foreign aid - economics

8/10/2019 Foreign Aid - Economics

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Foreign Aid

(Concessional financial flows)


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Foreign Aid: Concessional loans &grants

Largest share: ODA, including bilateral andmultilateral soft loans (25%) and grants

(75%). Donor countries: most of OECD countries,

some OPEC countries and some Eastern

countries.


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Multilateral organizations providing ODA: UN agencies

Single-issue funds (eg: global fund for AIDS)

International Development Association of the

World Bank

Regional development banks

IMF assistance for debt relief


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Purposes Humanitarian aid Debt relief

Development assistance:

Financial support to sectors Financial support for specific projects

Technical assistance (doctors, teachers,

agronomists).


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Donor motives

1. Political & strategic motives. Use of aid tosupport regimes considered to be friendlyto the interests of the donor governments.

2. Economic motives. Assistance to countrieswith strong economic ties, such as Japan,with aid directed to neighbouring countrieswith trade and investment links. Tied aid:

recipients must spent a portion of theborrowed funds on the purchase of g+sfrom the donor country.


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3. Humanitarian & moral motives

Short term emergency assistance Long-term development assistance on debt

relief and poverty alleviation

Political & strategic interestspredominate


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Arguments in favour of the effectiveness ofaid (Advantages)

1. Aid and poverty cycle. Very poor countrieswhich are trapped in the poverty cycle face aninvestments constraint due to low incomes. To

emerge from a poverty cylce they needinvestments in physical, human and naturalcapital. However, if the country doesnt havetax revenues the only way it can achieve this is

through foreign aid.2. Aid and provision of basic servcies. In

countries which are not stuck in the poverty

cycle, investments are required in health,education and infrastructure, which can hel


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Factors limiting the effectiveness of aid(Disadvantages)

1. Tied aid. In the context of bilateral aid:recipients must spend part of the borrowedfunds on g+s from the donor country.

Higher import costs. Purchase of inappropriate capital intensive

technologies & development and use of skillsinappropriate to local developing country conditions.

2. Conditional aid. Donors impose conditions tobe met by recipients to ensure that funds areused effectively.


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a. Policies towards market orientation.

b. Acceptance of projects decided by donors.c. Detailed reporting on spending, timetables,

priorities.

Problems with conditional aid:1. The preferences of the government or

population group are not considered.

2. Policy prescriptions by donors may be

incorrect: May not fit in with the governments priorities May undermine governments authority


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3. Aid volatility and unpredictability.

Makes it difficult for recipient governmentsto implement policies that depend on aidfunds

4. Uncoordinated donors inefficiencies inthe use of aid resources

5. Aid substitutes rather than complementsdomestic resources not enough effort

to increase revenues through taxation.


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6. Aid may not reach those most in need. Aid resources are not allocated on the basis

of the greatest need for poverty alleviation:

Bilateral donors guided by political & strategicinterests.

Recipient countrys gov may not be committed topoverty alleviation or lack expertise to design apoverty alleviation strategy.

7. Aid associated with corruption. Misuse of aid funds by recipient countries


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Aid vs Trade debate

Three different perspectives:1. Trade, not aid

2. Trade and aid3. Aid for trade


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Trade, not Aid

Proponents: development should be basedon an expansion of intal trade and

increasing exports of LDCs, while aidshould be curtailed or abandoned.


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Failures of foreign aid:

1. Aid is a breeding ground for corruption, asfunds are misappropriated by corruptleaders.

2. Aid substitutes for rather than complementsdomestic government revenues.Governments lose incentive to increase taxrevenues and increase efficiency of tax

system dependency on aid funds.3. Aid does not reach those most in need.


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Countries need international trade:

Success of East Asian countries: intaltrade contributes to growth anddevelopment.

BUT: on the condition that DCs eliminatetheir trade barriers and protection oftheir agricultures.


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Trade and Aid

International trade and an exportorientation are indispensable to growthand development, but not enough by

themselves in the case of LDCs. Foreign aid has not failed. Many of its

weaknesses (tied aid, conditional aid, lack

of coordination, volatility) are theresponsibility of donors and there ispressure to correct these problems.


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Foreign aid is necessary...

1. ...to help LDCs to escape the povertycycle.

2. ...to increase provision of basic services.Aid can make resources available forinvestments in health, education and

infrastructure, helping the poor toimprove employment opportunities andimprove their incomes.


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3. ...to improve income distribution, by

focusing on the most disadvantagedgroups.

4. ...for growth. Aid makes possible

increased investment and consumptionlevels.

Mozambique, Tanzania, Uganda, which relyheavily on aid, have achieved high growthrates.

5. ...for the achievement of the MDGs.


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6. ...for debt relief purposes. Aid helps

countries reduce their debt burden andreleases resources that can be used forpoverty reduction and economic growthand development.


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Intal trade may be of little use

1. Elimination of agricultural subsidieswould have mixed effects for food

importers (Africa): positive for producers,negative for consumers.

2. Countries may have little to export:

Limited access to credit Difficult to move into production of goods

that can be exported.


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3. Geographically isolated countries andcommunities: no access to markets,urban centres or to ports unable tocompete in international markets.

Investments in communications andtransportation are necessary to benefit from

trade aid can provide the resources.


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Aid for trade

Consensus among developmenteconomists:

In order to benefit from from intal trade, LDCsmust have the institutional capacity toincrease their exports.

A portion of aid should be used to supportthe development of institutions thatimprove a countrys abilities to export.


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Institutional constraints:

High transport costs due to poor transportnetworks

Limited access to credit

Poor power supplies higher productioncosts

High administrative costs (border procedures)

Lack of capacity to meet technical and

sanitary standards


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Aid and trade policies should be integrated.

The aid for trade would be in addition to andnot a replacement for ODA.

Efforts to address institutional constraints to

trade should also focus on middle incomedeveloping countries, which do not qualify for

ODA funds.

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