CHAPTER 4: The Impact of Aid
Aid and Growth
23. Evidence of the effect of development aid
on economic growth is not clear cut. Professor Wood said "There
are no really clear and uncontested conclusions on the effects
of aid on economic growth."[35]
Dr Evans agreed: "The broad global relationship between aid
and growth will probably remain forever inconclusive."[36]
Uncertainty reflects in part the innately complex relationship
between aid and growth and in part the challenges of drawing lessons
from "a period of history in which the political, social
and economic context [for aid] has changed markedly" as the
global political context has shifted and attitudes to development
have changed.[37]
The challenges of assessing the
impact of aid
24. The question about the effectiveness of aid
should perhaps be: "how best, if at all, can aid transfers
be designed to finance and support growth-promoting activities?"[38]
The period over which the impact of aid is measured also matters:
aid for critical infrastructure is likely to have an immediate
impact on incomes and growth, whereas the impact of aid for health
and education is longer-term.
25. The statistical evidence, which is inconclusive,
relates to the average impact of aid, across countries and across
donors. It does not tell policymakers the marginal effect of different
forms of additional aid from a specific donor to a specific
set of recipient countries.
26. There are "… numerous possible
determinants of growth, many of which are highly correlated with
each other."[39]
Disentangling the effects on growth of aid and identifying the
right counterfactual—what would have happened if a country
had not received any aid or had received more aid—is very
challenging. Since aid tends to be allocated to low-growth countries
comparisons between countries receiving aid and others are difficult.[40]
27. Finally, there is a question of scale. Globally,
aid accounts for a relatively small share of total financial flows
to developing countries (see Table 1). Thus, even if every dollar
of aid was as effective as private investment in generating economic
growth, the measurable impact would be modest. Calculations suggest
that at its most efficient, aid flows at their historical
average level of 3.5% of recipients' GDP might contribute no more
than an additional 0.5% to recipients' overall per capita growth
rates.[41] This would
represent a not insignificant contribution to growth but impacts
of this size (or smaller) are nonetheless difficult to discern
from the economic data. As Mr Owen Barder, Director for Europe,
Center for Global Development, put it "Given the modest volumes
of aid, we should not expect an impact on growth which is bright
enough to shine through the statistical fog."[42]
What does the evidence say?
28. There is an enormous amount of research seeking
to peer through this fog using a variety of techniques and looking
at different sets of countries and over different historical episodes.
Results necessarily vary but a large majority of studies suggest
a statistically significant but relatively weak positive effect
of aid on growth in the short-run and the long-run.[43]
A smaller number of studies suggest no statistically significant
measurable impact.[44]
All agree, however, that there is no robust evidence that aid
has a significantly negative effect on economic growth on average.[45]
29. Delving behind the aggregate numbers, the
research paints a picture that is broadly consistent with expectations.
Aid tends to be more effective in well-governed countries with
sound institutions and good macroeconomic management so that aid
is effectively channelled into investment in infrastructure; and
when there is a clear alignment of objectives between donors and
recipients.[46] In countries
where political institutions are weak or corrupt, and where economic
policymaking is inimical to private sector investment, aid transfers
are more vulnerable to expropriation and may lead to capital flight
and undermine growth. Aid can also serve to strengthen the hand
of the political elite against the people and help perpetuate
autocratic rule.[47]
30. These results reinforce the well-known paradox
that aid tends to be most effective where it is needed least.
But the paradox may not always apply in post-conflict countries.
Ms Sue Wardell, Director, Conflict, Humanitarian, Security and
Middle East, DFID, cites recent research by Professor Collier
and by the World Bank (2011) indicating that aid can be effective
in stabilising post-conflict environments.[48]
In his book The Bottom Billion, and in oral evidence, Professor
Collier suggests that aid may have added "around 1% to these
countries' annual growth rate", admittedly against a counterfactual
of very poor economic performance. He claims that aid helped stop
such countries from falling apart and thus gave them a chance
to re-establish a measure of economic order.[49][50]
31. Most witnesses discount aid as a serious
cause of Dutch disease[51]—where
a foreign exchange windfall leads to a strengthening of the exchange
rate, damaging export competitiveness and underpinning an excessive
reliance on (relatively cheap) imports, and so damages growth.
