EC3040 Economics of LDCsModule B Topic 4

Aid

Savings, investment, borrowing

• In a closed economy, domestic savings=investment

• But in an open economy this is not necessary in the short-to-medium term

• Rational for a country to borrow as it builds up its capital stock (smooth consumption over time)

• But – International financial markets can suddenly shut down– Inflows of capital can boost real exchange rate and thereby slow

export growth

K

sY

δK

Y

Long-term equilibrium in simplest Solow model

Stationary point

Two-gap model I < F + sY (m1 – m2)I + m2Y – E ≤ F F is capital inflows s is saving rate m1,m2 are marginal propensity to import out

of investment and other spending E exports Y GNP

Ethiopia: International PaymentsUSD mn USD mn

Exports 1000 Imports 4593Services (net) 149 Interest etc (net) 38Private current transfers 1229Official current transfers 866

New public debt 343 Amortization public debt 148LT Private capital (inc FDI) 365 Other (net) 30

Use of official external reserves 216Debt relief 133

Errors and Omissions 5074808 4809

Figure 15.2

1990-1991 average

1995-1996 average

2002 2003 2004 2005 2006

I. Official Development Assistance (a) 54 574 57 277 58 297 69 065 79 432 107 099 104 421

1. Bilateral grants and grant-like flows 34 419 36 394 39 818 50 888 57 246 83 453 79 450

of which: Technical co-operation 12 023 14 229 15 452 18 352 18 672 20 753 22 252

Developmental food aid (b) 1 609 1 087 1 086 1 196 1 169 887 956

Humanitarian aid (b) 1 738 2 153 2 779 4 360 5 193 7 110 6 751

Debt forgiveness 5 167 3 561 4 538 8 317 7 134 24 999 18 600

Administrative costs 2 059 2 873 3 046 3 545 4 032 4 115 4 250

2. Bilateral loans 6 250 3 404 939 -1 153 -2 942 -1 008 -2 490

3. Contributions to multilateral institutions 15 614 17 479 17 540 19 330 25 127 24 653 27 461

of which: UN (c) 4 351 4 379 4 739 4 828 5 129 5 469 5 239

EC (c) 3 807 5 112 5 695 6 946 8 906 9 258 9 931

IDA (c) 4 467 4 702 3 279 3 120 5 690 4 827 6 787

Regional development banks (c) 1 480 1 440 1 813 1 734 2 274 2 096 2 466

II. Other Official Flows 7 890 7 861 - 45 - 348 -5 601 1 430 -9 774

1. Bilateral 7 746 7 731 2 401 - 818 -5 349 2 262 -9 598

2. Multilateral 144 130 -2 446 470 - 252 - 832 - 177

III. Private Flows at market terms 17 792 108 610 5 621 46 573 75 262 179 559 194 779

1. Direct investment 24 584 55 681 35 655 49 340 76 901 100 622 129 291

2. Bilateral portfolio investment -7 701 50 364 -26 902 -6 164 -3 544 73 335 60 507

3. Multilateral portfolio investment 1 821 - 869 -3 146 1 083 -4 657 40 2 798

4. Export credits - 912 3 433 14 2 313 6 561 5 563 2 183

IV. Net grants by NGOs 5 240 5 871 8 768 10 239 11 320 14 712 14 648

TOTAL NET FLOWS 85 496 179 619 72 640 125 529 160 412 302 800 304 074

Total net flows at 2005 prices

and exchange rates (d) 111 239 198 431 92 303 139 994 163 897 302 800 296 669

USD million

1990-1991 average

1995-1996 average

2002 2003 2004 2005 2006

64 32 80 55 50 35 34 I. Official Development Assistance (a)40 20 55 41 36 28 26 1. Bilateral grants and grant-like flows14 8 21 15 12 7 7 of which: Technical co-operation

2 1 1 1 1 0 0 Developmental food aid (b)2 1 4 3 3 2 2 Humanitarian aid (b)6 2 6 7 4 8 6 Debt forgiveness2 2 4 3 3 1 1 Administrative costs7 2 1 -1 -2 -0 -1 2. Bilateral loans

18 10 24 15 16 8 9 3. Contributions to multilateral institutions5 2 7 4 3 2 2 of which: UN (c)4 3 8 6 6 3 3 EC (c)5 3 5 2 4 2 2 IDA (c)2 1 2 1 1 1 1 Regional development banks (c)

9 4 -0 -0 -3 0 -3 II. Other Official Flows9 4 3 -1 -3 1 -3 1. Bilateral0 0 -3 0 -0 -0 -0 2. Multilateral

21 60 8 37 47 59 64 III. Private Flows at market terms29 31 49 39 48 33 43 1. Direct investment-9 28 -37 -5 -2 24 20 2. Bilateral portfolio investment2 -0 -4 1 -3 0 1 3. Multilateral portfolio investment

-1 2 0 2 4 2 1 4. Export credits

6 3 12 8 7 5 5 IV. Net grants by NGOs

100 100 100 100 100 100 100 TOTAL NET FLOWS

Per cent of total

What is ODA?

