Overseas Aid and Economic Development | tutor2u Economics
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Overseas Aid and Economic Development

  • Levels: AS, A Level, IB
  • Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC

What role can and what role should overseas aid play in promoting and sustaining economic development?

Overseas aid and development - revision video
UK overseas aid

These are hugely contentious questions in the subject. Estimates vary from those which suggest that overseas development aid has added about 0.5 per year to growth in recipient countries to those which suggest that it has had no positive, or indeed negative, effect on growth.

Backgrounds statistics on overseas aid

  • Aid spending in real terms has increased steadily in the past 50 years, to $134.8 billion in 2013
  • In 2010, global military expenditure = $1630 billion versus $128 billion on development aid
  • The value of trade outweighs aid by a large multiple. The export earnings of all developing countries in 2010 were more than 40 times the level of official aid flows.
  • Denmark, Luxembourg, the Netherlands, Norway and Sweden exceed the United Nations ODA target of 0.7 per cent of gross national income (GNI)
  • The largest aid donors are the United States, Germany, the United Kingdom, France and Japan
  • South Korea, China and India now also significant donor nations
  • The main destinations of aid from advanced rich nations in 2010 were Sub-Saharan Africa (44%), which also received more aid per head than other regions, followed by South and Central Asia (19.5%) and Middle East and North Africa (10%)
  • In 2010, total UK aid was $13.1 billion. DFID is in charge of allocating overseas aid payments
2014 Overseas Aid data (source OECD)

Types of Aid

  1. Bilateral aid: Aid on a country-to-country basis e.g. from UK to Kenya or from Brazil to Tanzania
  2. Multi-lateral aid: Aid channelled through international bodies / aid agencies such as CARE
  3. Project aid: Direct financing of specific projects for a donor country
  4. Technical assistance: Funding of expertise of various types
  5. Humanitarian aid: Emergency disaster relief, food aid, refugee relief and disaster preparedness - Humanitarian aid accounts for less than 10% of global aid flows
  6. Soft loans: A loan made to a country on a concessionary basis with a lower rate of interest- for example, India has received over $2 billion in low-interest funds from the World Bank for many of its welfare schemes, these soft loans are set to stop as India heads towards middle-income status
  7. Tied aid: i.e. projects tied to suppliers in the donor country - the UK abandoned tied aid in 1997
  8. Debt relief – this may take the form of cancellation, rescheduling, refinancing or re-organisation of a country's external debts

Statistic: Public sector expenditure on foreign economic aid in the United Kingdom (UK) from 2009/2010 to 2013/2014 (in million GBP) | Statista
Find more statistics at Statista

Financial Flows into and out of Developing Countries

Financial flows into developing countries (also known as foreign savings) can come in different forms:

  • Although aid is important for many of the poorest nations, exports from developing countries are now more than 40 times the level of official aid flows
  • Remittances for migrants are about three times as large as aid flows
  • Private capital inflows are 10 times aid flows

Assisting Post Conflict Nations

Examples of aid projects from the UK to help fragile countries and those in post-conflict reconstruction:

  • Clearing minefields in Nepal, road building in the Democratic Republic of Congo
  • Malaria prevention and treatment programmes in Ethiopia, Training midwives in Pakistan.

Does overseas aid help or hinder economic growth and development?

  • Aid has a range of economic, social, environmental and political objectives
  • Economic development can take place without aid - China and Vietnam have both experienced sustained and rapid growth over nearly two decades without receiving much in the way of international aid payments measured as a share of their GDP
  • Well directed and targeted aid can enhance a country's growth potential but the effects may not be seen for many years e.g. Aid might help finance the building of a power station contributes directly to aggregate demand and increases supply potential. Or aid that is designed to put more children through school or humanitarian aid to vaccinate kids and prevent them dying will have an impact over a longer time horizon
  • Different kinds of aid projects can affect growth at different times and to different degrees

Building the Case for Overseas Aid

Overcoming the savings gap: Aid provides a financial inflow for low income countries - it helps to overcome the savings gap. Also important in stabilising post-conflict environments - e.g. generate jobs to keep fighters away from conflict

Building the Capital Stock

Project aid can fast forward investment in critical infrastructure projects - an increase in the capital stock lifts a country's growth potential

Human Capital and Post Conflict Help

Long term aid for health and education projects - builds human capital and raises productivity. Aid combined with good policy can have lasting positive effects

Higher Growth and Trade Spillovers

Well targeted aid might add around 0.5% to growth rate of poorest countries - this benefits donor countries too as trade grows

Counter arguments – Limits / Disadvantages of Overseas Aid

Corruption:

In poorly governed countries much of the aid flow to politicians and relatively little may directly benefit the poorest communities in greatest need.