Mr Riddell notes "… [the Dutch Disease] is a problem
but two things seem to be critical. The first is for recipients
to be aware of the potential problem, understand how it could
occur and take steps to mitigate those effects. The second is
a message for donors ... They have a key role to play by providing
aid in a predictable manner, as short-term volatile inflows can
be potentially the most disruptive."[52]
32. The difficulties of accurate measurement
and attribution, and of assessing what would have happened if
no aid had been given, are so formidable that the evidence that
aid makes a contribution to growth in recipient countries is inconclusive.
Aid and accountability
33. Even if aid helps promote growth, it may
still have harmful side-effects, for example by undermining the
recipient governments' accountability to their own people. Professor
Wood said "I think there is a serious concern there. It is
one of my biggest single worries about aid. If you give a country
too much aid for too long you damage its basic governance structure
because the politicians pay more attention to the donors than
they do to their citizens."[53]
Ms Wrong put it more graphically, describing a slum resident in
Nairobi during an outbreak of cholera "… looking at
the television cameras and saying 'where are the donors?', and
I thought why wasn't he saying 'where is the mayor'…'where
are the MPs?'…'where is the government?',… for me it
really exemplifies what seems to be a massive problem with aid
… it whittle[s] away the accountability of African governments."[54]
We also heard compelling evidence, to which we return later in
this Chapter, that aid can frequently finance corruption.
34. Aid, particularly budget support, can also
undermine recipient governments' incentive to invest in effective
domestic tax collection, although the evidence is mixed.[55]
35. Witnesses expressed concern that ill effects
of aid could be magnified in fragile states whose institutions
of governance and systems of political accountability are already
weak, especially if fragile states are to receive a greater share
of aid resources in future.
36. Large and prolonged aid programmes can
have a corrosive effect on local political systems when the priority
becomes to attract aid rather than to solve problems. DFID should
pay close attention to the scale and composition of aid programmes
to ensure that resource flows do not overwhelm local ability to
manage them and undermine systems of governance in recipient countries.
They should also support recipient governments' systems of audit
and public financial management and have a credible exit strategy.
Fungibility
37. Aid can be diverted from its intended use
to other uses. This "fungibility" can happen directly,
if aid given for one programme is spent on another programme,
or indirectly, if aid given to support one programme frees other
revenues for other purposes. Aid is said to be fungible if it
does not add dollar-for-dollar to existing expenditures on the
activity for which the aid was earmarked by the donor. Notorious
examples are cited where money provided by donors is used to support
purposes not approved by donors, for example military expenditure
for internal repression.
38. Some forms of aid are less fungible than
others. Technical assistance tends to be the least fungible, simply
because it is tied to specific projects that might otherwise not
take place. Budget support is the most fungible.
39. It is not necessarily true that all cases
of fungibility are a bad thing. Sometimes circumstances change
and money given for one purpose will produce a larger development
return if used for another. However, fungibility is too often
abused. It makes the evaluation of the effectiveness of aid harder;
it reduces confidence in donor countries in their aid programmes;
and in some cases it may cause side-effects which outweigh any
beneficial effects of the donation. We believe that the closest
possible audit of aid flows is necessary to minimise any risk
of unjustified use of fungibility by recipient countries.
Graduation from aid dependency
40. Between 1961 and 2011, 36 countries worldwide
graduated from eligibility for the most concessional aid from
DAC donors to middle-income status. But eight of these subsequently
reversed and are now eligible again for the most concessional
form of aid.[56] Perhaps
the most celebrated graduate is South Korea. As recently as 1960
it was receiving 10% of GDP in aid (not counting an even larger
share of non-aid military support from the US). By the mid-1970s
aid accounted for less than 1%. In 2010, South Korea completed
the transition from recipient to donor and became a member of
the DAC group of donors.
