Unit 4 Macro: Aid and Development

A2 Macro – October 2012

Financial Flows

Foreign (overseas) development aid

Remittances from migrants

Foreign direct investment (FDI)

Portfolio capital investment

Loans from international institutions

Scale of Financial FlowsAid and Private Capital Flows to Developing Countries 2010

Flows US$ billions % of total official and private flows

Total Official Development Flows

128 10.9%

Total Private Flows (including remittances)

1042 89.1%

Foreign direct investment 509 43.5%

Portfolio Investment 128 10.9%

Net private long-term debt 84 7.2%

Remittances 321 27.4%

Different types of aid

• Bi-lateral aid: From one country to another• Multi-lateral aid: Channelled through international bodies• Project aid: Direct financing of projects for a donor country• Technical assistance: Funding of expertise of various types• Humanitarian aid: Emergency disaster relief, food aid, refugee

relief and disaster preparedness• Soft loans: A loan made to a country on a concessionary basis

with a lower rate of interest• Tied aid: i.e. projects tied to suppliers in the donor country• Debt relief – e.g. cancellation, rescheduling, refinancing or re-

organisation of a country’s external debts

UK Overseas Aid

Source: www.guardian.co.uk/global-development/aid

Building the Case for Overseas Aid

Helps to overcome

the savings gap + aid can play a key role in stabilising

post-conflict

environments and in

disaster recovery

Project aid can fast forward investment in critical

infrastructure projects – capital deepening effects

+higher productivity

Long term aid for health and education projects - builds human capital and stronger

social institutions. Aid projects for enterprise

Well targeted aid might

add around 0.5% to

growth rate of poorest countries -

this benefits donor

countries too as trade

growsBuilding a Case

for Overseas Aid

Risks and Costs of Overseas Aid

Poor governance -

aid can be expropriated

and leaves recipient

country - aid can finance corruption / strengths /

locks-in ruling elites

Lack of transparency – hundreds of $m spent on aid consultants and developed

country NGOs – many donors forget cost of maintaining a

pet capital project

Dependency culture – one aid paradox is that aid tends to be

most effective where it is needed least – it may stunt

entrepreneurial culture

Aid may lead to a

distortion of market

forces and a loss of

economic efficiency

and risks of inflation

Some arguments against overseas

aid

Paul Collier on Aid “There is mounting cynicism about aid—some of it amply justified by past donor practices. Yet few realise just how smart and highly geared modern British aid can be. Perhaps the most sensational recent economic development in Africa has been the explosive growth of “branchless” telephone banking in Kenya. DfID thought up the idea, spent money successfully piloting it, and demonstrated to the private sector that there was a market opportunity. British aid was smart, and thereby catalytic.”

Source: Prospect Magazine, 2010

Dierk Herzer and Oliver Morrissey• More often than not aid damages developing countries• An increase in the aid-to-GDP ratio is associated with a long-run

decrease in GDP in almost two-thirds of the countries• 3 key barriers to aid effectiveness1. Religious tensions, which are common in the poorest countries, and

a big role for the military in politics2. Large government, which is often a sign of a large military presence

and a corrupt government. 3. Low level of law and order. ‘Law and order’ captures the quality of

institutions, which many economists argue are essential to economic development.

Better law and order suggests that countries are more open to trade and have better protection of property rights. This gives people the ability and incentives to invest aid money productively in the economy.

Dambisa Moyo – Dead Aid“I have long believed that far from being a catalyst, foreign aid has been the biggest single inhibitor of Africa's growth. Among its shortcomings, aid is correlated with corruption, fosters dependency, and invariably instils bureaucracy that hinders the emergence of an essential entrepreneurial class.

For Africa to grow in a sustained way, foreign aid will have to be dramatically reduced over time, forcing countries to adopt more transparent strategies to finance development.”

Source: Independent, March 2009

Moyo’s Tough Love Approach“In five years, all aid to Africa must stop. In its place, African nations will need to implement new policies including micro-loans, improved remittances and formalised domestic savings schemes, as well as, internationally, improving foreign direct investment, borrowing responsibly and securing more equitable trading arrangements with the west.”

Source: Dambisa Moyo, Dead Aid

Aid GraduatesCountries whose overseas aid as a share of GDP has declined over the years

Country Maximum aid as % of

GDP

Year Minimum aid as % of GDP

Year Growth of GDP per

capita p.a. 1990–2010

Bangladesh 8.2% 1977 1.3% 2009 5.8%

Botswana 31.6% 1966 0.5% 2005 7.1%

China 0.7% 1992 0.01% 2008 11.6%

Ghana 16.3% 2004 4.1% 2008 4.0%

India 4.1% 1964 0.1% 2009 7.0%

Kenya 16.8% 1993 6.1% 2008 3.1%

Malaysia 1.2% 1987 0.07% 2009 6.1%

Vietnam 5.9% 1992 2.9% 2008 7.4%

Source: World Bank, Global Development Finance

Michael Clemens, Steven Radelet, Rikhil Bhavani and Samuel Bazzi (EJ, 2012)

The impact depend on policies, ‘deep’ structural characteristics and the size of the inflow. When aid rises by 1% of a recipient country’s GDP, growth typically rises by between 0.1 and 0.2% within the following five to ten years. This positive but modest effect tends to decrease at high levels of aid receipts.

Duflo and Banerjee – Poor Economics

• Duflo and Banerjee - Poverty Action Lab• Have pioneered use of randomised

controlled trials to find out what works in development

• Test efficacy of projects / interventions within a population – 2 or more groups (inc control)

• Many “top-down” aid projects afflicted by– Ideology (prejudices, beliefs)– Ignorance (info gaps about local conditions)– Inertia (failure to change when project does

not work)

“Precisely because [the poor] have so little, we often find them putting much careful thought into their choices: They

have to be sophisticated

economists just to survive.”

Evaluation arguments on aid• Aid can bring economic, human, environmental benefits• Development can take place without aid • Well targeted aid can boost growth but the time lags can take years• Aid effectiveness boosted by:

– Randomised control trials– Improve transparency of aid budgets– Conditionality linked to improved governance– Aid that stimulates and supports enterprise

• Different aid projects can affect growth at different times and to different degrees

• Consider alternatives to direct aid – e.g. Debt forgiveness, lowering trade barriers for least developed countries

Sovereign Wealth Funds

Micro-Finance

Schemes

More equitable

trade

Remittances from

Diaspora

Formalised domestic savings

Breaking out of the aid cycle

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