Boons and Banes of Economic Aid

A number of aid givers believe that what really matters are government policies that support development in many different ways. According to this view aid plays only a marginal role. In fact, in the countries with weak institutions and weak legal systems, aid may corrupt the officialdom. The primary emphasis, therefore, has to be institutional development and improvement in the quality of governance. Without it, aid can be counterproductive

The aid receivers take an entirely different view. They maintain that most of them are so poor that they cannot adopt the policies that would support sustainable development unless some room for maneuver was created by large flows of aid. They were looking for fiscal space within which they could operate. Which of these two points of view is correct?

The evidence for both positions on aid can be gleamed from the data and information available in the various studies carried out by the World Bank. The data on global poverty can be used to argue in favor of both propositions.

Roughly $1 trillion of aid provided to the developing world since World War II has accomplished little. One half of the world’s population still lives in poverty, earning less than $2 a day per head. One third of the world population lives in abject poverty with per capita income of less than $1 a day. Some development aid agencies which audit their projects admit to significant failures.

 
The same numbers can be told in a different way — the glass is not half empty; in fact, it is half full. Since 1980, the number of people living on less than $1 a day has declined by 200 million. This happened while the world’s population has increased by 1.6 billion.
Not only have the number of poor declined but there has been a significant improvement in the well-being of the poorer segments of the population. The adult illiteracy in the poor world has been reduced by one-half during the past three decades and life expectancy at birth for the people living in the world’s poor countries has increased by 20 years over the past four decades. In other words, although there are still a very large number of poor people in today’s word, the proportion of the world population living in poverty has declined steadily in the last several decades

Although the income gap between the rich and poor countries has been widening, that has happened not because per capita incomes in poor countries have not increased.
The gap has increased because incomes in the rich countries have increased faster since their populations are not growing. What was added to their gross domestic product was distributed among the same number of people — in some cases even fewer people. In the developing world, on the other hand, population growth consumed a significant part of the increase in economic output.

These global numbers do not, of course, provide a robust argument for more aid. In fact, as a recent World Bank study on the effectiveness of aid suggests, much of the global improvement in living conditions occurred in the countries that did not receive much government to government assistance. China — and more recently India — with a combined population of more than 2 billion people have done well for their poor people. The improvements in living conditions in both countries have made enormous contributions to the improvements in literacy and health in the developing world.

Much of what China and India accomplished by way of poverty alleviation was the consequence of good government policies and not because of large amounts of foreign aid. Aid flows to these countries were only a fraction of those received by scores of smaller countries in Asia and Africa. If we take out China and India from our calculations, the claim on behalf of aid based on a significant improvement in the lives of people becomes weaker.

To further strengthen its argument, the pro-aid lobby has come out with another set of numbers, once again relying on the copious work done by agencies such as the World Bank. The World Bank maintains that aid has a direct and visible impact on poverty not camouflaged by global statistics. It has calculated that $1 billion in extra aid lifts more than 250,000 people above the $1-a-day poverty line.

Those who suggest that capital flows from the world’s financial markets do a better job of helping developing countries, must contend with both old and recent history. Capital markets don’t invest in health and education in the developing world. Economic historians maintain that Britain’s 19th century economic take-off would not have happened without public sector’s investment in sanitation. It took a great deal of money provided by the government to clean up London’s sewerage and water supply systems. History offers several other examples. For instance, it was the massive investment by the government in health and education that laid the basis for China’s spectacular growth in the last quarter century.

It is now well recognized that public investment plays an important role in human and social development. The primary resource for development is the great untapped reservoir of human creativity and talent of the people of the developing countries themselves; the release of this human potential requires investment in education, infrastructure, public health and other basic social services, as well as in production for the market. But how is this untapped human resource to be prepared and motivated to participate in the important but often difficult task of sustained and sustainable development? This effort requires resources — a great deal of them. From where will they come? Good policies in poor countries cannot substitute for foreign capital flows. Aid is important to break the vicious cycle of poverty.

In 2000, countries around the world saved and invested $7.5 trillion out of global output of over $30 trillion. The global savings rate was of the order of 25 per cent of total product. The problem, however, was that this amount of money was not evenly distributed, let alone distributed in favor of the developing world. The net transfer of resources from capital surplus (generally the developed world) to the capital-importing (generally the developing world) was of the order of $450 billion. However, three-fourths of this amount was captured by the United States, by far the world’s largest economy.

Much of the cross-border capital flows emanate from private sources and most of these flows are among the countries of the developed world. Of the amounts that flow to the developing world, the bulk is directed towards a dozen or so countries, most of them in East Asia and Eastern Europe.

Money attracts money. A significant proportion of the capital flowing into the developing world goes to the countries that have high domestic savings rates. It is a combination of high rates of domestic savings and capital inflows that produced the East Asian miracle of the seventies and the eighties. The conclusions from all this is fairly clear. For a large number of poor developing countries there is no substitute for official development assistance if the world wishes to see them progress and alleviate poverty.