41. Vietnam, Bangladesh and Ghana are examples
of long aid-dependent very poor countries where recent growth
has been driven by a dynamic private sector and where DFID is
developing its exit strategy.[57]
The Secretary of State for International Development wrote "Ghana
shows that well-targeted long-term development, matched by political
and economic stability, does work. British support has played
a vital role in this … our relationship, already focused
on wealth creation, will soon move to an exit strategy as the
private sector and economic growth replace the need for international
aid."[58]
42. Recipient countries too wish to graduate
from aid dependency. Professor Benno Ndulu, Governor of the Bank
of Tanzania stated: "I think a very clear sense and commitment
is there to reduce aid dependency over time. In the medium-term
plan that was recently approved by Parliament, there is a target
that the country has set to reduce significantly the extent of
dependency through increasing domestic revenue to a very large
extent and finding other forms of financing that draw on the involvement
of the private sector."[59]
43. Table 2 below shows how aid dependence, measured
as aid as a share of GDP, has fallen very sharply in 11 fast-growing
countries, often over a relatively short period.
TABLE 2
Fast-growing aid graduates
| 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% |
| Indonesia | 6.2%
| 1971 |
0.05% | 2004
| 6.4% |
| India | 4.1%
| 1964 |
0.1% | 2009
| 7.0% |
| Kenya | 16.8%
| 1993 |
6.1% | 2008
| 3.1% |
| Korea | 9.8%
| 1961 |
-0.1% | 1984
| 8.4% |
| Mauritius | 4.9%
| 1981 |
0.2% | 2006
| 6.8% |
| Malaysia | 1.2%
| 1987 |
0.07% | 2009
| 6.1% |
| Vietnam | 5.9%
| 1992 |
2.9% | 2008
| 7.4% |
Source: World Bank, Global Development Finance.
Note: Korea, China and India now also donor nations.
44. DFID cite the finding of the report of 2006
of the Commission on Growth and Development[60]—a
group of government officials, business people and academics backed
by Western governments and the World Bank which examined the policies
that fostered rapid and sustained economic growth and poverty
reduction—that a key driver of success was a strong "future
orientation" that delivered high levels of private saving
and investment. In the Commission's view, while foreign savings
(i.e. aid and private FDI and capital flows) play an important
role in the early stages of a growth take-off, sustained growth
depended on domestic saving and investment. We turn in Chapter
6 to the role of foreign aid in catalysing the take off in private
sector growth.
45. We welcome evidence of graduation from
aid, or progress towards it, by a range of countries in Asia and
Africa. We recognise that any contribution by aid to the economic
growth which enables graduation may not have been great. We do
not subscribe to the fallacy that because graduation took place
after aid, it was even in part because of aid, since many factors
such as governance, trade and investment affect growth. It seems
likely that all contributed, and that aid's impact was greater
where, as in Botswana, Ghana or Kenya, it was a higher proportion
of GNP in the early days of development and was delivered in support
of a clear strategy for growth. We welcome the Secretary of State
for International Development's readiness to move with the times
and prepare exit strategies in countries where graduation is near.
Aid and corruption
46. Transparency International defines corruption
as "the abuse of entrusted power for private gain."[61]
Mr Laurence Cockcroft, of its UK Board of Trustees, suggested
that corruption damaged societies "first, at the level of
individuals; second, at the level of the macroeconomy; and, thirdly,
at the level of the environment. In each case, I think that one
can see that corruption is very devastating."[62]
He added that corruption is hugely regressive: the poor suffer
today, especially in their ability to access public services,
while future generations will suffer from the legacy of the low
investment, slow growth and the depletion of natural and financial
resources that a corrupt environment generates.
47. The association between aid and corruption
seems strong but precise causal links between aid and corruption
are hard to identify, not least because, unsurprisingly, no reliable
statistics on the scale of corruption exist.
48. Ms Wrong was nevertheless categorical that
"… [aid] and corruption always go hand-in-hand, because
aid is essentially seen by those entrusted with it as "free
money", whose loss will go unnoticed by the giver and whose
appropriation is nothing like as morally reprehensible as appropriating
local tax revenue, for example."[63]
49. Certain types of aid are particularly vulnerable
to corruption. Large and complex donor-funded projects can provide
scope for bribery and fraud. Fungible aid transfers such as budget
support which may be less easy to trace are also susceptible to
corruption.
50. The risks of corruption are greater in
weak, unstable or failed states. It is important for donors to
ensure that opportunities for corruption are as limited as possible
by setting in place systems of audit and control as rigorous as
local conditions permit and to withhold development aid altogether
where corruption is rife and therefore endangers the effectiveness
of aid. In the battle against corruption, to which we return later,
accountants are more important than economists.
