Lectures 18A Aid & 18B AiD Effectiveness

Transcription

1 Lectures 18A Aid & 18B AiD Effectiveness Introduction Development assistance ( aid ) has been a central part of the development policy landscape throughout the post war era. After a decline in the 1990s, aid is up again. Sachs asks for a doubling in aid to meet the MDG. There is a pledge by northern governments to give their contribution. Public perceptions reflect support for higher levels of aid. When asked what percentage of the federal budget they think goes to foreign aid, Americans% median estimate in % of the budget is: 25%, more than 25 times the actual level. Only 2% of Americans give a correct estimate of 1% of the budget or less. When asked how much of the budget should go to foreign aid, the median response is: 10%. Only 13% of Americans believe that the percentage should be 1% or less. Over 60% of Americans believe that contributing 0.7% of national income to meet the Millennium Development Goals is the right thing to do. Evidently Better aid is needed, not just more aid. Both the quantity and the quality of development assistance need to increase. Lecture 18A is about aid: stylized facts, theoretical arguments and practicalities while Lecture 18B is on aid effectiveness. Lecture Outline Introduction IStylized facts about aid A Definition B Level, allocation and evolution C Economic Rationale for aid flows IIGrowing disappointment with aid A Theoretical arguments B Problems: lack of accountability and incentives Conclusion I Stylized facts about Aid A Definition of Official development aid (ODA) Grants or Loans to developing countries which are: (a) undertaken by the official sector; (b) with promotion of economic development and welfare as the main objective (not military aid); (c) at concessional financial ter ms [if a loan, having a Grant Element of at least 25 per cent]. Remark 1: ODA can be managed individually (bilateral aid) by the countries or united and managed by multilateral agencies: World Bank, EU, regional development banks. Remark 2: most statistics only cover the 22 DAC (Development Assistance Committee) countries: Non DAC countries include other OECDC countries (Czech Republic, Hungary, Iceland, Korea, Poland, Slovak Republic, Turkey) and other countries such as OPEC countries and China I Stylized facts about Aid B Level, allocation and evolution of Official development aid (ODA): Total official development assistance (ODA) from DAC members rose by 32% in 2005 to USD billion a record high. This represents 0.33% of members combined Gross National Income in 2005, up from 0.26% in 2004 and the highest ratio 1

2 I Stylized facts about Aid B Level, allocation and evolution of Official development aid (ODA) Fact 1: Core development programs rose by 8.6% between 2004 and 2005, but most of this increase was accounted for by only two countries, Afghanistan and Iraq. If these two countries are excluded, core development programs increased by 2.9%. I Stylized facts about Aid B Level, allocation and evolution of Official development aid (ODA) On average, the world s richest countries provided just 0.33% of their GNP in official development assistance (ODA). The United States provided just 0.22%. I Stylized facts about Aid B Level, allocation and evolution of Official development aid (ODA) Fact 2: The lion s share of the aid increase in 2005 came from debt relief grants (to Iraq (14b$) and Nigeria (6b$)), which more than tripled, while humanitarian aid rose by 15.8% True enough debt relief helps to reduce the debt overhang problem but does not correspond to fresh money (in fact no change if the country was not reimbursing) Fact 3: Level falls short of the promises. At the Monterrey Financing for Development Conference in 2002, world leaders pledged to make concrete efforts towards the target of 0.7% of their national income in international aid. In today s dollars, that would amount to almost $200 billion each year (double the current level). Only Five countries have already met or surpassed the 0.7% target: Denmark, Luxembourg, Netherlands, Norway and Sweden. Five other countries have committed themselves to a timeline to reach this target before 2015: Belgium, Finland, France, Ireland and the UK. Out of the 73 billions of development programs, a small fraction is financial disbursed to the developing countries. 1/5 covers administrative costs, student costs and refugees in donor countries Around 50% is tied: either on trade, projects or technical assistance (experts service from the developed world) Tied aid Tied aid is aid given on the condition that the recipient will use it to purchase goods and services from suppliers based in the donor country C Economic Rationale fo r aid flows 1 Develo pment models (Easterly, AFD 2004) a Financing gap b Poverty gap c The expenditure to outcomes model in health and education 2 Critics of these development models Simplistic hypotheses: aid converts entirely into investment (no leakages through consumption or corruption) investment converts entirely into growth (cf. limits of Harrod Domar model) Empirical data reject the validity of the poverty trap model 2