Ruiling Elites

Aid can act as a barrier to true democracy - politicians pay more attention to aid donors than to their citizens. Aid-dependent governments are accountable to donors, not to their population

Aid dependency

A dependency culture on aid might be generated - the aid paradox is that aid tends to be most effective where it is needed least

Market distortions

Aid for example in the form of food aid in emergencies may lead to a distortion of market forces and a loss of economic efficiency

In the "The Bottom Billion" Professor Paul Collier suggests that, ceteris paribus, overseas aid may have added around 1% per year to the growth rate of the poorest countries of the world during the past 30 years. There are few economists who argue that aid has led to a reduction in economic growth of donor countries. Most of those who are critical of overseas aid focus instead on dependency and corruption. It is possible for countries to grow quickly without aid – but equally there are countries who were initially heavy aid recipients who have grown and developed and are now aid donors themselves for example South Korea.

The ceteris paribus assumption is important. Aid can provide a much needed injection of funds for some of the world's poorest countries and communities - but everything else is not equal. Many external factors may reduce or enhance the impact of aid on economic growth, for example the quality of government, the efficiency of financial systems and also the absence of conflict.

Key point: The contribution aid makes to growth differs sharply in countries at peace and countries in conflict

Aid Graduates – Countries whose overseas aid as a share of GDP has declined over the years
Country Maximum aid as % of GDP Year Minimum aid as % of GDP Year Growth of GDP per capita p.a. 1990–2010
Bangladesh 8.2% 1977 1.3% 2009 5.8%
Botswana 31.6% 1966 0.5% 2005 7.1%
China 0.7% 1992 0.01% 2008 11.6%
Ghana 16.3% 2004 4.1% 2008 4.0%
India 4.1% 1964 0.1% 2009 7.0%
Kenya 16.8% 1993 6.1% 2008 3.1%
Malaysia 1.2% 1987 0.07% 2009 6.1%
Vietnam 5.9% 1992 2.9% 2008 7.4%
Source: World Bank, Global Development Finance

Critics of much of the aid that has gone to Africa in recent decades argue that a high proportion of aid has gone to low-income countries with poor institutional regimes. The UK government has a target of allocating 0.7% of GDP to overseas development assistance (ODA) - this target came into being in 1970 and has never been revised! But is it right to stick rigidly to such a target independent of what else is happening in both the domestic and the global economy? 0.7% of UK GDP is forecast to equate to around £15 billion in 2015. In 2012 the UK announced it would end aid to India in 2015, to focus on trade links. It has also suspended aid support to Rwanda over its alleged funding of rebels in the Democratic Republic of the Congo, and to Uganda over alleged corruption

In a world of increasing resource scarcity, aid can also help to

  • Overcome skills shortages
  • Funding for infrastructure
  • Deliver projects to help the poorest countries become more resilient to climate change

Smart Aid

  • There is increasing interest in the use of "smart aid" - aid programmes that use experimentation and focus on bottom-up projects in order to increase the effectiveness of each £ or $ given in aid.
  • The work of Esther DuFlo, the author of "Poor Economics" and professor of development economics at the Massachusetts Institute of Technology, has been influential in shaping ideas about smart aid and the importance of randomized trials to improve the effectiveness of aid.
  • Oral rehydration therapy, vaccines and the spread of bed nets to reduce malaria in Africa are examples of where randomised testing has had an effect to give aid projects more positive impact.

An annual assessment of overseas development assistance from the Organisation for Economic Cooperation and Development in Paris found that aid to the least developed nations stood at $25bn (£16.7bn) last year – a 16% drop from 2013 Denmark, Luxembourg, Norway, Sweden and the UK spent more than 0.7% of their gross national income (GNI) on ODA, exceeding the UN’s suggested level of aid spending for rich countries. Last month, the UK became the first country to enshrine in law its commitment to spending 0.7% of GNI on overseas aid

The Guardian (April 2014)
William Easterly on the impact of Western Aid
Esther Duflo

Listing of recent articles on foreign aid from the Economist - http://www.economist.com/topics/foreign-aid

Listing of recent articles on foreign aid from the Guardian - http://www.theguardian.com/global-development/aid

The Economics of Foreign Aid

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