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Foreign Aid
Political Economy of the Global South
Prof. Tyson Roberts
Review of the “Resource Curse”
• Negative effects of natural resource
endowments
– Reduced economic growth
– Inferior institutional quality such as property
rights, rule of law, democracy, …
• Mechanisms
– “Dutch Disease”
– Revenue volatility
– Political/institutional deterioration
However, these negative effects are
not deterministic
• How can “Dutch Disease” be avoided?
– Invest (in the future) rather than consume (in the
present)
– Indonesia and Malaysia invested in agricultural
production and industry – increases
competitiveness
– Mexico mainly promoted its state oil company –
fell behind in competitiveness
However, these negative effects are
not deterministic
• How can revenue volatility be addressed?
– Stabilization funds
– For example, Chile’s Copper Stabilization fund
However, these negative effects are
not deterministic
• How can “political deterioration” be avoided?
– Natural resource revenues stabilize regimes
(including democracies), they do not necessarily
lead to transition to dictatorship
– Resource rents lead to more corruption in lowquality institutional environments (e.g.,
dictatorships), but not in high quality
– Botswana had (fairly) good institutions before
diamond revenues came on stream
– Sequence matters
How to address the resource curse?
• Two strategies:
– Take resources away from government or bypass
government (e.g., give revenues directly to
citizens)
– Keep revenues in hands of government but
change government policies (e.g., natural resource
funds)
Foreign Aid
Competing Views of Foreign Aid
“Big Push” vs. Dependency
• “Big Push”
– Poor economies are trapped in poverty (finance
gap)
– Need major aid inflows to push out of trap
• Dependency
– Aid flows make poor economies dependent;
undermine incentives to improve
– Aid => rentier state
Answers to the dilemma?
• Empirically-supported aid
• Conditional aid
• Selective aid
“Big Push”
• Harrod-Domar Model:
– y=f(k)
– Constant returns to capital
– Growth determined by savings rate
Poverty Trap – Finance Gap
• However, poor countries cannot afford
sufficient savings
– Low income => low savings => insufficient
investment => low income
• If rich countries transfer savings to poor
countries, poor countries will grow until they
can afford to self finance => “takeoff”
– High income => high savings => high investment
=> high income
Poverty Trap
Is X money?
If so, sending money should push aid recipients out of poverty
trap
Other determinants of growth
• Solow Model (based on Cobb-Douglas)
– y = Akαlβ ; α + β = 1
– Diminishing returns to capital & labor
– Growth determined by exogenous technology
• Improve labor (aid for education, health)
Increase in education often has no
effect on growth
Source: Pritchett 2001
Why might education not lead to
growth?
• Piracy: Educational capital goes into privately
profitable but socially unproductive activities
– Entrepreneurs exploiting monopoly opportunities
or government contracts
– Bureaucrats in patronage-based states
• Insufficient demand: Slow growth in demand
for educated labor
• Poor schools: Education system provides few
skills
Other determinants of growth
• Solow Model (based on Cobb-Douglas)
– y = Akαlβ ; α + β = 1
– Diminishing returns to capital & labor
– Growth determined by exogenous technology
• Improve technology
– Improve incentives to invest with better policies
• How to improve policies? Conditionality (?)
Source: H. Doucouliagos, M. Paldam 2008
Problems with Conditionality
• Structural Adjustment Loans in 1980s
emphasized conditionality – aid now for policy
changes
• Many governments received the aid and then
didn’t change the policies, because of vested
interests and lack of “ownership” in policy
design
• Donors continued to give aid
Donor goals of aid
• Altruistic
– Economic growth, human development,
democracy
• Commercial
– Trade and investment
• Geostrategic
– UN votes, military allies
• Organizational
Determinants of aid flows
• Altruistic
– Income level, political liberalization
• Commercial
– Trade flows, colonial history
• Geostrategic
– UN votes, military allies
• Organizational
– Small population, history of aid
poor-policy observations than for the good-policy observations.
Burnside & Dollar (2000):
Aid x Good Policies
=>
Growth
Growth, aid and policy
Figure 1. Growth, Aid, and Policy
1.5
1
0.5
Growth
0
-0.5
-1
Low
Medium
Aid
High
What is Good Policy?
