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University of Groningen - Minor Development Studies

Topical Themes in Development

Final

Version

February 2009

Foreign AidIs it likely that it really works?

Anne Jet Niermeijer and Pieter Hogeveen

Dirk Bezemer (supervisor)

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TABLE OF CONTENT

INTRODUCTION 3

Literature Review 5

1. HISTORY OF AID, WHAT IS IT? 9

2. MOTIVES FOR AID, WHY IS AID GIVEN? 13

Morale Motives 13

Historical Reasons 13

Sense of Responsibility 13

Economic Motives 14Financing Gap 14

Commercial interests 15

Political Motives 15

3. WHY WOULD AID WORK AND WHY WOULD IT NOT WORK? 17

Types of Aid 18

Main arguments pro aid 19

Why would aid work? 19

Main Arguments against aid 20

Why would aid not work? 20

Measuring the impact of Aid 23

Aid and Economic Growth vs. Socio-Political Factors 24

Conditions for Effective Aid 25

Policy Reform 25

Good governance and no corruption 27

Case Example 1 Aid Works in Tanzania 28

Case Example 2 Aid Does Not Work in Kenya 30

CONCLUSIONS 32

REFERENCES 34

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helping our fellow human beings in desperate need. This raises some questions on the honest

motives in aid giving of some countries.

Section three will go into further detail on why aid would work and why it would not work. It

discusses the main arguments pro and contra foreign aid. Furthermore, it discusses the several types

of aid and how they differ. The next section, section four will assess the evidence on aid. We wont

go into much detail on statistics, but elaborate on the different measurement methods. This will

provide insights in the difficulty of the measurement of aid effectiveness. We will illustrate the

effectiveness of foreign aid by discussing two cases. In either case it concerns an African country in a

comparable situation. However, in Tanzania foreign aid seems to work, while in Kenya it doesnt.

Finally, in our conclusion we will sum up the arguments and literature on foreign aid and argue that

based upon this literature it is not likely that current foreign aid works.

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Literature Review

Since foreign aid has been given to countries, it also became a hot debate which did vary in its

hotness but never seems to disappear. This explains the enormous amount of papers, books and

articles written on this particular topic. We have aimed to use the key pieces of literature written on

this issue and use additional literature for new insights. The literature is divided into the topics we

use for this article.

When discussing the definition and history of aid. There are two used sources which provide a good

overview on aid history. First of all, there is the book of Riddell(2007) which includes an extensive

description on foreign aid history. He claims that a few key stories can be told out of aid history.

Namely, that aid not only has continued to expand over the past 55 years, it also has become an

instrument for the construction of international relationships. Furthermore, there have been short

periods of stagnation in aid in almost every decade. Aid has always been subject to the GDP/Aid ratio

as its primarily measure standard. Lastly, we are in the midst of a period of revival and expansion of

high levels of aid giving. Secondly, the article of Thorbecke(2006) which guides us trough the

different decades of aid giving. In his article he describes the history of foreign aid by defining it as a

body of knowledge consisting of four interrelated components. The first component are the

development objectives and the definition of development. The second component, are the

development theories and hypotheses on development. The third component are the data systems

and the measurement of performance. These three influence each other but particularly influence

the development policies and strategies which is the fourth component described by Thorbecke.

These four components develop themselves and therefore change over het years. With respect to

development objectives he describes a change from an emphasis purely on GNP Growth in the 50s

and 60s to a more extended objective of Poverty Reduction and Equilibrium in payments and

budget in the 70s and 80s. This developed further in the 90s into good governance and policies

through institution-building. The current objectives brought the additional objective of Human

Development in education and health. Just as the objectives developed over the years, as did the

theories and data they were based upon and consequently the implemented policies and strategies.

Remarkable is how there seems to be an cyclical effect in the used theories. For example, the

Millenium Development Goals seems to go back to the big push theories of the 50s and 60s.

Alberto Alesina and David Dollar (2000) study the pattern of allocation of foreign aid from various

donors to receiving countries. They find considerable evidence that the direction of foreign aid is

dictated as much by political and strategic considerations, as by the economic needs and policy

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performance of the recipients. C

aid. They say that donor countri

country. Donors seem to have m

and financial relations.

At the margin, however, countri

aid flows respond to political var

incentives, particularly good p

We also uncover significant diffe

Steven Radelet (2003) explores t

reforming aid. He discusses the

with each other. He gives empiri

divided between research that fi

Radelet is one of the academics

Dollar, Devarijan and Holmgren

owned, not donor-owned. Count

provides empirical evidence forthat investigate whether and ho

ten received large amounts of ai

Ghana and Uganda were the mo

other eight did not. These eight

the mixed reformers and the no

1980s and 1990s. Dollar, Decarij

is measured is controversial.

