International cooperation has been seen as a global commitment and a shared responsibility for promoting peace, progress and prosperity across the world. In the present context, people are becoming increasingly inter-dependent. On the one hand, the whole world has become a global village due to advances in science and technology, and on the other hand, the gap between rich and the poor has widened over a period of time. Recognizing the importance of concerted efforts towards bridging these gaps and alleviating poverty in the world, developed countries have pledged to extend their support to developing countries with a focus on improving living standards and helping people live with dignity. It has now been globally acknowledged that ‘poverty anywhere is a threat to prosperity everywhere.’ Development cannot be sustainable unless poverty is eliminated from the world. The role of international cooperation is crucial and has become inevitable to poverty alleviation. It is therefore imperative that the global community work together to combat poverty and deprivation. The main goal of international cooperation is to mobilize and make optimal use of resources through foreign aid in reducing poverty and realizing sustainable economic growth of least developed countries.
Foreign Aid is the main means of international cooperation. It has helped bridge the resource gap between domestic saving and requirements for investment, and also helped narrow external deficit. Its role has become more pertinent in meeting resource gaps and in meeting the growing demands of people for more inclusive development geared towards poverty alleviation. Basically, it is well-established that foreign aid and economic growth are positively correlated.[break]
Data shows that the volume of foreign aid—which includes bilateral grants, loans, and technical assistance as well as multilateral flows—has been growing significantly over the last five decades, from $36.62 billion in 1960 to over $100 billion in 2010. However, developed economies have been allocating a decreasing percentage of their Gross National Income in comparison to 1960, going from 0.49 percent in 1960 to 0.25 percent in 2002, though it has increased to 0.32 percent in 2010.
There is some controversy as to the effectiveness of aid in developing countries, and some prominent economists such as Peter Bauer and Nobel Laureate Milton Friedman have strongly criticized foreign aid. Both have argued that aid is a source of corruption because it enlarges government bureaucracies, perpetuates bad governance, enriches the elite in poor countries, or has just been wasted. Furthermore, they argue that some of the least developed countries from Sub-Saharan Africa and South Asia, for instance Congo, Haiti, and Zambia, have been receiving large amounts of aid over the last four or five decades in various forms, but are still facing many problems such as the vicious cycles of poverty and famine. Those countries are also seriously impacted by various diseases such as HIV/AIDS and Malaria, and continuously achieve a low rate of economic growth.
On the other side, some prominent economists such as Columbia University’s Jeffery Sachs and Noble Laureate Joseph Stiglitz, as well as other supporters, have argued that although aid has not always worked well, it has been playing a positive role in the developing world as part of the fight against poverty and in accelerating economic growth. Some previous empirical researchers like Papenek, McGowan & Smith, Asteriou, Hansen and Tarp, Gomanee et al., Moreira, Morrissey, etc have found a positive relationship between foreign aid and economic growth.
This article analyzes the effects of foreign aid on the economic growth of developing countries, based on a study using cross-sectional panel data of one hundred and fourteen developing countries of various regions–Africa, Asia, and Latin America and the Caribbean—for the 25-year period between 1985 and 2009. Also, the study estimates aid effects on countries with three income levels: low, lower middle, and upper middle.
Between 2000 and 2009, foreign aid had a positive relationship with the economic growth of developing countries: an increase by the amount of one billion is associated with a 0.6837 percent increase in GDP growth.
In the 1980s, multilateral donors like the World Bank and the IMF mainly focused on macroeconomic policy adjustment and market liberalization. Then in the 1990s, development partners slightly changed the modality of aid and attached ‘good governance’ as an aid conditionality.
At the advent of the 21st century, UN member states unanimously adopted the Millennium Declaration, focusing on building “a better and safer world for the next century.” To achieve the goals, both multilateral and bilateral donors focused on the agenda of poverty reduction by shifting their aid mechanisms from macroeconomic to microeconomic issues. After the terrorist attacks of September 11, 2001, developed countries, especially the USA, concluded that the developing world is vulnerable to security and other threats due to the vicious cycle of poverty. As a result, they focused on close cooperation with the governments of developing countries, and the trend in foreign aid has been to focus on the social welfare sector. Are these changing strategies successful in strengthening the aid-growth relationship in the new century?
Empirical results show that foreign aid had a positive relationship with the economic growth of developing countries over both time periods, between 1985-1999 and 2000-2009. Over 2000-2009, a foreign aid increase of one billion dollars increased annual GDP growth by 0.8125 percent. Over 1985-1999, one billion dollar increase in foreign aid is associated with a 0.5001 percent increase in GDP growth. These results establish that the above-mentioned changing aid mechanisms have been playing a significant role in strengthening the aid-growth relationship.
Regarding income level, empirical results show that foreign aid has a positive relationship with GDP growth in countries with low, low-middle, and upper-middle income. In low income countries, the results show a strong relationship to the extent that one billion dollar increase in foreign aid is associated with a 1.0280 percent increase in GDP growth.
In conclusion, the findings of this study clearly show a positive relationship between economic growth and foreign aid in developing countries. But we have to understand that foreign aid is not a panacea, and has not been a universal success. In fact, aid is not a solution to a problem; rather, it is a means of development for the developing world as well as for countries with economies in transition, because it provides external finance for enhancing development. But the effectiveness of aid is likely to remain controversial. Empirical studies regarding aid-growth relationship have shown mixed results. It appears that aid has been successful in some countries, but not in others, depending on each country’s economic policy, institutional capacity, level of governance, as well as donor policies and conditions.
Regarding increasing aid effectiveness and harmonization, developing countries should employ the following strategies: primarily disperse foreign aid into the productive sector, maintain good governance, and control the fungibility of aid. Developing countries should focus on increasing national saving in order to accumulate enough resources for investment or for gross capital formation. Similarly, developing countries should attract Foreign Direct Investment. For these purposes, developing countries need to work towards a better and more conducive environment, comprising political and economic stability, good governance and rule of law, infrastructure and human resource development, enhanced market access, and effective economic diplomacy.
The author is associated with International Economic Cooperation Coordination Division of Ministry of Finance
lekhakbpl@gmail.com
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