(According to B&D 2000)
• Open economy (few trade restrictions)
• Macroeconomic stability (low inflation)
• Low budget deficits
B&D’s results were driven by outlier
cases, esp. Botswana & Zambia
Figure A1. B&D regression 5/OLS: Partial scatter of GDP/capita growth versus aid×policy
Original data
10
GAB74
GDP/capita Growth
-5
0
5
CMR78
ZMB86
ZMB90
BWA78
BWA82
BWA86
-10
CMR90
GAB78
NIC78
ETH82
-10
-5
Non-outliers
Outliers
Expanded sample
10
SYR74
DOM70
EGY82
NGA70
PRY78
EGY74
GAB70
ECU70 SYR78
MEX78
SYR90
BRA70
LKA82
NGA90
PAK82
ARG90
MLI86
KEN70
EGY78
KOR86TTO78
BOL82
PAK78
URY86
BRA86
IDN90
SEN82
URY78
KOR82
CMR82
SLV90
THA86
NGA74
DOM86
NGA86
PAK86
LKA90
ARG74
TUR90
IND86
KEN86
ETH86
MAR82
SOM74
MAR74
NIC74
TUN82
CMR74
CHL90KOR90
GAB82
THA90
IDN78
SLE78
IND82
ZWE82
GUY74
PAK90
PRY74
PER78
HTI78
NER78
NGA82
BRA82ARG82
ZAR82
GMB74
GTM70
COL78
IDN86
TZA82
ZWE86
GTM74
GAB90
IDN82
KEN78
CHL86
TGO78
SLV82
MWI82
CRI70
ZAR70
CHL78
LKA78
GMB82
MYS90
URY74PHL78
KOR74
BRA74
ARG86 BOL90
COL70
LKA86
MEX70
COL82
TTO74
SLV74
GHA78
COL90
GHA70
VEN90
TZA86
ARG70
PHL86
COL86 URY90
GHA86
SLE86
PHL74
KOR70
PER90
DOM78
GHA90
LKA74
MAR78
TUN90
THA82
SEN74
HND78
HND86
PRY70
SLE90
EGY86
SLE70
KEN82
BOL74
SYR70
IND90
DOM74
PER70
DZA74
GUY78
MYS78
PHL70
GTM78
HND70
ZAR86
PER74
TGO74
HND74
IDN74
MEX82
ZMB70
HND90
DZA70
ARG78
HND82
BRA78
PER86 BRA90
SLV70
PRY86
MDG86
TGO86
HTI74
PAK70
GHA82
GUY70
NIC82
CRI90
DOM82
MAR86
CRI74
MEX74
GTM86
ZWE90
SLE82
ECU82
GTM90
KOR78
SLV86
DOM90
IDN70
COL74
MWI78
MYS82
ZMB78
IND78
PAK74
GAB86
HTI82
ECU90
TTO70
HTI70
TGO82
JAM82
THA78
PER82
ECU78
IND74
LKA70
MWI90
EGY90
MAR70
ECU74
ECU86
MYS70
KEN74
VEN74
MEX90
GMB78
ZMB82
BOL78
GUY86
NIC70
CRI86
MYS86
KEN90
MWI86
CRI82
BOL70
TUN86
BOL86
SEN70
SLE74
CRI78
VEN70
SOM78
URY70
ZAR78
GUY82
ZMB74
VEN86
HTI86
PRY82
MYS74
GTM82
THA70
CHL70
PRY90
GMB70
MDG90
JAM78
CIV78
MDG70
NER74
THA74
NGA78
MEX86VEN82
PHL90
TTO82
MAR90
SYR86
SEN78
IND70
CHL82
MDG74
CMR86
CHL74
PHL82
GHA74
ZAR74
URY82
SLV78
VEN78
TTO86
JAM74
0
Aid*Policy
5
10
Fit to all data, coef = 0.19, t = 2.61, N = 270
Fit excl. outliers, coef = -0.05, t = -0.45, N = 263
-1
GAB78
NIC78
ETH82
-10
-5
0
Aid*Policy
5
10
If additional observations
are included, the relationship
Non-outliers
Fit to all data, coef = 0.19, t = 2.61, N = 270
excl. outliers, coef = -0.05, t = -0.45, N = 263
betweenOutliers
AidxPolicy Fitand
Growth turns negative
10
Expanded sample
GDP/capita Growth
-5
0
5
SYR74
NGA70MMR98
GAB70
CMR78
PRY78
BWA86
EGY74
DOM70
TGO94
BWA78
PNG90
SYR78
IRN90
CMR82
EGY82
CHN94
MEX78
BRA70
CHN90
BOL82
BWA82
KEN70
IRN82 URY86
KOR86
TTO78
SYR90
CHN98
CHL90
BWA74
CYP82
LKA90
BWA98
UGA94
UGA86
TUR90
CYP78
SEN98
CYP86
MAR74
ZWE78
PAK82
UGA90
THA86
PAK78
URY78
CHN86
URY90
