Trade, Development, and Immigration

Conditional aid – a misleading vision


Economic Theory
Housing and Planning
Problems with foreign aid are pervasive. There is plenty of discussion in the development community about aid worsening corruption in recipient countries, delaying progress towards democracy and damaging the growth of export industries through the ‘Dutch disease’. Proponents of foreign aid, however, have responded to these criticisms with claims that its effectiveness could be increased substantially by making it ‘conditional’ on good governance. Unfortunately for these pro-aid commentators, this policy is unlikely to enhance the effectiveness of foreign aid in stimulating development.

Let’s begin with some context. The debate on this topic was partly triggered by a paper put together by Burnside and Dollar (2000). These authors supposedly showed that when aid is placed in an environment of sound economic and social policies, including economic and political freedom, the benefits from aid disbursements for developing countries are far greater. Yet analysis by other academics has questioned these findings. Easterly, Levine and Roodman (2000) found that full inclusion of the data set in the period studied by Burnside and Dollar actually shows that their result is statistically insignificant. In jargon-free language, this means that Easterly and his colleagues did not discover any compelling evidence which supported the view that aid delivers tangible benefits in a good policy environment when a full range of data was used.

So why has ‘conditional’ aid been relatively unsuccessful? For one thing, discriminating according to institutional quality is not a practical policy for multilateral organisations such as the World Bank and the IMF. Refusing to prepare development assistance for countries with weak institutions runs counter to the rhetoric on ending ‘world poverty’ adopted by international agencies.

Furthermore, institution building is not generally thought to be the main aim of these global lenders. The IMF’s challenge is to ‘foster global growth and economic stability’ and the organisation ‘works with developing nations to help them achieve macroeconomic stability and reduce poverty’. While institutional building should naturally occur in the pursuit of fulfilling these objectives, neither the IMF nor the World Bank can directly withhold aid from specific countries on the basis of their unsatisfactory systems of governance. For multilateral donors, at least, aid conditional on sound institutions cannot offer a feasible policy setting for the future.

Another reason could be the incompatibility of ‘conditional’ aid policies with the motivations of bilateral donors in disbursing aid. The view of donors serving under non-altruistic interests is not unacknowledged by academics. Gustav Ranis of Yale University pointed to the use of aid as a foreign policy tool, with the United States being the primary suspect. Indeed, Ranis showed that the US, being the largest shareholder of both the World Bank and the IMF, employed aid as part of ‘Cold War foreign policy’, the ‘war on terror’ and even used aid to procure UN votes for the invasion of Iraq in 2003.

It appears that the self-interest of the donors often supersedes attempts to discriminate among recipients according to the quality of governance – otherwise aid would mostly flow to countries with superior institutional quality. The exceptions to this case are the Scandinavian countries that restrict their aid donations to countries with strong economic performance and low corruption.

Finally, there continues to be little ‘ownership’ on the recipient side in spite of repeated attempts at reform. Without adequate ownership being granted to the recipient in the aid process, efforts to use ‘conditional’ aid run the risk of reaching a similar outcome to that of the structural adjustment programmes of the 1980s. That is, even if the conditions imposed by donors are not fulfilled, aid continues to be disbursed. In addition, it is also doubtful that ‘conditional’ aid is always in the best interest of the recipient, especially considering that the recipient rarely plays a significant role when it comes to policy changes.

Taken together, these arguments cast doubt on the view that ‘conditional’ foreign aid policy offers greater hope in the use of aid to achieve development. Policymakers should consider that foreign aid might not represent a beneficial solution in all cases and other methods, such as liberalisation of trade, should receive consideration in public policy. IMF estimates of the potential economic gains to be attained from greater liberalisation of trade actually exceed the value of aid being disbursed to developing countries. If the Western world is genuinely concerned with helping low-income countries achieve higher living standards and become reasonably developed, it should open its borders to trade.