Grants or Loans to countries and territories on Part I of the DAC List of Aid Recipients (developing countries) which are:

(a) undertaken by the official sector; (b) with promotion of economic development and welfare

as the main objective; (c) at concessional financial terms [if a loan, having a Grant

Element of at least 25 per cent]. In addition to financial flows, Technical Co-operation is

included in aid.

• Grants, Loans and credits for military purposes are excluded. • Transfer payments to private individuals (e.g. pensions, reparations

or insurance payouts) are in general not counted.

Who gives how much to whom?

Donors• Bilateral Official (the biggest source)• Multilateral Official

– About one-third of total official– Resources come from bilaterals– Additionally, non-concessional IFI flows are sizable

• Private / NGOs / CSOs / Philanthropic foundations– Part of their funding also comes from bilateral official

sources

Who gives how much to whom?

Who are the main multilaterals?

• World Bank’s IDA

• Other regional IFIs (ADB,AfDB,IADB,CDB, etc)

• UN Agencies (UNDP, UNICEF,UNHCR…)

• New entities (Global Env Facility; …

ODA: 1990-2007: % of GNI and $ bn

Source: OECD DAC

ODA: Real, Nominal, % of donor GDP, 1973-2004

Overseas Development Assistance 1956-2007

0

20

40

60

80

100

120

1956

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

2004

$ bi

llion

Well below track agreed at Gleneagles

Source: OECD DAC

Who gives how much to whom?

Recipients• Part I countries• Part II countries (income too high – not

counted as development aid

No of donors per recipient

No of recipients per donor

Aid and mean income Per capita by country

0

1

10

100

1000

10000

100 1 000 10 000 100 000

Per capita GNI

Per

cap

ita A

id

Net ODA rcpts

GNI/CAP GNI/CAP ODA/GNI GNI/CAP ODA/Cap

2006 2006 2006 2006 2006 2006USD mn USD USD per cent USD USD

Nigeria 11 434 640 Solomon Islands 680 60.6 Wallis & Futuna .. 5119Iraq 8 661 .. Liberia 140 54.4 Montserrat .. 3237Afghanistan 3 000 .. Burundi 100 52.8 St. Helena .. 2813Pakistan 2 147 770 Micronesia, Fed. States2 380 41.3 Palau 7 990 1866Sudan 2 058 810 Afghanistan .. 35.7 Mayotte .. 1777Congo, Dem. Rep.2 056 130 Palestinian Adm. Areas.. 34.6 Nauru .. 1740Ethiopia 1 947 180 Malawi 170 30.5 Cook Islands .. 1614Viet Nam 1 846 690 Marshall Islands3 000 28.5 Tuvalu .. 1534Tanzania 1 825 350 Guinea-Bissau 190 27.9 Micronesia, Fed. States2 380 986Cameroon 1 684 1 080 Sierra Leone 240 25.7 Marshall Islands3 000 786Mozambique 1 611 340 Congo, Dem. Rep. 130 25.2 Anguilla .. 442Serbia 1 586 3 910 Timor-Leste 840 24.7 Solomon Islands 680 417Uganda 1 551 300 Rwanda 250 23.6 Palestinian Adm. Areas.. 387Palestinian Adm. Areas1 449 .. Palau 7 990 23.5 Dominica 3 960 277Zambia 1 425 630 Mozambique 340 23.2 Cape Verde 2 130 266Indonesia 1 405 1 420 Guyana 1 130 20.1 Samoa 2 270 248India 1 379 820 Sao Tome & Principe 780 17.9 Grenada 4 420 244China 1 245 2 010 Uganda 300 16.9 Guyana 1 130 231Bangladesh 1 223 480 Gambia 310 14.8 Vanuatu 1 710 222Ghana 1 176 520 Ethiopia 180 14.7 Tonga 2 170 215Morocco 1 046 1 900 Tanzania 350 14.5 Serbia 3 910 213Colombia 988 2 740 Zambia 630 14.3 Timor-Leste 840 204Kenya 943 580 Djibouti 1 060 14.0 Lebanon 5 490 174Egypt 873 1 350 Burkina Faso 460 14.0 Montenegro 3 860 157Burkina Faso 871 460 Nicaragua 1 000 13.9 Seychelles 8 650 155

OECD DAC

Volatility of aid

Celasun and Walliser, 2008

Volatility of aid

Celasun and Walliser, 2008

…and why?Official reasons• USA • Japan• Others (mostly poverty, MDGs, Human rights

Real reasons• May be more complex• Trade, security (USA to Afghanistan, Iraq, Pakistan), international

diplomacy (Australia to neighbours: is biggest single donor to PNG)

Public opinion favours Aid (even in US, if question is worded carefully)

NB: Claessens et al. 2007: After fall of Berlin wall, bilateral aid responds more to economic need and the quality of a recipient country’s policy and institutional environment and less to debt, size, and colonial linkages.