Learning about development pol

roles of effective aid. The ten co

ended up with very different poli

They did not find an ongoing rela

to disguise the fact that aid supp

others. The purpose of country s

reform. Improvements in econo

Africa. The question is; how can

lonial past and political alliances are major det

s fail to look at the political and economic situat

ore interest in giving aid to countries with which

s that democratize receive more aid, ceteris par

iables, foreign direct investments are more sens

licies and protection of property rights in the

rences in the behavior of different donors.

rends in aid, motives for aid, its impacts and deb

ultiple motivations and objectives of aid, some

al evidence on the relationship between aid an

nds no relationship and research that finds a po

ho says aid can be effective, unless certain circ

rgue in their book, that development programm

ry ownership is the way to make assistance effe

evelopment partnership. They discuss ten caseforeign aid affected economic policy in the diff

. Yet the policy outcomes are very diverse amo

st successful reformers and achieved sustained

ountries are divided into three groups; the post

-reformers. The case studies look at the reform

n and Holmgren say that what constitutes goo

icies and good policy is an ongoing process and i

ntries from these case studies all received large

cies. This suggests that aid is not a primary dete

tionship between aid and reform. The average r

orted policy reform in some cases and sustained

tudies is to delve more deeply into the relations

ic policy are the key to more rapid growth and

id support these improvements?

6

rminants of foreign

ion in the recipient

they have political

ibus. While foreign

tive to economic

receiving countries.

ates about

of which conflict

growth, which is

itive relationship.

mstances are met.

es must be country-

tive. Their book

tudies from Africa,erent countries. All

g all countries.

ood policy. The

socialist reformers,

process during the

policy and how it

s one of the main

amounts of aid, but

rminant of policy.

elationship is likely

poor policies in

ip between aid and

poverty reduction in

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These authors think that donors should look at the quality of policy in the receiving country, not only

at how poor the country really is. Also the composition of aid is important. In the pre-reform period

donors should provide technical assistance and policy dialogue. During the reform period policy

dialogue is also important as is finance. At a later stage in the reform period dialogue gets less

important while finance increases in importance. By altering the quantity and composition of aid,

donors could more systematically support genuine policy reform in the developing world.

Clearly the process of policy reform was more affected by domestic factors than by aid. The

resistance to, and the impetus for reforms are driven by ideology, not by economic analysis.

In the sample of this book there is no relationship between formal democratic institutions and

reform. Aid is so persistent because it was a foreign policy tool rather than a tool for economic

development.

Countries that have successfully reformed have had clear political movements leading to these

changes, what is often referred to as local ownership of reforms. Countries that have made less

progress typically have had powerful vested interests blocking change. Economic policies are

primarily domestically grown. While the recipient countries have different economies and go through

different phases of reform, donors tend to do the same things everywhere and at all times.

The general finding is that different instruments work in different phases of the reform process. If

donors use the wrong instrument at the wrong time, it will be a waste. Each country has a pre-reform

phase of very poor economic policy and no coherent political movement to change the situation.

There is a general agreement that TA and political dialogue are useful in this phase. It can lay the

foundation for policy learning. Conditionality does not work in this phase. The agreements were not

always implemented. Some case studies prove that aid financing can lead to worse economic policies

while is other cases the absence of aid finance encourages reform. In the case of aid absence the

impact of poor economies was clear and the political leaders felt that they had little choice but to

undertake serious reform.

The conclusion here is that large-scale finance in the pre-reform phase has a negative effect,

reducing the need to reform. Conditionality has typically failed in the absence of a serious domestic

movement for change. They dont say that countries with bad policies should be withheld from all

aid. Rather they think that is an environment of poor policies, budget support has sustained those

bad policies and has not produced good outcomes. Then there is a period of rapid reform. In this

period aid finance plays an important supporting role. When countries actually reform, finance

increases the benefits of those reforms. Aid increases confidence in the reform program and call

forth greater private investment. In this phase TA and policy dialogue retain their usefulness.

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Conditionality to be useful must reflect measures that the government wants to carry out. Not one

imposed by outside agencies.

Donors tend to discriminate against poor countries that have put good policy into place. Aid rises as

policy improved. However once good policy was achieved, aid declined. Donors continue to use

conditional assistance, when in fact it has outlived its usefulness by this point. Conditionality is useful

during a period of rapid reform in which the government is trying to establish its credibility as a

reformer and get macroeconomic policy measures well entrenched. Conditionality might disguise the

ownership of reforms. It tends to limit participation in policymaking.

George Mavrotas and Bazoumana Ouattara (2003) develop a new fiscal response model for aid,

which combines the ideas of both endogenous and disaggregated aid. They endogenized aid on the

grounds that the recipient government has some influence over aid disbursements. Regarding aid

disaggregation, they argue that each of the main four categories of aid, namely project aid,

programme aid, technical assistance and food aid may exert different effects on the recipient

economy. Furthermore, in case the preferences of the aid-recipient government are higher for some

of these types of aid, neglecting aid disaggregation would lead to aggregation bias in the results and

conclusions. The model adds an important new dimension to the vast aid effectiveness literature and

calls for further modelling as well as empirical work in this promising research area so that significant

policy implications can be derived.

Simeon Djankov, Jose Montalvo and Marta Reynal-Querol, Marta (2008) discuss the effect of foreign

aid and try to document its magnitude. They say foreign aid provides a windfall of resources to

recipient countries and may result in the same rent seeking behaviour as documented in the curse of

natural resources literature. They used data from 108 recipient countries in the period of 1960-1999.

They find that foreign aid has a negative effect on institutions and say there is little chance that aid is

effective.