3 C Economic Rationale for aid flows 3 Less rosy picture on why donors give aid: political motivations (Todaro and Smith CHAPTER -15) Donor country governments give aid primarily because it is in their political, strategic, or economic self interest to do so. II Growing disappointment with aid A Theoretical arguments 2 Weakening of institutions II Growing disappointment with aid A Theoretical arguments 1 Ressources are not everything Aid may finance schools and required textbooks, but education will not improve unless teachers and students show up regularly (refer to the problem of complementarity inputs and incentives. 2 Weakening of institutions: a induces laxism on raising taxes for receiving country Illustration: political economy model of Adam and O Connell (1999) discussed in Gunning AFD (2004) Framework: Government has two sources of revenue R: aid and taxes and uses R to ensure two types of spending: minimum social services to population to prevent rebellion transfers to favored group Case 1: aid is used entirely for tax cuts: higher growth since reduction of tax induced distortion but no improvement in social services. This provides an incentive for CONDITIONALITY (but inefficient) Case 2: aid is used entirely for additional transfers to favored group (even if targeted to social services as government resources are released and can be used for transfers: context of FUNGIBILITY). b counter intuitive results that aid may reduce social services The social services are paid to compensate for the tax burden and thus to prevent unrest. Aid allows paying the transfers to favored group without requiring taxes. The government can reduce taxes and social services without launching unrest. c relaxes countries need to explain their actions to citizens By expanding a government s resource envelope, aid relaxes their need to explain their actions to citizens, which may have a corrupting influence even on the best intentioned of governments in the long run. II Growing disappointment with aid A Theoretical arguments 3 Adverse effects on competitiveness Macroeconomic effect on a country s competitiveness of large windfalls and their associated spending ( Dutch Disease ). The problem is limited absorption capacity. Two channels: a Aid inflows could push up the price of some critical (scarce) resources: Rise in input costs of engineers, doctors, teachers, civil servants, and aid administrators. Sectors for which prices are fixed by foreign competition (tradables) will lose competitiveness and profitability. 3

4 b In flexible exchange regime aid inflows may also push up the nominal exchange rate, rendering the traded goods sector uncompetitive if wages in that sector do not adjust downwards. Consequences Effect of a real exchange rate appreciation: the traded sector becomes uncompetitive and shrink s. All the more detrimental as traded sector is often modern, characterized with learning by doing effect 4 Costs associated with aid flows: real value of the aid is much lower a Administrative costs: Planning nightmare (Easterly, 2005).Multiplicity of donors/projects is demanding for limited administrative capacities of states: meetings, proposals b Substantial debt repayment burdens: Aid is a mix of grant and debt. c Tied aid: by source (loans or grants have to be spent on the purchase of donor country goods and services) or by project (funds can only be used for a specific project, such as a road or a steel mill). Consequences Costs as the specified source is likely to be an expensive supplier or the project is not of the highest priority (otherwise, there would be no need to tie the aid). Aid may be tied to the importation of capital intensive equipment, which may impose an additional real resource cost, in the form of higher unemployment, on the recipient nation. A former British minister of overseas development once noted that about two thirds of our aid is spent on goods and services from Britain... Trade follows aid. We equip a factory overseas and later on we get orders for spare parts and replacements. [ Aid] is in our long term interest. d Volatility of aid flows: lack of predictability entails investment risks. II Growing disappointment with aid B Problems: lack of accountability and incentives 1 Lack of accountability of donors (Easterly, 2005) No sanction in case of failures (no improvement in LDCs, MDGs failures) goals too optimistic? (insufficient financing as argued by Sachs) plan misconception, model inappropriateness? were benefits of aid more than compensated by costs? was improvement the donors objective in the first place? Crucial questions (so far not enough empirical evidence) but so far not addressed: calls for further aid expansion coexist with litany of failures: a is failure caused by adverse external factors or by program failures? b if inherent program failure: who is to blame? Donors or recipients? Two different cases a Unrestricted Aid is simply a lump sum transfer to the government of the recipient country, who has complete discretion over its allocation Drawbacks: might be used to finance politician s private consumption misalignment between donor and recipient s preferences (e.g. aid used to buy weapons instead of medical supplies) The recipient is to blame (bad governance) except if failure is due to negative external shocks (bad luck). Conditional Aid is effectively a contract between donor and recipient, by which funds are disbursed only if recipient picks the right policies 4

