Foreign Policy Tools: Foreign Aid
Graham, Carol, Brookings Review
At a time when the entire foreign affairs budget is under fire, it is more important than ever to address the question of whether foreign aid is effective. Official development assistance, or ODA, as the foreign assistance component of the foreign affairs budget is called, is roughly half of that budget, and is arguably the part about which the public is most skeptical.
The United States, once the world leader in global aid, is now in fourth place after Japan, Germany, and France in terms of absolute amounts. In terms of percentage of GDP, with 0.1 percent of American GDP allocated to ODA, the United States is well at the bottom of all industrialized nation donors. This clearly imperils U.S. leadership not only in international financial institutions such as the World Bank, but also in the aid debate more generally. Washington is increasingly being seen as unwilling to pay its global dues.
It is time to ask some hard questions about foreign aid. What do we know about it? Does it work? Is it effective? There has been much debate in recent years. I'd like to try to sum up what we know about aid effectiveness - and what we don't.
One reason for the extensive debate over aid is that so many diverse objectives drive its allocation that it is hard to evaluate how effective it is. While economic growth is clearly not the sole objective of foreign assistance, it's one of the few areas where empirical evidence permits evaluation. Growth is also important because without growth it is difficult, if not impossible, to achieve all the other goals - security, human rights, democracy - attributed to aid.
Recently the debate has been heightened by a series of studies that have found a negative relationship between conditioned aid flows and economic growth, particularly in low-income countries in Africa. These same studies, however, are also finding that the broader policy orientation that aid seeks to promote - market-friendly, open economic policies with prudent macroeconomic management - is producing strong results in countries worldwide. And the experience of many Asian countries and, more recently, many Latin American countries confirms that appropriate policies do yield good results.
These findings raise three questions about aid flows. First, is aid ineffective, or would poor economic performers have fared worse without aid? Second, how effective is conditionality in its current form? How are we allocating aid, and how is it working? And third, what is the causal relationship? Do policies produce growth, or do better initial economic conditions facilitate the implementation of better policies?
CAN AID SLOW GROWTH?
What accounts for the negative correlation between aid flows and growth performance? Africa, for example, receives 10 times more aid per capita than Latin America or East Asia and yet performs far worse by most or all economic measures. There are several explanations, and I don't want to oversimplify the issue, but one point is clear. By removing a hard budget constraint, aid inflows to a country can impede formation of a domestic consensus on the need for difficult economic reforms. Recent research on economic crisis undertaken at the World Bank suggests that countries that enter high-inflation crises tend to implement more complete reforms and then enjoy higher average growth rates than countries that just muddle along at "medium" inflation rates. What happens is that aid flows are often cut off in countries with very high inflation rates but continue in countries with medium inflation rates. These aid flows protect countries from the full costs of bad economic policies, often preventing the onset of deeper crisis and the important policy learning experience that is often critical to successful economic reform. Countries often have to hit bottom to get a domestic consensus on the need for economic reforms. Of course, allowing countries to enter acute crisis is hardly an acceptable policy recommendation. …