Paul Collier and David Dollar (2001) review the three recent attempts to nuance the analysis. Each

takes as its starting point the notion that a donor will be working with the recipient governments.

They also review the attempts that donor countries have done to influence the policy and conduct of

the receiving governments. The conclusion is that while much can be done to improve the potency of

aid in these respects, it is unlikely to be a very powerful instrument for inducing either type of change

and so these considerations should not become a dominant influence upon aid allocation.

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1. History of Aid, What is it?

First of all, what is aid precisely? Riddell (2007) defines it as all resources, physical goods, skills,

technical knowhow, financial grants or loans transferred by donors to recipients. We will leave out

the loans as aid, since we dont consider this as real aid. Furthermore, this definition is too broad to

work with. Therefore, we will define aid as all resources, physical goods, skills, technical knowhow,

financial grants provided by official agencies including state and local governments. With the main

objective of economic development and socio-economic welfare of developing countries. Lastly, in

our definition aid is Official Development Assistance (ODA) and excludes humanitarian aid.

The total amount of ODA over the past decades is shown in the graph1 below.

There were some forms of aid in the 1920s and 1930s by the British Government to their colonies

for example. Furthermore, there has always been aid giving by civil society through churches and

other private initiatives. Foreign Aid really started in the late 1940s, and was formed by an economic

and political tense climate caused by the second world war. It started with the well-known Marshall

plans to help Europe recover from the war. US President Harry Truman emphasized renewed

foreign aid in his inaugural speech in 1949:

1Source: www.oecd.org

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Fourth, we must embark on a bold new program for making the benefits of our scientific advances

and industrial progress available for the improvement and growth of underdeveloped areas. More

than half the people of the world are living in conditions approaching misery. Their food is

inadequate. They are victims of disease. Their economic life is primitive and stagnant. Their poverty is

a handicap and a threat both to them and to more prosperous areas. For the first time in history,

humanity possesses the knowledge and skill to relieve the suffering of these people.

The UN Charter (1945) and the Declaration of Human Rights (1948) provided further basis for foreign

aid. In the 1950s and 1960s it became it institutionalized in Official Development Assistance (ODA).

According to Thorbecke(2005) the selection and adoption of a development strategy depends on a

set of three building blocks. First, the prevailing development objectives. Secondly, the conceptual

state of art regarding the existing body of development theories and hypotheses. Thirdly, the

underlying data system available to diagnose the situation, measure the performance and test the

hypotheses. In these 50 years of foreign aid, policy makers have searched for a match between those

three building blocks. This match resulted in a policy which would enhance development. However,

the change in all three building blocks forced a change in policy, so policy changed as well.

In the beginning of aid programs the focus was on technical assistance and cooperation, since these

skills where seen as a catalyst for the economic development. However, financial aid also emerged

and led to the establishment of the World Banks International Development Association (IDA) in the

end of the 1950s.

The 1950s and 1960s were the glory years of foreign aid. The motives for aid were clear and the

figures show socio-economic growth in developing countries. Therefore, the amount of aid

increased. Economic growth in GNP became the main policy objective, and other economic and

social objectives were thought to be resulting from GNP growth. This objective was to be reached by

huge amounts of investment based upon the idea that the developing countries needed a big push

and a take-off in order to get their development going. Furthermore, the industrial sector was

believed to be the engine of growth and consequently the agricultural sector was neglected.

However, at the end of the 1960s, the optimism turned into doubts and uncertainties about foreign

aid. The effectiveness of aid was disputed. A new question came up, did foreign aid reduce poverty?

The Pearson Commission evaluated the concept of foreign aid in a report called Partners in

Development Pearson (1969) The new focus on reducing poverty instead of solely increasing

economic growth added a new dimension to foreign aid. This led to further expansion of foreign aid

in the 1970s as is shown by the graph. Furthermore, increased employment became one of the

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objectives in the 70s multi-objective approach.

A combination of heavy foreign debt burdens of the developing countries and a debt crisis in the late

1970s caused a decline in foreign aid. Before donors were willing to move on, the third world had to

be stabilized and structurally adjusted. The 1980s was the decade of the so called Structural

Adjustment Plans. Economies of developing countries had to be transformed, enabling growth and

poverty reduction in an effective way. During the 1980s the world economy was growing again after

the crisis of the 1970s and this caused aid levels to rise again. The 1980s decade was characterized

by a significant growth in NGOs which focused their attention to poverty reduction and other socio-

economic development issues. The cold war ended in 1989, and signaled a new era for foreign aid

and development. In the early 1990s political incentives seemed to have disappeared, new

skepticism on foreign aid aroused, and according to the graph on ODA, aid levels decreased. While

the adjustments continued, there was a resurgence of poverty alleviation as a primary goal.

Furthermore, the fast economic growth of east Asia was taken as an example for development. The

results of extraordinary economic growth of Asian countries like China, India and Indonesia without

large flows of foreign aid where astonishing. As a result, there was deregulation, liberalization and an

increased reliance on market mechanisms.

