Tuesday, February 16, 2010

Foreign Aid - Is it free?

Foreign aid has attracted a bit more attention lately, but it has, since its inception in 1950, been a controversial issue. Recently a book by William Easterly (Title: The White Man’s Burden: Why the West’s efforts to aid the rest have done so much ill and so little good. Publisher: Penguin Press, 2006) has set off a new round of discussions and questions and polemics. So I thought that I would join in.

I will concentrate on Official Development Assistance (ODA), essentially aid in the form of funds given by the rich countries to the low and middle GDP countries of the world. ODA is the largest of the various aid categories. I may try to discuss other categories, especially technical aid, in a later post.

Official Development Assistance has been of significant size. In the year 2006, for example, it amounted to $120 billion in current prices. (This is the world total.) This seems to me to be a sizeable figure, but it is a small proportion of the West’s Gross National Income, and it was spread over many countries, not necessarily on the basis of need or the ability of a country to use it productively.

This foreign aid of course is meant to provide a country with resources in addition to those of its own. Aid then is a supplement to domestic saving. Government can then do things it could not have done without the aid. This is obvious of course. Suppose a government is using its own resources effectively, and then gets some aid. It can then do more–can build more elementary schools, can improve or maintain more roads, can guarantee farmers a good price for their crops, and so on–than it could in the absence of aid. Aid obviously can be of great help in the development of a country. Why are there doubts?

There are several reasons that have been mentioned by opponents of aid. It breeds corruption, it is wasted on pet projects pushed by some government officials, it enables the continuation of harmful policies, it makes exchange rate management more complicated, it dampens pressure on domestic resources to seek productivity gains, donor countries often put damaging restrictions on the use of aid funds, and so on and on. These doubts are real and there are many examples that one could cite of their impact. At the same time there are many examples of aid having a very favorable effect on a country’s development effort. Botswana and Korea are examples of aid working in an effective way.

For aid to be effective the overall economic policy of a country must be in order. The country must understand how its economy functions. As noted above the aid receiving country must be using its own resources effectively and to appreciate how it can use additional resources in an equally effective way. This is not an easy thing to do. And it is not surprising that aid is often misused, not because of corruption or selfish government officials, but because the understanding of the aid receiver’s economy is so limited. Thus foreign aid is beneficial where those who manage the economy understand how their economy in fact works. Where the donor imposes conditions for its aid that the recipient believes to be inappropiate, aid must be rejected. Do not think because it is aid it is free, and doesn’t matter. The costs may be high. There is no such thing as free aid, as there is no such thing as a free lunch.