Capital flight
51. Capital flight occurs when owners of liquid
assets move them to other countries perceived as safe havens or
as offering better returns. It can be legal or illegal. When legal
it stays on the books of the entity or individual making the outward
transfer. When illegal it disappears from records and is often
associated with corruption.[64]
52. Transparency International UK cited a report[65]
which estimated the developing world lost US$8.44 trillion over
the decade to 2009 in illicit financial flows. They also observed
that "Leakages … as a result of the illicit transfer
of the proceeds of bribery, theft, kickbacks and tax evasion have
been increasing relative to trade mispricing"[66]—when
imports are corruptly over-priced and exports under-priced on
customs documents as a means to transfer money overseas. Capital
flight also reduces tax revenue. Christian Aid research estimated
that developing countries lose $160 billion a year from transfer
mis-pricing and false invoicing, around 1.5 times the global aid
budget.[67]
53. Transparency International recommended that
the Government should work with the G20 "to curb illicit
financial outflows from developing countries as well as ensure
that the UK and other major financial centres do not absorb and
benefit from these illicit outflows."[68]
54. Developing country economies can also suffer
from legal capital flight when domestic economic conditions and
investment opportunities are poor. Donors can help governments
halt and reverse capital flight both by supporting government
efforts to achieve macroeconomic stability and through measures
aimed at improving the investment climate including infrastructure
investment, the reduction of red tape and bureaucratic barriers
to investment and so forth, what Professor Collier has referred
to as "investing in investing."[69]
55. We recommend that DFID should monitor
and report on flows of capital from recipient countries, with
a view to reducing aid where there are excessive outflows. We
agree with Transparency International that the Government should
explore with other G20 countries the scope to discourage illicit
capital flight from developing countries.
Aid and poverty
56. Sustainable poverty reduction is the main
aim of development assistance.[70]
Aid can reduce poverty in three main ways: direct support to the
poor and vulnerable in the form of food aid, cash or in-kind transfers,
usually in response to a pressing humanitarian imperative; budgetary
contributions to government—or NGO-run programmes designed
to improve social and welfare services to the poor, often in pursuit
of Millennium Development Goals; and development assistance that
helps create the conditions for sustained economic growth.
57. Local effects of aid to reduce poverty can
often be seen. But assessing the role of aid in long-term sustainable
global poverty reduction is much harder, in part because progress
is so gradual and in part because of familiar difficulties of
measurement, attribution and unknown counterfactuals. Researchers
at the World Bank have tried to estimate the cost of lifting an
individual permanently out of poverty through the so-called 'growth
elasticity of poverty reduction' which seeks to measure the amount
of poverty reduction achieved for a given increase in average
per capita incomes.[71]
Their estimates range widely—reflecting a host of characteristics
including how unequal the country is and how labour-intensive
the growth—but tend to reinforce the importance of economic
growth to poverty reduction.[72]
58. Growth seems the most effective remedy
for global poverty. We are surprised that the role of growth is
not more fully acknowledged in the international community's collective
approach to poverty reduction. We recognise that trade, investment
and remittances are all much more substantial than aid and more
important in driving growth. We accept that accurate measurement
of whether or how much aid helps promote growth is not available.
But similar difficulties arise over measurement of the contribution
to growth of trade, investment and remittances, though their indispensability
to growth is undeniable. It is uncertain that aid makes a proportionate
contribution.
35 Q 2 Back
36
Q 82 Back
37
Carter and Temple, para 5 Back
38
Roger Riddell "Is aid working? Is this the right question
to be asking? Open Democracy (November 2009) (http://www.opendemocracy.net/roger-c-riddell/is-aid-working-is-this-the-right-question-to-be-asking)
Back
39
Barder, para 6 Back
40
Carter and Temple, para 3 Back
41
Tarp, para 11 Back
42
Barder Back
43
Tarp, para 10. Arndt, Channing; Jones, Sam; and Tarp, Finn (2010)
"Aid, Growth, and Development: Have We Come Full Circle?,"
Journal of Globalization and Development: Vol. 1 (2) and
Clemens, Michael, Steve Radelet, Rikhil Bhavnani and Samuel Bazzi
(2004) "Counting Chickens when they hatch: timing and the
effects of aid on growth" Centre for Global Development
Working Paper 44 Back
44
Tarp, para 11. Raghuram G. Rajan & Arvind Subramanian, 2008.