The new millennium provided new political incentives for aid after the 9-11 terrorist attack. The

graph on ODA clearly points this out by taking the example of Iraq. It received nearly 20% of ODA in

2005. Besides political incentives, aid regained attention through institutions as the World Bank with

their World Development Report Attacking Poverty (Worldbank, 2000). Furthermore, the

resurgence of the Human Development Index (HDI). The most well known development in

development arose from the Millennium Development Summit of Heads of State in 2000 held by the

UN. An agreement was reached, called the Millennium Declaration which led to the famous

Millenium Development Goals. With the primary goal to cut poverty in halve by 2015 and the

primary instrument is increasing the amount of aid. In 2005 another report by key-author Jeffrey

Sachs was published under the name Investing in Development: A Practical Plan to achieve the

Millennium Development Goals(2005). As it says in the title, a concrete plan. As a follow up for the

Structural Adjustment Plans, a new concept was introduced. The Poverty Reduction Strategy Papers

(PRSPs). They will function as an instrument for poverty reduction. However, they seem to be a SAP

make-over. At this point in time, UN and other agencies are trying to increase foreign aid for the

MDGs and use the MDG to increase foreign aid. These latest developments have increased the levels

of foreign aid significantly in the past decade to over more than 100 billion US dollars.

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In conclusion, it seems that the development community has run out of big ideas for making

development work. What we see is an amazing reversal of ideas over the 50 years of development

evolution with respect to the roles of the market, government and underlying theories. Although,

each time differently packed and based on different figures there is some resemblance. For instance,

the Millenium Development Goals are big plans which needs a lot of money and government

coordination. It resembles to the big plans of earlier decades which required also a lot of money and

governmental effort. Easterly(2006) calls it a big push dj vu and claims that today, just as then it

overlooks the unsolvable information and incentive problems facing any large scale planning

exercise.

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2. Motives for Aid, Why is aid given?

Upon what basis do donors allocate their aid? In first instance, one would say that aid is being given

solely altruistically to save lives in emergencies and to contribute to development, growth and

poverty eradication in poor countries. However, this provides a incomplete picture of reality.

Although, donors claim the noble reasons for giving aid. Their allocation of foreign aid is influenced

by other factors and reveals other motives. The ways that aid is allocated and the tying of aid have

profound effects on the overall contribution of aid to development and welfare goals. In this section

we will briefly discuss three types of motives for countrys providing foreign aid; morale, economic,

and political motives for aid.

Morale Motives

Historical Reasons

Several developing countries have historical ties with a developed country, as a consequence of the

colonial era. This provides a developed country with a motive to give aid to its former colony. This

statement is also made by the paper of Alesina&Dollar(2000). In their regression analysis the own

colony variable is highly significant with respect to aid giving pattern of the donor country.

Moreover, this can be interpreted as elasticitys. For instance, doubling the length of time as a colony

of France would result in a 100% increase in aid. Moreover, even against variables as democracy

and openness, colonial past is more significant in determining the allocation of aid. For example, a

non-democratic closed developing country with a colonial past receives twice as much aid as an

developing open democratic country with no colonial past.

Sense of Responsibility

Based on our ethics, norms and values, we find it hard and morally unacceptable to see countries and

its citizens suffer from poverty. Practically all individuals, companies and foundations who give

voluntarily to support the work of humanitarian and development charities do so because of some

sense of responsibility or duty to help people suffering and in need. Based upon this public opinion

governments state that they provide foreign aid for these moral reasons This provides grounds for

foreign aid, to share our wealth and reduce their poverty out of solidarity. This obviously implies that

rich countries are the donors while poor countries are recipients, as is shown by Alesina&Dollar

(2000). One particular ethical theory closely associated with this argument is described by

Riddell(2007) Utilitarianism. The basic notion that moral life should be guided by the objective of

trying to achieve the maximum happiness and satisfaction for the greatest number of people.

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Consequently, if greater overall satisfaction can be achieved by providing assistance to those in need,

then we should do so. As long as the reduction in our happiness is less as the raise in their happiness.

Furthermore, after the declaration of Human Rights in 1949, the developed countries also had a

responsibility in taking care of these human rights. Hence, human rights perspectives and approaches

form another important framework which provides profound grounds for foreign aid. Extreme

poverty has repeatedly been described in UN documents as a violation of human economic, social

and cultural rights. Therefore, attention should be given to their fulfillment. Encompassing human

rights is the equality in gender and race, which should be ensured through foreign aid giving.

Although, the human rights perspective provides solid grounds for foreign aid it is a very broad

perspective and therefore difficult to use for pointing out responsibilities and tasks.

Economic Motives

Financing Gap

One of the first economically derived motives for foreign aid was the financing gap and the 2 Gap

Model as described by Chenery and Strout (1966). Firstly the investment-savings gap, It assumes

that developing countries have no money left to save and consequently to invest. They need every

penny to survive and there consume it. When they receive money through foreign aid to bridge the

gap so they can invest an become self sustainable. The second gap explained by Chenery and Stout isthe foreign exchange gap or the balance of payments gap. The developing countries are structural

importing more goods in terms of value than they are exporting. As a result they face a structural

deficit on their balance of payment. These gaps can be solved by a flow of foreign capital as the

following economic model will show.

