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Scottish Independence and Scotland's Future
The questionable economics of foreign aid

In 2015, David Cameron’s government enshrined in law the UK’s commitment to spend 0.7 per cent of its gross national income on foreign aid each year. Ahead of last month’s general election, Theresa May reaffirmed Cameron’s commitment, which amounted to over 13 billion pounds in 2016. “Let’s be clear,” May said, “the 0.7 per cent commitment remains and will remain.”

British charities, including Save the Children, Oxfam, Christian Aid and Comic Relief, praised Mrs May’s decision, stating that “the aid should be untied, focused on poverty reduction and spent through an independent Department for International Development.” Yet many of the same organisations are also concerned about what they perceive as the lack of government spending at home.

“Grenfell Tower is a Hurricane Katrina moment, revealing the shameful state of Britain,” wrote Oxfam’s strategic adviser Duncan Green following the Grenfell Tower fire. “Austerity, which has seen the budgets of local government cut dramatically with the greatest cuts felt by the poorest areas,” was partly to blame for the disaster, he averred.

While the continued plight of the world’s poor and problems experienced by the British underclass should not occasion jokes about “magic money trees”, it is a simple fact of life that the UK, like most Western nations, must economise. The British debt and deficit amount to 86 per cent and 2.6 per cent of GDP, and while UK domestic spending is best left to British economists to address, I would like to offer some thoughts on foreign aid. And, in particular, the theory behind foreign aid and its impact on the world’s poorest region, Africa.

The first question is whether aid is necessary. In the 1950s and 1960s, many development economists believed in the “vicious cycle of poverty” theory, which argued that poverty in the developing world prevented the accumulation of domestic savings. People in poor countries consumed all of their income and had nothing left to save and invest. Low savings resulted in low domestic investment, and low investment was seen as the main impediment to rapid economic growth. Foreign aid, therefore, was intended to fill the apparent gap between insufficient savings and the requisite investment in the economy.

Today’s calls for more foreign aid are often based on the same theory. Thus, the UK’s Department for International Development (DfID) website claims that it is “targeting British international development policy on economic growth and wealth creation [in poor countries].” The United States Agency for International Development (USAID) promises to work “with private-sector companies to spur economic development, so that citizens can participate in a vibrant economy that allocates resources wisely.”

Yet experience contradicts the “vicious cycle of poverty” theory. Today, many formerly poor countries enjoy high standards of living, while others have stagnated or, in some cases, regressed. For example, the 1960 per-capita income in South Korea was $1,102. In Ghana it was $1,053. By 2015 Korea had reached $25,022, while Ghana is yet to break $2,000, only rising to $1,696 (the figures are in 2010 dollars). Yet, as can be seen in the graph below, Ghana received much more in net official development aid (ODA) per capita than South Korea between 1960 and 2015 (figures are in current U.S. dollars).

As New York University Professor William Easterly wrote, “It doesn’t help the poverty trap story that 11 out of the 28 poorest countries in 1985 had not been in the poorest fifth back in 1950. They had gotten into poverty by declining from above, rather than being stuck in it from below, while others escaped. If the identity of who is in the poverty trap keeps changing, it must not be much of a trap.”

Countries that improve their policies and institutions — by increasing their trade openness, limiting state intervention in the economy, building a business-friendly environment, and emphasising protection of property rights and the rule of law — tend to grow faster than others. Such countries also tend to attract foreign capital, which can help to increase economic growth. Improvement in policies and institutions also creates a suitable environment for growth in domestic investment. As trust in institutions such as the rule of law and protection of private property grows, people feel more confident investing in the local economy.

Today, the size and the scope of global capital markets make Africa’s access to capital potentially easier than at any time in the past. Indeed, private capital flows to developing countries now dwarfs aid flows.

According to Brookings Institution, ODA to African countries has fallen from “62 per cent of total external flows in 1990 to 22 per cent in 2012,” and the disappearing aid has been largely replaced by private capital. “The volume of external flows to the region increased from $20 billion in 1990 to above $120 billion in 2012. Most of this increase in external flows to sub-Saharan Africa can be attributed to the increase in private capital flows.”

Sub-Saharan Africa is the least economically free region in the world. There is a general consensus among economists that Africa needs to catch up with the rest of the world in terms of economic liberalisation. Aid is often intended to promote policy reform, yet it has helped to create disincentives to liberalisation for a number of reasons.

