The 0.7% aid target was based on flawed modelling
26 November 2020
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The UK has ditched the 0.7% of national income foreign-aid target after eight years of spending at this level. But where did the target come from?
The target, set by the UN, popped out of an economic model in 1969, although attempts at re-estimating it in 2007 using modern data produced a very different figure of 0.01%. The model, also used by Soviet Union apparatchiks in its heyday, fell out of favour with economists long ago.
The international goal to send 0.7% of national income to developing countries came from a 1969 report, headed up by former Canadian Prime Minister Lester B. Pearson. The report was designed to “elaborate an aid strategy based on a convincing rationale…”. A year later, the target was adopted by the UN.
But 0.7 is not a round number, so where did it come from? While today it could be described as arbitrary, when it was first calculated it was based on very precise modelling. However, somewhat embarrassingly for its modern-day defenders, said precise modelling relied on economic theories which had also been tried by Soviet planners in their flawed attempt at achieving prosperity.
In the mid-to-late 1940s, aid spending was mainly focused on the reconstruction of infrastructure in Europe following World War II. By the 1950s, aid had become a competition between the First World (the nations aligned with NATO) and the Second World (the Soviet Union) for the allegiance of the so-called Third World countries (the neutral, developing countries of Asia, Africa and Latin America).
Opinion-makers in the 1950s believed the Soviet system, although less free than the West, was capable of superior results when it came to measured volume of output. They credited this to the Soviets’ ability to extract large forced savings and therefore to invest heavily in factories, machines and other capital goods. As Professor William Easterly, a development economist at New York University, explained: “There was a danger that the Third World, attracted by ‘certain advantages’, would go communist”.
At this point, economists subscribed to the belief that saving and capital investment were essentially the be all and end all of economic growth. Professor Easterly explained: “A country that wanted to develop had to go from an investment rate of 4 percent of GDP to 12-15 percent of GDP. Investment had to keep ahead of population growth. Development was a race between machines and motherhood”.
But in the poor “Third World”, people were just scraping by. They could not possibly save more to plough into capital investment. So the solution was simple: send money from rich First World countries to “plug the gap” between their current saving levels and the rate the economists’ models showed they would need in order to start growing. This idea was laid out for the layperson in 1960 by economist Walt William Rostow in his best-selling book, Stages: A Non-Communist Manifesto.
Essentially, these economists had swallowed the Soviet development plan hook-line-and-sinker and believed the sheer quantity of capital investment funded through saving was all that mattered for economic growth. The dilemma they presented to policymakers was plain: either send developing countries the necessary financing to “plug the gap”, or they would resort to a command economy and force up the saving rate and capital investment that way.
The Pearson 1969 report estimated that 0.7% of rich countries’ national incomes as official aid would be necessary to “fill this savings gap” and spur economic growth, and that if developed nations committed to this target by 1975 (or by the very latest 1980) there would be no more need for aid by the turn of the millennium.
However, as alluded to above, the model of growth relied upon to reach the 0.7% target is no longer considered credible, with modern economists having shifted their focus onto the roles of strong institutions, technology and human capital, rather than simply the amount of money poured into capital investment.
Even assuming the model used in 1969 to come up with the 0.7% figure is valid, plugging in the relevant variables from today yields wildly different results: indeed, development economists Michael Clemens and Todd Moss did just that in a paper from 2007, and the model told them a meagre 0.01% of rich-country GDP should be sent to developing countries based on today’s conditions. The authors commented: “We do not claim in any way that this is the ‘right’ amount of aid, but only that this exercise lays bare the folly of the initial method and the subsequent unreflective commitment to the 0.7% aid goal”.
The target, set by the UN, popped out of an economic model in 1969, although attempts at re-estimating it in 2007 using modern data produced a very different figure of 0.01%. The model, also used by Soviet Union apparatchiks in its heyday, fell out of favour with economists long ago.
The international goal to send 0.7% of national income to developing countries came from a 1969 report, headed up by former Canadian Prime Minister Lester B. Pearson. The report was designed to “elaborate an aid strategy based on a convincing rationale…”. A year later, the target was adopted by the UN.
But 0.7 is not a round number, so where did it come from? While today it could be described as arbitrary, when it was first calculated it was based on very precise modelling. However, somewhat embarrassingly for its modern-day defenders, said precise modelling relied on economic theories which had also been tried by Soviet planners in their flawed attempt at achieving prosperity.
In the mid-to-late 1940s, aid spending was mainly focused on the reconstruction of infrastructure in Europe following World War II. By the 1950s, aid had become a competition between the First World (the nations aligned with NATO) and the Second World (the Soviet Union) for the allegiance of the so-called Third World countries (the neutral, developing countries of Asia, Africa and Latin America).
Opinion-makers in the 1950s believed the Soviet system, although less free than the West, was capable of superior results when it came to measured volume of output. They credited this to the Soviets’ ability to extract large forced savings and therefore to invest heavily in factories, machines and other capital goods. As Professor William Easterly, a development economist at New York University, explained: “There was a danger that the Third World, attracted by ‘certain advantages’, would go communist”.
At this point, economists subscribed to the belief that saving and capital investment were essentially the be all and end all of economic growth. Professor Easterly explained: “A country that wanted to develop had to go from an investment rate of 4 percent of GDP to 12-15 percent of GDP. Investment had to keep ahead of population growth. Development was a race between machines and motherhood”.
But in the poor “Third World”, people were just scraping by. They could not possibly save more to plough into capital investment. So the solution was simple: send money from rich First World countries to “plug the gap” between their current saving levels and the rate the economists’ models showed they would need in order to start growing. This idea was laid out for the layperson in 1960 by economist Walt William Rostow in his best-selling book, Stages: A Non-Communist Manifesto.
Essentially, these economists had swallowed the Soviet development plan hook-line-and-sinker and believed the sheer quantity of capital investment funded through saving was all that mattered for economic growth. The dilemma they presented to policymakers was plain: either send developing countries the necessary financing to “plug the gap”, or they would resort to a command economy and force up the saving rate and capital investment that way.
The Pearson 1969 report estimated that 0.7% of rich countries’ national incomes as official aid would be necessary to “fill this savings gap” and spur economic growth, and that if developed nations committed to this target by 1975 (or by the very latest 1980) there would be no more need for aid by the turn of the millennium.
However, as alluded to above, the model of growth relied upon to reach the 0.7% target is no longer considered credible, with modern economists having shifted their focus onto the roles of strong institutions, technology and human capital, rather than simply the amount of money poured into capital investment.
Even assuming the model used in 1969 to come up with the 0.7% figure is valid, plugging in the relevant variables from today yields wildly different results: indeed, development economists Michael Clemens and Todd Moss did just that in a paper from 2007, and the model told them a meagre 0.01% of rich-country GDP should be sent to developing countries based on today’s conditions. The authors commented: “We do not claim in any way that this is the ‘right’ amount of aid, but only that this exercise lays bare the folly of the initial method and the subsequent unreflective commitment to the 0.7% aid goal”.
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