Under the assumption that goods and services in an economy come from two sources, domestic

output and imports we can derive an economic equation: Y = C + I + ( X M )

Government and individuals can choose to either consume or save, and therefore we can derive the

following equation: I = S + (X-M)

Y national income C consumption

I investment S saving

X exports M imports

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In this equation we can calculate that for a certain investment to be made there is the requirement

of a certain amount of savings and/or a certain trade balance (X-M). When investment is greater than

the savings, a savings gap exist. Moreover, when imports are greater than exports a trade gap exists.

These gaps dont have to equal each other, and usually they differ. As a result of this economic

model the gaps must be met by a net capital inflow. According to Chenery and Strout(1966) foreign

aid stimulates development in this way by filling in the gap of domestic savings as well as closing the

trade gap. However, this theory was criticized by other economists. For instance Easterly(2003)

shows that this foreign capital flow leads to consumption instead of investment and Griffin(1970)

performed a data analysis and found that there was a negative correlation between aid and savings.

Commercial interests

Since aid was provided, it has been linked with the commercial interests of donor countries.

Commercial interests were expressed in a lobby under politicians by businesses to gain access to aid

funds, by using the main argument of win-win situation. Where domestic jobs and export will get a

boost while simultaneously development will be stimulated abroad. Hence, commercial interests of

donors remain a significant determinant of current donor relationships. This phenomenon of the

commercialization of aid is particularly visible in the tying of aid. Data reports published in 2006 by

the OECD/DAC2

showed that only 42 percent of Official Development Aid was reported by donors as

untied. This tied aid is very costly, because it undermines the benefits of free trade within a free

competitive market. The obligation for developing countries to trade with their donor countries is

detrimental for their overall development and the world trade system.

Political Motives

After the Cold War the political incentives for giving aid seemed to disappear. See also the graph on

ODA in section 1. However, foreign aid remains a strong instrument in forming the political landscape

and international relations. For example, we still see that Russia gives aid to different countries than

the USA with respect to the middle east problems with the Palestine and Israel. Alesina and

Dollar(2000) describe this relations as UN friend variable and find this variable particular significant

for all the major players in international relations in their regression analysis. Money is a strong mean

to influence peoples behavior. As is the case for countries. Therefore, if you want to form a coalition,

this can be done through decisions on the distribution of foreign aid. Japan is a good example with

respect to receiving countries of Japanese Aid and voting behavior within the UN. Furthermore, this

voting behavior shows the existing political alliances between countries, which provide incentives for

2Source: www.oecd.org

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the allocation of foreign aid. For the future, the US is building an alliance in their war on terror. For

example the case of ODA in Iraq mentioned in section 1. Therefore, the link between national

interests and aid giving will continue to exist. This resembles to the cold-war era.

In conclusion, it seems that the allocation pattern of donors is not so much dictated by the numbers

of poverty or good governance. Instead, historical, political and commercial criteria matter greatly in

the allocation of foreign aid. Foreign aid has become an instrument in the self interest of donor

countries. This is detrimental to aids potential development and human welfare effects.

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3. Why would Aid work and why would it not work?

Since the 1990s many research has been done on aid effectiveness. In mid-1990s talks about the

future contribution of foreign aid were mainly pessimistic. Many developing countries faced

deepening poverty, even though they received large amounts of aid. Many academics say this is not

only the recipients fault, but its often the donor who had too little control over how the finance was

used by the government for a particular project (Collier & Dollar, 2001).

Since the 1980s almost every country in Africa received large amounts of aid, mainly aimed at

stimulating political reform. The results have varied enormously among the recipient countries.

Different academics formed different opinions about the topic of foreign aid. Hansen and Tarp said

that aid is effective, without qualification, in enhancing the growth process. Collier and Dollar (2001)

put it in a different way. They say that aid is effective in some circumstances and in other not, or less

effective.

In the 1980s the typical African country had government intervention in almost every sector of the

economy. Donor countries agreed on the fact that improving economic policy was the highest

priority. They started aiming their aid at inducing governments to reform their policies. Twenty years

later there is no relationship visible between the amounts of aid given and the extent to which the

receiving countries reformed their policy. Clearly the process of policy reform was more affected by

domestic factors than by aid. (Dollar et al, 2001)

Donors tend to discriminate against poor countries that have put good policy into place. Aid rises as

policy improved. However in many cases, once good policy was achieved, aid declined. Donors

started to turn aid into conditional assistance, and then in fact, it has outlived its usefulness by this

point. Conditionality is useful during a period of rapid reform in which the government is trying toestablish its credibility as a reformer and get macroeconomic policy measures well entrenched.

Conditionality might disguise the ownership of reforms. It tends to limit participation in policy

making (Dollar et al, 2001).

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situations are superior for large programs. But in the end it all depends on what the government

does with the resources that are given by the aid projects. The way the government implements the

given resources is important in their evaluation of the impact of their aid.

The question of what aid ultimately finances is interesting when the preferences of the recipient and

donor differ. If the preferences are identical it would not matter if aid is given as budget support of

to a specific project.

These different types of aid operate in different ways in the receiving countries and every type has its

own conditions relating to the different countries. This results in different effects in every specific

country. (Mavrotas and Ouattara, 2003)

Main arguments pro aid

Why would aid work?