Does aid work to increase growth?

Hmmm… not obvious

Optimistic view

(Allow a nonlinear relationship)

Pessimistic view

(Confirmed by a straight-line relationship)

Conditional view

(Nonlinear + other variables)

Be careful with regressions (Anscombe’s charts)

How might aid work to increase growth?

By closing one of the two gapsthereby making needed investable funds in fx available

to build capital stock

By improving health/education, thereby enhancing worker productivity

By being the vehicle through which technology is transferred (fx, ta, green rev)

Radelet, 2006

Clear successes in health

– eradication of small pox, – near-eradication of polio, – control of river blindness.. and other diseases, – spread of oral rehydration tablets to combat

diarrhea, – dramatic increase in immunization rates in

developing countries since 1970

Radelet, 2006

How might aid be ineffective or reduce growth?

Might be wasted or spent on luxuries for the elite

Might actually increase corruption

Might keep bad governments in power

Might prolong war

Recipients might not have capacity to make use of aid

Might result in offsetting reductions in saving (about ½?)

Might have damaging side effects on incentives for investment or productivity (e.g. real exchange rate appreciation; free food vs. local farmers)

Might aid work only under some conditions?

Characteristics of recipient countryRecipient policies adopted (e.g. macro and trade policies);Civil liberties, institutional quality; type of government, warfareexport price shocks, terms of tradeLocation in the Tropics

Donor policiesEnsure recipient ownership; monitoring; coordination

Type of aidemergency and humanitarian aid (no link with growth) slow-burning aid (health, education, environment, democracy)aid directly aimed at growth (roads, ports, power infrastructure;

agriculture).

Radelet, 2006

Recent empirical studies on aid and growth

• Burnside and Dollar (2000): aid works in countries with good economic policies. Hansen-Tarp (2004)..only outside the Tropics

• Easterly Levine Roodman (2004): showed that these results were fragile, being sensitive to small changes in the data set. HT: 4 countries decisive

• Clemens, Radelet and Bhavnani (2004): “aid that could plausibly raise growth within a few years (budget support, infrastructure, industry) in fact does”

• Rajan and Subramanian (2005):aid has no significant effect on growth (bad instruments).

Roodman, 2007

Which of the three is confirmed by data?

Not the second – almost all studies in recent years find some growth effect:(especially when they allow for a nonlinear effect)

So even if the bad mechanisms are present, the net effect of aid can be positive

The third one (conditional) seems to be empirically the most promising, but evidence is fragile for policiesnot much evidence re donor policiesslow-burn shows little effect—but that’s not surprising

Radelet, 2006

The micro-macro paradox

• Education aid enrolment

• Health aid infant mortality

• Conditional cash programmes school attendance, health

• (Not all: even donors admit relatively high failure rates WB: 22%)

Roodman, 2007

How to give aid

• Principal-agent problems

• Conditionality

• Five fashionable ways forward

Principal-agent problems

“A unique and striking characteristic of foreign aid is that the people for whose benefit aid agencies work are not the same as those from whom the revenues are obtained; they actually live in different countries and different political constituencies. This [separation] blocks the normal performance feedback process: beneficiaries may be able to observe performance but cannot modulate payments (rewards to agents) as a function of performance. Although donors are typically interested in ensuring that their funds are well spent, it is extremely difficult for them to do so, since there is frequently no obvious mechanism for transmitting the beneficiaries’ point of view to the sponsors.”

Martnes (2004, cited in Radelet, 2006)

Conditionality

• Designed to create preconditions for aid effectiveness– But what conditions?– And not much empirical evidence that conditionality works– An administrative burden on recipients

• Too many…or too few?– State-led; human needs; macro discipline & markets; institutions– Environment; labour conditions; human rights; democracy

• Enforcement– Political pressures to continue program– (Failure of structural adjustment as much a function of lack of

implementation as of insufficiency of policies)– Samaritan’s dilemma

Radelet, 2006

Easterly J Ec Persp 2008

Five favoured ways forward

1. Country selection– Give to countries that have shown their fitness –

and then give unconditionally

– (US Millennium Challenge Account)

2. Recipient (NGO) Participation/Country Ownership

– In/of design of programmes

– Process conditionality

3. Harmonization and coordination– Among donors

Radelet, 2006

Five favoured ways forward

4. Results-based management

− Channel funds to programmes that are working

− Or more broadly for results (“payment for progress”)

− Detecting problems early and modify/strengthen

− Improving design of future programs

− (Requires stronger monitoring and evaluation)

5. Capping aid at 50% tax revenue

− (recent proposal of Adrian Wood, 2008):

− About 30 countries with populations over 1m, (>20 in Africa), get aid above this (about half of them aid>100% tax)

Conclusion on aid effectiveness

• Some forms of aid are effective

• Too much does not work

• There is waste on recipient and donor side and in the process

• Overall results are disappointing

• But volumes of aid are small relative to needs

Radelet, 2006

Aid for trade

• Stiglitz Charlton

• Also EPA