5 Drawbacks: Issues about how perfect the contract can be due to observability and enforcement problems: principal agent (especially multiple principals) Also, not clear whether it is desirable that the beneficiaries preferences have no role (local knowledge, lack of ownership) Finally, conditionality can create distortions on other domestic policies or outright cheating II Growing disappointment with aid B Problems: lack of accountability and incentives 2 Bad incentives (for donors and recipients) In this latter case blame may be shared between recipient and donor: merry go round of aid failure (similar arguments as for debt: Lenders face incentives that cause them to aid even when the conditions of aid are not met. So that recipients face incentives that cause them not to abide to conditions. Add to that the issue of fungibility. 1 Solicitude of donors for the poor makes their threat of cutting off lending if conditions go unmet not very credible Perverse incentive to recipients: stay poor!! 2 Disbursement incentives: Larger budgets are associated with more prestige and more advancement. If not disbursed cut the next year. So incentive to lend every time positive change is identified. Perverse incentive to recipients: zigzagging policies 3 Political embarrassment as failure may harm managing reputation and thus threaten the lender s budget allocation (public support for aid) CONCLUSION End of the 1980s, development aid went through a crisis of legitimacy without precedent, due to various factors and the disappointments about aid: International environment change (end of the Cold War) transformed political foundations of bilateral aid, long considered as an instrument for promoting the political and geostrategic interests of donor countries. Economic crisis and strong budgetary constraints weighing on several donor countries, notably European countries in the Euro zone has, since 1992, led to a brutal fall in aid flows to developing countries. Problems of increasing debt in recipient countries and successive financial crises opened a broad debate over the reform of international financial architecture and the role given to multilateral institutions. Economic foundations and the justification of development aid were attacked by numerous very critical studies emphasized the absence of macro economic effectiveness, and the failure of conditionalities. World Bank reopened the debate on aid and allocation effectiveness, with the release of its 1998 report entitled Assessing Aid based on work by Burnside and Dollar. 5

6 Various Types of Creditors International Debtor Public Private Bilateral Multilateral Public Paris Club: IMF London Club (Banks) Non member States (China) WB Market: Bonds Emitted Regional International financial Development markets Banks Private Ex: Development Agency Ex: IFC EX: International Bank Branches specialized in the Borrowing private sector support 6

7 Sub Saharan Africa home of 35% of the absolute poor (420 millions) receives 30% of The rise in 2005 of Bilateral Net ODA to sub Saharan Africa from DAC members is mainly due to Nigeria s exceptional debt relief rose. Excluding Nigeria (home of 70 millions absolute poor), total ODA to the region fell 2.1% to USD 24.9 billion. 7

8 Lecture 18B Aid effectiveness Introduction In a very unfavorable context the World Bank reopened the debate on aid and allocation effectiveness, with the release of its 1998 report entitled Assessing Aid based on work from Burnside and Dollar. International environment change (end of the Cold War) transformed political foundations of bilateral aid, long considered as an instrument for promoting the political and geostrategic interests of donor countries. Economic crisis and strong budgetary constraints weighing on several donor countries, notably European countries in the Euro zone has, since 1992, led to a brutal fall in aid flows to developing countries. Problems of increasing debt in recipient countries and successive financial crises opened a broad debate over the reform of international financial architecture and the role given to multilateral institutions. Economic foundations and the justification of development aid were attacked by numerous very critical studies emphasized the absence of macro economic effectiveness, and the failure of conditionalities. Introduction Literature was inconclusive until the paper by Burnside and Dollar came out in the mid 90s One major challenge (as always in the economic development literature) is the issue of endogeneity: reverse causality: aid goes where development is difficult Implication is tendency to under estimate the potential positive impact of aid on growth omitted variables: factors both correlated with aid and growth are not taken into account Two key contributions of Dollar and Burnside paper: take non random allocation seriously: seek exogenous variation in aid allow effect of aid to differ as a function of the policy environment Debate has been intense since Lecture Outline Introduction I Dollar and Burnside paper A Lack of consensus before BD B BD approach C BD results and implications II Intense polemic since A The implicit hypothesis of BD B Critics C Back to where we were before BD or what else should be considered? Conclusion 8

