The Economic Impact and Effectiveness of Development Aid - Economic Affairs Committee Contents

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.


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.


Fast-growing aid graduates
Maximum aid as % of GDP
Minimum aid as % of GDP
Growth of GDP per capita p.a.

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) (  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  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  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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