Many academics have argued that, even though aid has failed in some cases, it has been successful in

some countries, where it supported growth and poverty reduction, and prevented worse

performance in others. People like Jeffrey Sachs and Joseph Stieglitz believe that a lot of the

weaknesses of aid have more to do with the donor countries than with the recipients. They point to a

number of successful countries that have received large amounts of aid such as Botswana, Indonesia

and Tanzania.

The optimists argue that aid augments saving, adds to the capital stock and finances investments. For

example; aid is likely to increase investments in health and education, which increases worker

productivity. Aid could also provide a conduit for the transfer of knowledge and technology from

developed countries to poor countries by paying for imports, technical assistance of through direct

transfer of technologies. One good example of this is the introduction of fertilizers and new seeds in

the Green Revolution. This all contributes to a better economic environment (Radelet, 2006).

In their book, Dollar, Devarijan and Holmgren (2001), argue that development programs must be

country-owned, not donor-owned and that this is the way to make assistance effective. They use

data from ten case studies done in Africa. All ten received large amounts of aid, but ended up with

different policies. This suggests that aid is not a primary determinant of policy.

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The overall view is that aid works in a good policy environment (Mavrotas and Ouattara, 2003). So

this states that if donor countries want aid to be effective, they should focus on countries with good

economic policy. We will go further into this in paragraph four about conditions for effective aid.

Main Arguments against aid

Why would aid not work?

Aid has always had its critics who say it does more harm than good. Within the discussion about aid

effectiveness there are a lot of pessimists. Several observers argue that large amounts of aid from

developed to poor countries is wasted. They say that aid is increasing unproductive public

consumption. They point out different reasons for these results such as corruption, bureaucratic

failures, poor institutional development and inefficiencies in the developing countries.

As mentioned in section one, aid started as an institution in 1947 with the Marshall Plan. Almost

immediately there arose concerns over the behavior and attitudes of recipient governments. The US

was worried that the European countries were relying too much on foreign funding and not able to

mobilize resources themselves for their recovery. At this point it was already argued that too little

attention is being paid by the participants to the elements of self-help. (Knack, 2001)

As aid started to expand across more poor countries, practitioners began to emphasize that foreignaid must not involve dependence but should be based on partnership. Riddell calls aid dependence;

a state of mind, where aid recipients lose their capacity to think for themselves and thereby

relinquish control. There have been concerns about the effects of aid giving from the moment it

started.

As was discussed in section 2, Allesina and Dollar (1998) found evidence that the aid giving pattern is

dictated by strategic and political considerations. A mismanaged non-democratic, inefficient,

economically closed former colony, politically friendly to its former colonizers, receives often more

aid that another country which has the same level of poverty and a better political situation, but

without a colonial past. They did not only find significant differences between receiving countries but

also between donors. Some donors respond more to correct incentives, namely good institutions,

income levels and openness. Other donors give former colonies aid tied by political alliances, without

regard to other factors such as poverty levels of choice of political regimes. Donors also tend to give

more aid to countries that have democratized. Most of these countries received aid immediately

afterwards.

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Boone (1996) finds that aid has no effect on investment or growth. Burnside and Dollar (2000) put

this in a different way. They say that aid has a positive effect on growth when a country has good

policies and has no effect when it has poor policies.

Another reason why aid is likely not to work is the lack of coordination. In many of the aid giving

cases aid coordination lacked in the period before 1990. In the 1990s it improved considerably, with

governments playing a more active role. Since then there is more partnership between donors and

recipients. Because of the lack of coordination, the receiving country doesnt know what to do with

the aid, and so it doesnt go to the right places, which makes it ineffective (Dollar et al. 2001).

Another big problem with aid effectiveness is the case of poor governance. Governance reforms can

happen, and they did in some countries. And aid can even contribute to these processes. Yet we

believe that foreign aid poses more problems than good for governance in aid-dependent states.

Knack (2004) says that underlying the litany of Africas development problems is a crisis of

governance (pp. 255). Here he refers to the poor quality of institution, high levels of corruption and

weak rule of law which still characterizes many governments in Africa today.

There are many reasons for the poor status of governments in developing countries. A few of them

are colonialism, economic crisis, civil wars and political instability. It is hard to separate the impact of

these factors from the impact of foreign aid, which is most of the times high in the countries that

have to deal with these kinds of problems.

State capacity and governments have never been really strong in many developing countries. The

new independent nations were not prepared for self-government and many faced ethnic tensions,

which had been established during colonial rule. Many countries also suffered from economic crisis,

which is a big contributor to poor governance. Another major problem in Africa has been the

experience of political instability and the presence of war. Political instability, often a result of civil

wars and violent coups, disrupts the whole society and makes the countries more dependent on aid.

Despite some benefits aid can have, it is also possible that the way aid is delivered makes it more

difficult to develop good governance. This means improving the law system, building a better

bureaucracy and reducing corruption (Knack, 2004).

Academic literature also finds that in the period 1982-1995 aid has been associated with an increase

in corruption and deterioration in bureaucratic quality and the rule of law. Since 1995 donor

community has given much more attention to corruption. Many projects now were explicitly

designed to reduce corruption and all projects show greater awareness of the potential dangers.

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Despite these new projects to reduce corruption, aid is proven to be a weak instrument for reducing

corruption (Collier and Dollar, 2001).

Aid might help spur growth in countries with reasonably good policies, but might fail to do so where

corruption is rife and the economy is badly mismanaged (Radelet 2006).

