing nations; and helps improve the level of development in the aid receiving economy.
Through the aid offered to the developing nation, the economies are given a big push that would help them climb out of the vicious cycle of poverty (Dalgaard, Hansen, & Tarp, 20004). The much needed cash injection in terms of foreign dollars helps to spur high productivity by increasing the capacity to generate which in turn leads to the realization of higher national incomes then higher national savings and further, more investments which ultimately lead to improved levels of productivity. The presence of foreign aid in terms of foreign dollars to recipient economies, therefore, acts as the intervention that breaks the vicious cycle of poverty. It provides the big push needed to boost economic productivity of poor developing economies.
Conditions Attached to Foreign Aid
Most of the foreign aid advanced to recipient countries is tied to certain conditions or requirements. As is evident in the case of the USAID offering aid in the form of food to the Zambian people, it is clear that the US insisted on very stringent measures that were tied to the help; these were believed to largely benefits donor more than it did the recipient. The Western nation insisted that for the US to provide food relief to the Southern African nation the provision of support services would have to be done by American organizations.
The contract behind the aid stated clearly that all only American made products should be used in the food program from production to manufacturing & processing, to shipping. The fact that the US did not seek to help Zambia create its own sustainable supply of food goes a long way to reveal that the Western nation did derive greater benefit from the Food Aid Program than probably the recipients.
Tied aid also comes with conditions such as specific projects for which the aid is intended. Often times, the recommended project may not be a priority for the aid recipients and therefore distorted development may be realized. For instance, in the case of the Thaba – Tseka highway project in Lesotho, the aid may have solved an infrastructural problem but it certainly did not solve any social one.
The vast majority of the Basotho people left farming to go earn wages in the project by whose end they were importing rather than exporting grains and cattle as they had been doing prior. The construction of the road therefore ended up toppling the way of life for the subsistence farmers. In the end, the project did improve the infrastructure of Lesotho but ended up creating a social problem, joblessness, because of the conditions that it was tied to.
The Adverse Effects of Foreign Aid
Aid is offered to improve the capability of the recipient to be more productive in terms of economic output. It has been noted however, that aid may not always spur economic development. As a matter of fact, aid may stifle development, notes Manning (2006). The reliance on donor aid may reduce the levels of development in the recipient economy.
This may be due to the fact that assured aid produces a disincentive to produce and hence develop the local economy. Aid may lead to the distortion of certain sectors of the economy and hence reduce the economic capacity of a given nation to produce that which aid supplies. In the case of the food aid in Zambia offered by the USAID, the aid tends to create a disincentive for the Southern Africa nation to produce its own maize when cheaper supply will be availed from the American people.
Foreign aid usually comes tied to certain conditions that need be fulfilled in order to increase the donor-recipient cooperation. This was commonly seen in the case of the ideological wars in the period after the end of the Cold War. The aid offered to countries at that time, as McGillivray (2007) notes was intended to win over client nations.
This created a tricky situation in which economies who received aid from a communist economy were expected to embrace communism and to not accept aid from capitalist economies. This created a situation where countries had to embrace ideologies that may not have been friendly to their populations in a bid to attract and retain foreign aid.
Aid may also require the recipient nations to adopt certain values that may not resonate with their internal systems and beliefs. For example, in 2012, when the African nation of Uganda passed a law that outlawed gay and lesbian relations, most of its aid partners suspended their help in protest.
They aimed to press the government to repeal the statute which, in the view of the Western world was repressive to fundamental human rights and liberties. In the Ugandan culture and traditional practices, the concept of same sex relations is alien and therefore not tolerated. The case of the Republic of Uganda may be one of the instances of the adverse effects of donor aid.
How to Ensure Foreign Aid Facilitates Economic Growth and Development
In an attempt to ensure that foreign aid facilitates economic growth and development as is intended, the following strategies may be employed. The increased cooperation between the donor and the recipient in order to ensure that there is free flow of information and technology, and expert knowledge in order to spur economic growth and development. The donors should also let the recipients decide on the projects and development programs to be accorded priority in order to spur economic growth and development.
Donor aid should also not be tied to specific conditions such as those that were imposed for the Republic of Uganda. If aid is offered with fewer and less controversial attachments, it is likely to succeed in its intended role. Donor aid should also be intended for more than just single projects in order to avoid a situation such as the Thaba – Tseka road project of Lesotho where aid solved an infrastructural problem but ended up creating a social problem. Should aid be designed to be multifaceted, it will not only lead to economic growth but will come with attendant development.
References
Commonwealth of Australia (2011). Independent Review of Aid Effectiveness: April 2011.
Dalgaard, C. J., Hansen, H. and F. Tarp (2004), “On the empirics of foreign aid and growth,” Economic Journal, 114 (2), p.191–216.
Ekanayake, E. M. (2010). “The effect of foreign aid on economic growth in developing countries.” Journal of International Business and Cultural Studies, 13(2), p. 1-11.
Harmer, E., & Cotterrell, L. (2005).Diversity in Donorship : The Changing Landscape of Official Humanitarian Aid. The Humanitarian Policy Group, Overseas Development Institute of London.
Manning, R. (2006). Will ‘Emerging Donors’ Change the Face of International Cooperation? Development Policy Review, 24(4), pp. 371-385.
McGillivray, M. (2007).Is Aid Really Effective? World Institute for Development Economics Research (WIDER), Helsinki: Finland.
Ranis, G. (2007) Toward the Enhanced Effectiveness of Foreign Aid. Center Discussion Paper No. 938, Yale University : New Haven, Connecticut.