For example, aid is often driven by foreign policy considerations, not economics. For much of the Cold War, African countries were given bilateral and multilateral assistance on the basis of their geopolitical importance to the West and the Soviet Union. More recently, a 2015 study by AidData revealed that Chinese aid to Africa is used to both “promote Chinese foreign policy goals”, and advance “the economic interests of the Chinese state as well as Chinese firms operating abroad.” Likewise, American aid to African countries such as Ethiopia is often strongly influenced by geopolitical interests. As a recent piece in the Harvard International Review noted, American aid to Ethiopia was long driven by a desire to prevent the spread of Islamic extremism in the country.

Aid has not led to economic reforms in Africa. In the 1980s, the World Bank started to promote structural adjustment loans that were meant to disburse aid to countries in exchange for their commitment to economic reforms. Such conditional lending soon proved ineffective, in part because aid agencies have no enforcement mechanism, and also because they have a well-known bureaucratic incentive to lend, which undermines the credibility of their conditionality.

In fact, aid may also actively retard policy reform. Between 1970 and 1993, for example, the World Bank and the IMF gave Zambia 18 adjustment loans with little or no reform staking place, forcing World Bank researchers to conclude that “this large amount of assistance sustained a poor policy regime.” More generally, two World Bank researchers concluded that “higher aid slowed reform [in the developing world] over the 1980–2000 period.”

Even in those countries that follow sensible macroeconomic policies, aid appears to have no positive effect and may go so far as to discourage reform. Some World Bank research claimed that developing countries that follow good fiscal, monetary, and trade policies benefit from foreign aid. But that research has been difficult to independently corroborate. Scholars who used updated World Bank data found no positive correlation between foreign aid and economic growth in countries with “good policies.” Research suggests that when governments do decide to undertake economic reforms, they tend to do so because of domestic factors, including economic crises.

In short, the theoretical case for foreign aid is, at best, questionable, and aid’s practical impact on some of the world’s poorest economies may well have been harmful.

The case against aid doesn’t stop there. There are also problems with aid delivery and the negative impact of foreign aid on the spread of democracy.

Official aid is disbursed in a plethora of ways. The European Union, for example, gives aid through the European Commissioner for Development and Humanitarian Aid. But individual EU member-states also have their own aid agencies. Europeans also have a strong voice on the governing boards of the World Bank and IMF, which also disburse aid. In addition to those official agencies, there has been a massive increase in the number of aid-promoting non-governmental organisations (NGOs), which also receive and disburse the money of Western taxpayers.

The “aid industry” provides employment for many thousands of people. Consequently, a large percentage of the money spent on foreign aid goes to cover overhead costs, including administration, travel and accommodation. Michael Maren, a former aid worker, writes that the money spent on aid bureaucracies creates perverse incentives. “We have to take advantage of this famine to expand our regular program,” argued one aid official that Maren encountered in Africa. She saw hunger and poverty as “a growth opportunity”. “Whatever the original intentions,” Maren notes, “aid programs had become an end in themselves.”

Dealing with swarms of donors and aid agencies, all of whom require some degree of attention, puts an enormous strain on African bureaucracies. The time and effort spent on dealing with the needs of foreign donors rather than concentrating on the population has further distanced African governments from their electorates. Working with aid organisations operating in Kenya, for example, became such a problem that the “government and donors… agreed on some principles of partnership that included a ‘quiet time’ between May 1 and June 30 each year.”

Moreover, effective and efficient delivery of aid by a multitude of actors has proved to be an insurmountable challenge. Often, it has resulted in “duplication” of their efforts. Thus, “monitoring surveys indicate that limited progress has been made toward coordination goals by the United States or donors in general.” In Ethiopia, for instance, government officials spend “half to one-third of their time” participating in “coordination meetings” with a multitude of NGOs, international aid agencies and bilateral donors.

Also, many foreign donors have their own agendas that may be detrimental to the welfare of the very people they are supposed to be there to help. Like the 19th-century European missionaries who went to Africa to spread their idea of a “good life”, modern day aid missionaries have found in Africa a fertile ground for social experiments that would never be accepted in their home countries. Tanzania, for example, is still recovering from an attempt to centrally plan the economy, the so-called “Ujaama” policy of collectivisation that was bankrolled to the tune of $10 billion by socialist governments in Scandinavian countries in the 1970s and 1980s. Similarly, some Western NGOs, like Oxfam, have urged African countries not to liberalise their trade regimes even though there is a general consensus among academics that free trade is an important source of economic growth and prosperity.