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success. OED independence within the World Bank means that there is no necessary bias in the

results. Historically half of the reform programs in Africa supported by lending have been judged to

be a failure by OED. This is in line with the literature that has highlighted the poor policy

performance of many African countries. (Svensson, 2002)

The biggest problem with measuring aid effectiveness is that data is incomplete; the reason for this is

often data is not obtained properly at periods of civil conflict and periods of domestic unrest, which

tend to be common problems in the developing countries.

It is difficult to measure aid dependence, because it cannot be directly measured. This is why a proxy

which reflects aid intensity is used often (Knack, 2001).

Some countries with low incomes per capita are less dependent on aid that others, this indicates that

aid dependence is not simply a function of poverty.

Aid and Economic Growth vs. Socio-Political Factors

Most foreign aid is designed to meet one or more of four broad economic and development

objectives (Radelet, 2006):

- Stimulate economic growth through building infrastructure, supporting productive sectors

such as agriculture, or bringing new ideas and technologies

- Strengthen education, health, environment, or political system

- To support subsistence consumption of food and other commodities, especially during relief

operations or humanitarian crises

- To help stabilize an economy following economic shocks.

Economic aid has always been the main yardstick used to judge aid effectiveness, with more aid

expected to lead to faster growth. At a very broad level, there is no apparent simple relationship

between aid and growth. Some countries have received large amounts of aid and have recorded

rapid growth, while others, who also received large amounts of aid, recorded slow or even negative

growth. At the same time, some countries that have received very little aid have done very well,

while others have not.

Several early studies found a positive relationship between aid and growth. The tendency is that the

greater the capital inflows from abroad, the lower the rate of growth of the receiving country.

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(Hansen & Tarp). Aid also can have a positive impact on development outcomes other than growth,

such as health, education or the environment.

Conditions for Effective Aid

Policy Reform

Governance is added to the list of conditionalitys imposed as requirements for funding from the

World Bank, IMF and bilateral donors. Poor governance is not the result of one cause, it has multiple

causes. Once it starts to decline, it gets into a vicious cycle and poor performance is easily created

(Knack, 2004). Many other academics agree that good policy is significant to raise growth. A receiving

country with a new government is more likely to have success than a country with a government who

are in power for a long time.

Collier and Dollar (2001) say there is also a difference between different types of governments. A

democratically elected government has a 95% probability of success. An authoritarian government,

although in power for 12 years, only has 67% chance at success. These governments are less likely to

change and by a large extent the low success rate of reform programs can be explained by

characteristics that can change. Dollar et al. (2001) state in their book, with case studies on aid and

reform, that there is no relationship between formal democratic institutions and reform. The twostrongest positive policy reformers from these case studies Ghana and Uganda had both leaders

who came to power through military coups. Other, democratically elected governments, never

seriously embraced economic reform and were not as successful as Ghana and Uganda. These two

successful countries were convinced that market friendly policies were not desirable. The failures

that followed helped trigger the introduction of market-based reform programs. These programs

received good support from the donors. Aid flows increased when the reform programs took off. Aid

started to decrease in the 1990s when policies were still improving. Conditional financial aid was

later most helpful in pushing the reform agenda and implementing the reforms (Dollar et al. 2001).

This shows that sometimes failure is needed for a country to see they are acting the wrong way.

The situation was different for the post-socialist reformers from the case study of Dollar et al. Aid

volumes they received were quite steady over time. These countries received large amounts of aid

irrespective of policy performance. When policies got worse, aid in relation to GDP increased. The

worse the policies got the more aid they received. Technical assistance had played a large role in this

group of reformers.

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Mixed reformers received more aid when their policy was bad than they did when policies were

good. In the 1990s policies and aid levels moved in a synchronized way for the mixed reformers.

Only a small amount of cases shows that policy significantly improves in the following five years, and

in a same amount of cases it significantly worsens. This shows that large changes in policies are the

exception, not the rule. Aid can be expected to have two opposing effects on the incentive for a

government to reform. If aid is linked to reform there is one favorable substitution effect; if the

government agrees to reforms it will receive more aid. Offsetting this effect is the income effect; the

more aid the government expects to receive, the less necessary it is to implement those reforms

which are politically costly. (Collier & Dollar, 2001)

Dollar et al. (2001) say that donors should look at the quality of policy in the receiving country, not

only at how poor the country really is. Also the composition of aid is important. In the pre-reform

period donors should provide technical assistance and policy dialogue. During the reform period

policy dialogue is also important as is finance. At a later stage in the reform period, dialogue gets less

important while finance increases in importance. By altering the quantity and composition of aid,

donors could more systematically support genuine policy reform in the developing world. (Dollar et

al, 2001)

The general finding is that different instruments work in different phases of the reform process. If

donors use the wrong instrument at the wrong time, it will be a waste.

Each country has a pre-reform phase of very poor economic policy and no coherent political

movement to change the situation. There is a general agreement that technical assistance and

political dialogue are useful in this phase. It can lay the foundation for policy learning. Conditionality

does not work in this phase. The receiving countries are mostly not able to implement the

agreements at that time.