"Aid and Growth: What Does the Cross-Country Evidence Really
Show?" Review of Economics and Statistics: Vol. 90(4) Back
45
Adrian Wood, Q 2. "The one thing we can be clear about is
the evidence that almost certainly aid does not reduce growth".
And Tarp, para 12, "Put differently, there is no systematic
evidence that perverse economic effects from aid overshadow its
benefits" Back
46
Morrissey, para 2-3; Barder, para 5. Riddell, Q 2 Back
47
Booth, para 4 Back
48
Wardell, Q 179 Back
49
Collier, Q 317 "I do not think that I would even claim that
it [aid] is necessary, but it can certainly be useful. Historically,
it might have been necessary to reduce the number of countries
that fell apart and to pull back those that did. We see from Somalia
the enormous costs of what happens when a country really falls
apart. The lesson of Somalia is basically that whatever it costs
to avoid that situation is money well spent." Back
50
Wardell, Q 179, quotes Collier's research on conflict prevention
suggesting that that raising average per capita incomes "from
$250 per head to $500 per head, you can reduce the chance of conflict
occurring by 50% over a five-year period." Back
51
Wood, Q 4, Sachs, Q 466 "… if your aid policy is sensible,
it will promote productivity on the supply side through the provision
of infrastructure or a healthier labour force or a better educated
labour force …"; Ndulu, Q 41, Picciotto, Q 41 Back
52
Riddell, Q4 Back
53
Q 7 Back
54
Q 399 Back
55
As with aid-growth evidence, results are contested. S. Gupta,
B. Clements, A. Pivovarsky and E. Tiongson (2004) "Foreign
Aid and Revenue Responses" in S. Gupta, B. Clements and G.
Inchauste (eds) Helping Countries Develop: The Role of Fiscal
Policy find that development grants have a mild negative effect
on tax effort, although loans had a contrary effect. Subsequent
work, including Morrissey and Clist (2011) "Aid and Tax Revenue:
Signs of a Positive Effect since the 1980s" Journal of
International Development vol 23, pp 165-80, tends to overturn
this result, particularly when the focus is on the last 15-20
years. Back
56
The 36 graduates are: Albania, Azerbaijan, Botswana, Cameroon,
Chile, China, Colombia, Congo, Costa Rica, Cote d'Ivoire, Dominican
Republic, Ecuador, Equatorial Guinea, Egypt, El Salvador, Honduras,
Indonesia, Jordan, South Korea, Mauritius, Macedonia, Montenegro,
Morocco, Nicaragua, Nigeria, Papua New Guinea, Paraguay, Philippines,
Serbia, St. Kitts, Swaziland, Syria, Thailand, Tunisia, Turkey,
Zimbabwe.Eight of these have reversed and are again eligible for
concessional aid: Cameroon, Congo, Cote d'Ivoire, Honduras, Nicaragua,
Nigeria, Papua New Guinea, Zimbabwe.Sources: DFID 1, para 20,
and The World Bank International Development Association Graduates
available at http://go.worldbank.org/PSTVR12110 Back
57
DFID 1, para 21 on Vietnam; Manning, Q 287 on Bangladesh Back
58
The Observer, 'Ghana's boom proves aid really can work',
15 January 2012 Back
59
Ndulu, Q 32 Back
60
Secretary of State for International Development, (SoS 2), para
10 Back
61
Transparency International-available at http://www.transparency.org/news_room/faq/corruption_faq
Back
62
Q 483 Back
63
Wrong Back
64
Global Financial Integrity, Illicit Financial Flows from Africa:
Hidden Resource for Development, page 7 Back
65
Global Financial Integrity, Illicit Financial Flows from Developing
Countries Over the Decade Ending 2009 Back
66
Transparency International Back
67
Christian Aid, para 6.4 Back
68
Transparency International Back
69
Q 323 Back
70
International Development Act (2002) Back
71
Martin Ravallion (2004) "Pro-Poor Growth: A Primer"
World Bank Policy Research Paper 3242. Washington DC, World
Bank. Back
72
Those countries that have made most rapid progress towards the
first of the MDGs-to halve those living in extreme poverty by
2015-have been the fast growing countries of East Asia, most notably
India, China and Vietnam. Back
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