9 I Dollar and Burnside paper A Lack of consensus before BD Not surprising that this research has mixed findings for several reasons Economic growth is not the sole objective of foreign aid, and in some cases it is not the objective at all. *aid given following natural disasters is aimed at supporting immediate consumption and humanitarian needs *aid provided to build political systems or support democracies has growth as only a secondary and distant objective. *much aid is given primarily for political purposes: support war action, promote firms interests *French aid explicitly aims at promoting French language Aid effectiveness will depend on th e context: Conditional/Unconditional aid Absorption capacity of the country Resolution of the incentives problem I-Dollar and Burnside paper A Lack of consensus before BD Not surprising that this research has mixed findings for several reasons Typical problem with impact evaluation on economic growth: endogeneity due to omitted variable Positive correlation with aid Negative correlation with aid Positive Correlation with aid 1. Upward bias: Geo proximity: favorable agglomeration forces and preferential trade: Eastern Europe 3. Downward bias: Conflict, drought, nuclear threat (North Korea) Negative correlation with aid 2. Downward bias: successful development 4. Upward Bias: Banned regime (Cuba, Zimbabwe ) SOLUTION: need to find an exogenous source of aid to instrument. If cases 2 and 3: instrumentation will recover a positive impact I Burnside and Dollar paper B BD approach Use panel data across 6 four year periods from and for 56 countries to run regressions of the form: 9

10 where ait is instrumented (see below) pit is a "policy index" increasing in the quality of policies, i is country and t represents 4 year periods. Note that the effect of aid on growth is now equal to: so that β only captures the effect of aid in a country that has pit = 0; γ > 0 indicates that aid is more effective in countries that pursue good policies. I Burnside and Dollar paper B BD approach To instrument aid they use measures of "political influence", that is; (i) Log population, (ii) Arms imports, (iii) Egypt dummy, (iv) Franc zone dummy, (v) Central America dummy The hypothesis is that (i) (v) influence growth only through their effect on aid. As a measure of policy, they use an index that combines: (1) trade openness, (2) inflation, (3) fiscal s urplus/gdp. It is however debatable. As a measure of policy, they use an index that combines: (1) trade openness, (2) inflation, (3) fiscal surplus/gdp. I Burnside and Dollar paper C BD results and implications 1-BD results Findings indicate that: instruments are good predictors of aid allocation aid is indeed correlated to income per capita aid has no effect on growth on average aid has no effect on growth when the policy index is low, but has a positive effect when the index is high enough (γ > 0 and β = 0) Source: Burnside and Dollar 10

11 1 BD results It is possible to compute the marginal impact of aid on growth: % increase in growth for an additional % increase of GDP in aid CD stands for Collier and Dollar. They draw on a larger dataset and a broader measure of the policy environment I Burnside and Dollar paper C BD results and implications 2-BD results Findings indicate that: instruments are good predictors of aid allocation aid is indeed correlated to income per capita aid has no effect on growth on average aid has no effect on growth when the policy index is low, but has a positive effect when the index is high enough (γ > 0 and β = 0) They also find that bilateral aid (but not multilateral aid) is fungible as it increases government consumption (and not investment): thus conditionality fails I Burnside and Dollar paper C BD results and implications 3 BD results implications Three main implications: *Aid works if good policies, if no good policies then ideas. This is the concept of Selectivity *It is possible to derive an optimal allocation formula (Collier & Dollar) to maximize the effectiveness of aid: best results per dollar of aid *Possibility to evaluate the good practices of aid policies by individual & multilateral donors. Collier Dollar provides a striking measure of effectiveness: the number of people lifted out of poverty by an extra $1 million of aid. By this measure, there are huge differences between donors, e.g. about 350 or higher for Denmark, Norway, the Netherlands and IDA, just over 200 for the US and 150 for the EU Commission. 11

