Rethinking Foreign Aid

By Osborne, Evan | The Cato Journal, Fall 2002 | Go to article overview

Rethinking Foreign Aid


Osborne, Evan, The Cato Journal


Recent years have witnessed escalating criticism of the industrialized word for declining levels of foreign aid, especially the official development assistance (ODA) that is expressly supposed to facilitate prosperity in the developing world. Criticism of the alleged foreign-aid shortfall is striking because critics fail to ask a more profound question: Do ODA and other forms of transfers to poor nations actually help them prosper? The increasingly loud controversy over inadequate "foreign aid," in turn, hinges on whether it is effective in reducing poverty compared to other things rich and poor countries might do to achieve that aim.

This paper details the substantial changes that have occurred during the past 30 years in trade and aid patterns between the developed and developing worlds. It then provides a statistical analysis of the effects of foreign aid on growth compared to the effects of foreign trade, market-friendly policies, and other considerations. It also augments the findings of the body of economic literature known as "new growth theory" by testing whether its results are robust when developing countries are examined alone. Finally, in light of the findings, it reassesses the relative contribution to development of the Western European nations, the United States, and Japan.

Trends in Aid and Trade

While there is an old controversy over the ability of foreign aid and international trade to help countries develop, in recent years the patterns of the developing world's trade with and aid from developed nations have changed dramatically. This section briefly summarizes those changes.

Official Development Assistance

Official development assistance by wealthy countries, as a percentage of gross domestic product, has declined sharply in recent years and provoked much critical commentary. (1) Figure 1 depicts the ratio of ODA to GDP from 1967 to 1997. The ODA data are collected from OECD governments as well as the European Commission, and include capital projects (e.g., dams and roads), monetary transfers to provide general budgetary support, lending to support nations with balance of payments problems, food and other commodity aid, technical cooperation, and emergency relief. Although they do not allow differentiation among those types of assistance, the potential confounding factor of military assistance is avoided.

[FIGURE 1 OMITTED]

Figure 1 indicates that measured ODA from the United States has declined relentlessly throughout. In 1967, the United States gave almost 0.5 percent of GDP in foreign aid, while by 1997 it gave less than 0.15 percent. In contrast, Europe gave a progressively larger share of GDP in ODA until the mid-1980s before that share begin to continuously decline in the early 1990s, although not as much as that of the United States. Finally, Japan's transfers have been relatively stable throughout the entire period.

During this period the United States has thus changed from being the largest provider of ODA to the smallest. U.S. ODA is now barely a third as much as that of the European nations collectively and, despite Japan's economic malaise of recent years, barely half as much as that of the Japanese. The decline in foreign aid, particularly from the United States, is undoubtedly the major evidence for the claim that the developed world in general and the United States in particular are shirking their duty to assist poorer countries. Hence, the recent UN Monterrey Declaration and President Bush's decision to increase U.S. aid to developing countries, on the condition that they pursue sound policies.

Trade between the First and Third Worlds

Long-term economic growth in developing countries is assumed to be the primary goal of ODA, and therefore the basis for its comparison to openness and sound economic policy in the developing world. In analyzing why foreign trade might also positively affect growth, there are several (nonexclusive) theories to choose from. …

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