ZWE94
BGR98
EGY78
LKA82
MLI86
MMR94
IND98
NGA90
KOR82
MLI98
ARG74
PER94
CHL86
MYS90
IND94
NGA86
CHL94
TTO74
SEN82
THA90
IDN90
CMR74
GHA98
MWI90
IND86
DOM98
MAR82
TUR82
POL94
TUN70
SGP70
BRA94 PER90
GTM78
IND82
PRY74
NGA74
IRN98
HUN98
KOR90
CMR98
ETH94
CYP98
IDN78
UGA98
GMB74
PAK86
TGO78
TUR86
URY94
PAK90
ETH86
MMR90
BRA82
KEN86
LKA78
NGA98
GTM70
URY74
NIC98
MEX98
VEN90
KEN78
SEN94
TUN98
HTI78
COG98
LKA94
DOM86
IND90
MYS94
ARG94
IDN86
NIC74
CHL78
POL98
DZA98
DZA70
BFA94
TUR74
SLE78
TZA98 GHA86
TUN78
BRA74
TGO74
LKA86
GTM74
MWI82
TTO82
MMR78
ZMB98
MMR82
BFA82
COL90
UGA82
GTM90
TUR94
TTO94
TUN90
PER78
ZAR82
CRI70
COL78
GMB82
KOR94
COL94
KOR74
TUN74
COL86
COL70
ZAR94
DOM94
PRY86
MDG98
GAB82
ETH98
TUN82
IDN70
CRI98
SGP86
IDN94
LKA98
EGY98
PHL86
GHA90
CYP90
ZAF98
GHA70
ECU70
PRY70
IDN82
ZWE86
EGY90
GAB90
JAM90
HND90
MLI94
SLE82
PAK98
DZA74
ARG70
BOL90
GMB78
ZAR86
SGP90
MEX90
MEX70
ROM94
SGP78
SYR70
CRI90
SEN74
BFA98ARG78 CIV94
BWA94
EGY86
BFA90
SYR98
GHA78
MEX94
ZWE82
PHL78
KOR98
BFA74
PHL74
TZA90
SLE70
THA94
SYR94
IDN74
KOR70
HUN86
ZMB70
COL82
PHL70
NER78
PAK94
TGO86
NGA94
GHA94
BRA78
MAR86
ZAR70
BFA86
THA82
IRN94
CYP94
HND78
SLE86
GTM86
GTM94
KEN82
HND86
PAK70
TTO70
TUN94
BRA98
BOL74
DOM74
LKA74
DZA94
HTI74
MEX82
EGY94
SGP94
MAR98
MMR74
ETH90
GTM98
HND70
BOL94
ZAF94
COG90
ZWE90
HND74
MYS78
BWA90
CRI74
MAR78
MEX74
ECU86
HTI98
ZMB78
DOM78
HUN94
THA78
MAR70
PAK74
BOL70
GHA82
BFA78
KEN74
VEN94
NGA82
ECU90
PER70
VEN74
PER74
CHL98
KEN90KEN94
TUR70
MEX86
ECU74
NIC82
ROM98
COL74
CRI86
ECU98
KOR78
SLV98
HND82
SLV70
IND74
TZA94
PER82
MDG86
BOL86
VEN86
ZMB82
VEN70
GAB86
ECU94
HTI70
MYS86
DOM82
CIV98
COL98
JAM82
MLI90
SGP82
IND78
PRY90
BOL98
URY70
TUR98
CRI94
TTO90
MYS70
MWI78 ECU78
JOR98
TUR78
CMR94
MWI86
KEN98
HND98ZAR98
HND94
SLE98
THA70
ZMB74
DOM90
MYS82
NIC70
MAR94
THA74
NER74
PHL94
TGO82
JAM98
PNG82
MDG94
CIV78
ZAR78
SEN70
MYS74
SLE74
TUN86
BGR94 CHL74
GMB70
LKA70
HTI82
BOL78
JOR90
URY98
ZAF90
PER98
JAM78
CHL70
PRY94
VEN98
ARG98
MDG90
COG94
CRI82
CIV86
PNG86
PRY82
JAM94
PNG98
CRI78
ECU82
HTI86
SYR86
MAR90
PHL98
PNG78
MMR70
TGO98
SGP98
PRY98
PNG94
SGP74
GHA74 JOR94
GTM82
MYS98
SLE90
THA98
ETH82
CHL82
IND70
CIV82
VEN82
SEN78
CIV90
HTI94
MDG70
BFA70
PHL90
ZAR90
ZAR74
TTO86
CMR86
VEN78
NGA78
MDG74
HTI90
IDN98PHL82
URY82
IRN86
JAM74 ROM90
GAB78
MMR86
HUN90
CMR90 TGO90 JOR86
SLE94
-10
NIC78
IRN78
-4
-2
Non-outliers
Outliers
0
Aid*Policy
2
4
Fit to all data, coef = -0.04, t = -0.23, N = 436
Fit excl. outliers, coef = -0.27, t = -1.33, N = 426
36
Why might aid have negative effect on
growth?
• Dutch Disease
– Aid makes economies less competitive
• Aid volatility
– Volatlile aid undermines ability of governments to
plan, encourages short-time horizon thinking
(roving bandit vs. stationary bandit)