12 The share of aid going to countries with good or very good policies declined after 1998 for all donors except for Norway, the DAC average falling from 55.5% in to 50.1% in WHY? II Intense polemic since DB s simple credo Aid works if good policies, if no good policies then idea did not convince: Several questions emerged in the literature Is DB s theoretical framework reliable? Are DB s empirical results reliable? Good methodology and robustness Is good policy the only conditioning factor? Is it the single right criterion to which aid should be allocated? II Intense polemic since A Disagreement on BD s implicit assumption The view that conditionality is ineffective is not held universally. The assumption (on which the World Bank policy conclusion of targeting aid at countries with good policies critically depends) that aid is ineffective in promoting policy reform The view that conditionality is ineffective is not held universally. Aid may improve the results: policies and projects may be better designed and implemented as a result of donor engagement. Aid may help to compensate losers of reform and thus increase the support for the reforms Empirical evidence on relation from Aid to Policy is mixed: no correlation between aid and policy some evidence of a dynamic mechanism: aid effectiveness is all the more important that initial quality of institutions is low II Intense polemic since B Critics of BD results 1 Lack of robustness of the results to time extension and more countries Easterly, Levine and Roodman (2004) extended the dataset to include 4 more years and 8 more countries. They find that the link between aid and growth disappears in the larger sample Both unconditionally and conditionally Casts doubts on the external validity of BD s findings highly sensitive to sample selection 12

13 II Intense polemic since B Critics of BD results 2 Critics of the methodology *Critics of the indicator of economic policy: why only 3 components critics of the weighting *Critics of the PPP measurement of GDP *Critics of the empirical estimations: sensitivity of outliers pooling of all aid flows: should consider only aid for which an impact is expected within a 4 year window why restrict the potential conditional effectiveness relationship only to policy? 2-Critics of the methodology Non linearity captured by the interactive term A*P in fact vanishes when other non linearity is allowed for So aid effectiveness depends: on the economic vulnerability of a country (potential bad luck) on the existence of a post conflict situation (Collier Hoeffler, 2004) on the capacity of aid to allow for an improvement of policies when at first they are wrong (so aid improves policies) on factors more or less precisely grouped under the term of capacity absorption and which condition the rhythm of the reduction of the aid s marginal effectiveness up to the point where it becomes negative, etc. I Stylized facts about Aid C Back to where we were before BD or what else should be considered? 1 Back to where we were: «State to the art» instrumentation method of aid by Rajan et Subramanian (2005) C Back to where we were before BD or what else should be considered? 2-Additional areas of necessary investigation: Potential solution of the conundrum will come from Decomposition of aid into Urgency aid Short term projects Long term projects (training ) 13

14 Look at long period / short period of time: aid may need less or more than 4 years to have pay P otential detrimental effects: Dutch disease, weakening of institutions Look at other left hand side variables since aid as other objectives than just growth: poverty alleviation reduction of migration improving health care reduction of conflicts Conclusion Three different questions in the very important policy issue of aid 1 Is the way we empirically test the proper way? Much remains to be done to assess its effectiveness and optimal design Interesting results come from micro level studies but incapacity to generalize the results It would seem logical that aid effectiveness very much depends on the context and that aid would not be the most effectiveness tool in all cases 2 As it is logical that aid effectiveness depends on the context, could aid not be the most effectiveness tool in all cases? for small countries (like Uganda or Mozambique) which have recently implemented reforms possibly creating favorable environments for the development of the private sector. Priority is that they lack access to capital markets because of a poor dissemination of information regarding the reforms under way. for countries in pre conflict situations. While aid has important effects, other actions may better prevent conflicts: regulating the diamond trade, for example, to make financing rebellions more difficult, sending United Nations peace keeping missions to prevent an explosion of violence, etc 3 If no unconditional effectiveness, how to improve? As Easterly argues a major impediment to effectiveness is the lack of feedback and accountability: no learning on past failures The Planners approach of pouring massive resources is not as effective (despite the goodwill) as it does not take into account the incentives The Searchers approach of trial and experimentation works better but requires more time & flexible approach and thus is incoherent with the pre determined setting & schedule and massive disbursement of international donors Illustration of getting the bed nets to the poor : hand out free nets: often out of stock and 70% are not used sold by nurses (little commission) to pregnant women: always in stock and 100% use. 14