If the purpose of aid is to reduce poverty (“Our dream is a world without poverty” says the entrance to the World Bank office in Washington for instance), it would make sense for us to look at countries that have been relatively successful in achieving this goal. China, Singapore and Malaysia are examples. So what is the relation between aid and development for these countries? Professor Easterly, professor of Economics at New York University, tells us they received very little aid per capita. The median ratio of aid to GDP of the 10 countries with the highest per capita growth rates between 1980 and 2002 was just 0.23 percent. In contrast, the 10 countries with the lowest per capita growth rates in that period, all negative rates, had a median aid-to-GDP ratio of 10.98 percent. That in itself says nothing about causation, but it’s still not very encouraging.
Rebuttals to this data set and development aid follies of the past includes: We did it wrong in the past but we have learnt, and things have changed now with aid being given only to better governed countries. These assertions are based partly on research by economists Craig Burnside and David Dollar in 2000, which found that aid did boost growth in countries with good governance. This became conventional wisdom.
But, to assume that aid is now on the “right” track is to accept the conclusion of this study. What complicates the scenario is that this study has been proven wrong. Easterly repeated the study by Burnside and Dollar but drew on a larger pool of data. This time he found no evidence that “aid works in a good policy environment.” Raghuram Rajan and Arvind Subramanian of the IMF came to the same conclusion, and they also suggested a reason. After closely examining the evidence, they concluded that “aid inflows have systematic adverse effects on a country’s competitiveness.”
This piece, co-authored by Rajan – a former chief economist at the IMF – is worth looking at in greater detail. So, why is aid, even in the presence of good governance, bad in the long term? It argues that aid could atrophy the tax-raising mechanism and relax the governments need to explain itself to its citizens.
Even though aid resources are initially additional to the budget, eventually the country becomes more lax on raising tax revenues, and more aid is necessary just to keep the country on even keel.
Even though aid resources are initially additional to the budget, eventually the country becomes more lax on raising tax revenues, and more aid is necessary just to keep the country on even keel. If that aid is not forthcoming, and if the country’s tax-raising mechanisms have atrophied, short-term gains are rendered redundant by long-term dependency. Also, by expanding a government’s resource envelope, aid relaxes its need to explain its actions to citizens, which may have a corrupting influence even on the best intentioned of governments in the long run. The government is no longer responsible to the people as the money for its continued existence comes from elsewhere.
Iqbal Z Qadir, the founder of GrammenPhone Bangladesh, uses a very interesting analogy to make this point in a John Templeton Foundation paper entitled “Will Money Solve Africa’s Development Problem?”. In the 13th century, the British parliament was able to exact steadily more influence from the crown by making sure the crown was not financially independent, thus using this as the bargaining chip. Governments have to be made fundamentally accountable to their own people. Aid by distorting this and making accountability to donors more important hurts empowerment and progress.
The piece also argues, like the “Dutch disease theory”, that aid has a negative impact by raising the exchange rate and thus hurting export competitiveness. With Nepal’s currency pegged to India’s, appreciation can be the result of India’s growth, so this is hard to study here. However, monetary economics would suggest that an increase in money supply without an increase in suppy is inflationary and this in turn would have a negative impact on input costs on the tradable sector hurting competitiveness. This crowding out also affects the scarce supply of skilled manpower in the country as well with many falling for fat paychecks in the aid industry rather than the private sector.
This brings us to another argument – that the aid agency has become self-perpetuating and thus is at loggerheads with its explicit aims. Dambisa Moyo argues in her book “Dead Aid” that aid has become a self-perpetuating industry. She argues that “some people actually have a vested interest to see the continual cycle of (Nepal) in despair so that they can justify their existence.” Miller-Adams (1999) argue, noting that organizations strive to ensure organizational survival and better their bargaining power with others through steady growth, of the World Bank’s continued moves to increase its branches even in areas where other development banks are present. This despite the potential for duplication of duties and conflict in those regions.
This sort of overlap just highlights at the macro level the perpetuation tendencies within aid organizations where livelihood and careers are now planned specifically for the sector and many have a vested interest in seeing it continue. If we are to agree that at some stage we want to see a world that does not need aid, we have to set timelines. President Obama by setting a clear deadline for troop withdrawal from Africa has made it clear to President Hamid Karzai that he needs to get his act together because US involvement is not a blank check.
So, are there any alternatives? Can aid be replaced by investment that is responsible to a bottom line and does not crowd out the private sector. Justin Muzinich and Eric Werker (the latter an assistant professor at Harvard Business School) have a suggestion. The US Congress, they say, should provide a 39-cent tax credit for every dollar of American investment in developing countries. If Company X were to build a $100 million factory in Nepal, its tax bill would be reduced by $39 million. Because for-profit companies are focused on the bottom line, they will be more protective than government agencies of the money they invest in developing countries.
An even more politically incorrect but potentially effective solution was propagated by Economist Paul Romer. His answer to the question of how a struggling country can break out of poverty if it’s trapped in a system of bad rules is: “Charter cities”. These city-scale administrative zones governed by a coalition of nations will employ rules that have proven to work and bring that to the developing world. Seeing the possibilities in this new framework, people will be attracted in to strive for higher things but also demand similar accountability outside. The model is not very different from the model Deng Xiaoping followed when he used Hong Kong to model Special Economic Zones that led to the economic boom in China. While this idea may seem like colonialism all over again, if we are to judge it from the head rather than the heart, it makes sense.
So, maybe, aid does not work. Maybe there are alternatives. And maybe, just maybe, your anger at that SUV is justified.
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