• Rentier State/Enclave Economy/Fungibility
– Aid enables bad policies & bad institutions
Burnside & Dollar (2004)
Aid + Good Institutions => Growth
• Donor behavior changed after Cold War
– 1980s: Aid went to countries w/good & bad
institutions
– 1990s: Good institutions attracted more aid
• Institutions condition affect of aid (in 1990s)
– Aid + good institutions => positive growth
• India, Botswana
– Aid + bad institutions => negative growth
• Pakistan, Zaire/DRC
Aid x Good Institutions => Growth
• Doucouliagos & Paldam 2008
– Aid x institutions: robust
– Aid x policy: not robust
Some conditions under which aid has been
found to be beneficial for development
• Civil liberties (Isham, Kaufmann, and Pritchett
1995)
• Good policies (Burnside & Dollar 2000,
Economides et al 2004)
• Good institutions (Burnside & Dollar 2004)
• Democracy (Kosack 2003)
• Sufficient human capital (Kosack and Tobin
2006)
31
Trends in foreign aid
• Post-WW2: IBRD, Marshall Plan
• 1960s: Bilateral aid focused on former colonies
• 1973: McNamara Revolution, focus on poverty
reduction
• 1980s: Structural adjustment, focus on economic
liberalization policy, conditionality
• 1990s: Increased focus on institutional quality,
selectivity, and donor-government partnership
– HIPC, Millenium Challenge Account
– Increased funding for non-government bodies
32
Lessons of Foreign Aid
• Selectivity works better than conditionality
• Government ownership of policy increases
probability of implementation
Recommendations to address
“Resource Curse”
• Countries with good institutions: Help with
natural resource extraction (and give aid)
• Countries with poor institutions/policies and
seek to develop natural resources: Do not give
aid until institutions improve
• Countries with poor institutions that already
have natural resource production: boycott
Possible solutions
• Tracing production / embargos / consumer action
campaigns – the Kimberley Process and “blood diamonds”
• Creating greater transparency of who is paying what to
whom and holding gov’ts to account for those funds (EITI)
• Developing national savings mechanisms
• Privatization
• Anti-corruption commisions & improved sector legislation
and regulation.
• Direct distribution of benefits to people
• Choosing not to exploit the resource in the first place
• Reduce demand for oil from the US, etc.
• Clean Trade Acts & Clean Hands Trusts
Sources: www.sebstrategy.com, www.cleantrade.org, Birdsall & Subramanian 2004, Ross 2011
Solutions
Solutions
• Pay oil revenues into independent escrow
account for national development
– Worked for Norway
Why?
-- Didn’t work for Chad
EITI compliant & candidate countries
Solutions
• Privatization didn’t work so well in Russia