AID AND DEVELOPMENT

AID AND DEVELOPMENT – GENERAL NOTES 

There are generally thought to be two rationales for the giving of aid:

1. Fix market failures – such as building institutions, legal systems etc.
2. Get resources to needy individuals – this may look more like humanitarian relief.

However, the actual resources devoted to aid are tiny when compared with the total amount of resources devoted to development (i.e. government expenditure, personal expenditure etc.). However, it is a very visible political issue and hence there is generally a lot of media/academic attention devoted to whether aid achieves its goals. However, given the small amount of resources that are actually devoted to aid (only 4 countries maintain the UN goal of donating 0.7% GDP), perhaps it is not that surprising that quantitative studies find it difficult to uncover any beneficial impact of aid on growth etc.

Often aid is seen as a political instrument, e.g. rewards for assisting in war on terror, and historically Egypt received lots of funds due to the presence of the US military in that country.  Thus, if aid is a political tool that is directed at strategic interests rather than based on need/effectiveness, then we should not be surprised if it is difficult to uncover meaningful benefits of aid programmes.

The debate is quite high profile. Sachs and his crew argue strongly in favour of aid, whereas Easterly tends to assert that we need to search for mechanisms of improving outcomes rather than just throwing money at the problem. Moyo argues that aid actively harms. It is hard to model a situation where aid is bad as opposed to simply a waste (although it may cause conflict, crowd out local markets, encourage rent seeking and a dependency culture).

What do the data say? Well macro data is hard to analyze as aid is not applied in the same way in different regions, and this heterogeneity leads to difficulties in interpretation. Additionally the debate is rarely theoretically justified. If poverty traps are real, then aid will be useless until it is applied such that capital accumulation can occur at such a level that the trap is broken. Thus is aid is constantly applied to poverty trap countries, the results will always be negative growth until the right level of aid is disbursed. As ever, we do not observe the counterfactual, so even if growth is negative in the presence of aid, it may have been even more negative without it. Detecting results may also be difficult for the reasons noted in the opening paragraphs.

Potentially, micro studies could be of use, but without taking into the general equilibrium effects of aid, results will likely be of limited use due to poor external validity.