Research also suggests that some aid ends up in the pockets of government bureaucrats instead of reaching the intended beneficiaries. During a 2012 panel on economic and social policy, then World Bank President Ban Ki-moon claimed that 30 per cent of development aid “failed to reach its final destination”. A leaked 2009 cable from the U.S. embassy in Nairobi revealed that $1.3 million in aid for schools was “misappropriated” and another $17.3 million worth of textbooks purchased with aid dollars was “lost” by government officials.

Aid also encourages rent-seeking in recipient countries. Special interest groups and individuals focus their efforts not on being productive, but on lobbying government officials in order to get access to aid. In that way, aid reduces potential economic output and encourages corruption and political conflict.

Moreover, by transferring resources to the favoured projects of government officials, competition among domestic producers is undermined. As a result of government favoritism, parts of the domestic consumer base may become captive to firms that provide shoddy and expensive goods and services.

Similarly, aid can undermine the international competitiveness of African exports by artificially strengthening the local currency. As researchers at the IMF found, “aid inflows have systematic adverse effects on a [recipient] country’s competitiveness, as reflected in a decline in the share of labour intensive and tradable industries in the manufacturing sector. We… [found] evidence suggesting that these effects stem from the real exchange rate overvaluation caused by aid inflows.”

Making these matters worse is the lack of accountability and feedback in the aid industry. Very few aid agencies and virtually no individuals are directly responsible for specific outcomes. Independent evaluations of the effectiveness of donor efforts to alleviate poverty or to arrest the spread of disease, for example, are very rare. Moreover, the donors often determine what they will supply without much regard for what is actually needed. This top-down approach has most spectacularly failed to alleviate poverty in Africa where government accountability is weak and institutional deficiencies extensive.

But does aid, in spite of the many problems with its delivery, promote democracy? Many people, including former UN secretary general Kofi Annan, have argued that it does. Researchers from the World Bank, however, found no evidence that aid promoted democracy between 1975 and 2000. In fact, the aid agencies have repeatedly bankrolled some of the world’s most unsavoury regimes. According to one study, “The world’s 25 most undemocratic government rulers (out of 199 countries the World Bank rated on democracy) got a sum of $9 billion in foreign aid in 2002. Similarly, the world’s 25 most-corrupt countries got $9.4 billion in foreign aid in 2002.”

Other research goes further, suggesting that aid may hurt democratic development in developing countries. That may be the case for several reasons. Aid helps to undermine democratic accountability in Africa, because African governments find themselves increasingly answerable to the donors, not to the public. Government spending proposals, for example, allocate funds in accordance with the advice of foreign experts rather than the wishes of the electorate.

Aid encourages military spending. Since aid is fungible, it helps some recipient governments free up resources for military purchases that would otherwise be spent on roads and education, for example. Consider the World Bank’s recent contribution of $180 million toward the building of the Chad-Cameroon oil pipeline. Fearing that the oil revenue would be misspent, the World Bank got the Chadian government to commit to spending it on education, health, and infrastructure. What was the result? “The first $4.5 million received as a signing bonus from the oil companies was used to buy weapons—and it is estimated that as much as $12 million may be diverted to buy arms.”

In fact, Professor Paul Collier of Oxford University found that “something around 40 per cent of Africa’s military spending is inadvertently financed by aid.” Aid may also fuel armed competition for resources. There is some evidence, for example, that Somalia’s civil war was prolonged by the competition between different factions for the large amounts of food aid that the country was receiving.

A growing number of Africans question the effects of foreign aid on economic growth and democracy in Africa. President Paul Kagame of Rwanda, for example, has urged Africans “to be honest about the consequences of aid dependence,” for “what really matters most for socio-economic transformation is private capital.” He has called on African governments to create policy environments in which entrepreneurs can flourish.

Others, like Ugandan journalist Andrew Mwenda, have pointed to the negative political impact of aid. According to Mwenda, “foreign aid… is providing the government with an independent source of ‘unearned’ revenue. That allows the government to avoid accountability to Uganda’s citizens.” Unfortunately, when Mwenda spoke out against further aid at the 2007 TED Conference, the enraged Irish musician Bono heckled Mwenda with shouts of “Bollocks!” and “That’s bullshit.”

Not only has aid failed to deliver growth in Africa. It hasn’t helped democracy either. Western donors, including the United Kingdom, should re-evaluate their commitment to further disbursements of aid to the continent.

Marian L. Tupy is senior policy analyst at the Cato Institute's Center for Global Liberty and Prosperity.

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