Some case studies prove that aid financing can lead to worse economic policies while in other cases

the absence of aid finance encourages reform. In the case of aid absence the impact of poor

economies was clear and the political leaders felt that they had little choice but to undertake serious

reform. So it seems that large-scale finance in the pre-reform period has a negative effect and

reduces the need to reform.

After this period there is a phase of rapid reform. In this phase aid finance plays an important

supporting role. When countries actually reform, finance increases the benefits of those reforms. Aid

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increases confidence in the reform program and call forth greater private investment. In this phase

technical assistance and policy dialogue retain their usefulness. Conditionality to be useful must

reflect measures that the government wants to carry out, not one imposed by outsiders. (Dollar et al

2001)

Collier and Dollar (1998) estimate that if aid is redirected towards poor countries with good policies,

more than twice the number of people could be lifted out of poverty for the same aggregate level of

foreign aid.

Countries that have successfully reformed have had clear political movements leading to these

changes, what is often referred to as local ownership of reforms. Countries that have made less

progress typically have had powerful vested interests blocking change. Economic policies are

primarily domestically grown. While the recipient countries have different economies and go through

different phases of reform, donors tend to do the same things everywhere and at all times.

The overall thought is that in order to be effective, aid should be given to a country with good

economic policies. So for a development country to attract more foreign aid, they should consider

policy reform.

Recent literature indicates that policies depend primarily on domestic political-economic factors.

There is no ongoing relationship between aid and reform. The average relationship is likely to

disguise the fact that aid supported policy reform in some cases and sustained poor policies in

others. Improvement in economic policy is the key to more rapid growth and poverty reduction. The

question is; how can aid support these improvements? Collier and Dollar (2001) estimate the

poverty-efficient allocation of aid. They assume that aid has no effect on policy. But the effect of aid

on growth and poverty reduction increases with quality of good policy. Therefore aid should rise with

the quality of policy

Good governance and no corruption

Donors should not be too concerned about providing program aid in low probability environments.

As shown in the section above donors are often concerned about governance. There is a need for aid

policy to take government corruption into account. Good governance is desirable for aid to be

effective.

Donors can choose between two approaches when factoring this into their programs. The maximal

approach is to allocate aid so as to induce improvements in governance, whereas the minimal

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Between 1970 and 1996 Tanzania received a total of 16,632 million US dollars in foreign aid. This

accounted for 80 percent of total net inflows. In per capita terms aid peaked in the 1980s and early

1990s with more than US$40. As a share of GDP it peaked in 1990 at 30 percent. Tanzania was highly

dependent on aid, but the dependence declined significantly in the 1990s.

They received aid from more than 50 donors. The Nordic European countries have been the major

donors, accounting for more than 30 percent of the total aid between 1970 and 1996. At first it was

mostly bilateral aid they were receiving, since the 1980s the share of multilateral aid was rising.

The composition of aid also changed over time. In the beginning, the 1960s, investment projects

assistance made up almost two-third of total aid. In the 1980s aid shifted from project aid to program

aid. Reason for this was the growing balance of payment problems in Tanzania. This was seen as

evidence that project aid was unsuccessful and import support was needed to raise the level of

output.

Over the period 1970-1996 there can be three different phases of aid identified. The expansion

phase is the first one, which took place from 1970 to 1982. In this period the willingness of donors to

extend aid to Tanzania can be explained by the development policies the country pursued at this

time. It motivated many donors to provide aid to the country, this because the policies were in line

with the thinking of social democrats in Europe. The second phase was the contraction phase, from

1983 till 1985. In this period the donors attitude towards Tanzania changed. Donors became critical

of the countrys development strategy. There was evidence that effectiveness of aid had been low.

The general view among donors from Europe was that aid to Tanzania could not be effective unless

the country agreed to redress inappropriate domestic policies. Despite this general view the Nordic

countries continued to provide aid to Tanzania, although at a reduced rate. Aid flows scaled down.

The last phase was the adjustment phase from 1986 to 1996. The country made an agreement with

the IMF in 1986 helped to restore the donor confidence. Bilateral aid resumed leading to a second

boom in 1992. Tanzania is an example of a developing country in which foreign aid was attracted by a

good political situation.

To improve effective utilization of foreign aid and domestic resources efficiently national leadership

needs to articulate a development vision that inspirers its own population and gives hope for the

future. One of the most important visions for Tanzania is that of the commitment to primary

education, access to basis health care and clean water for everyone.

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Case Example 2 Aid Does Not Work in Kenya

In the years from 1980 to 1998 Kenya was engaged in a program of structural adjustment reform

with support from the World Bank. In the years before, from the 1970s, Kenya buildup nominal flows

of ODA. In the 1970s they received an average of US$205 million per year, this increased during the

1980s to more than US$630. In the 1990s it even went up to US$1 billion. This growth in nominal aid

flows in Kenya has followed the pattern for Sub-Saharan Africa as a whole. While there was great

buildup in nominal aid, there has been a decrease in donor support in the 1990s. Aid flows decreased

and the level dropped well below that of the mid-1980s.

Kenya has performed a curious mating ritual with its aid donors. Kenya won its yearly pledges of

foreign aid and then the government began to misbehave. The donors retreated, but Kenya knew to

get them to review the case and then aid was pledged again. This is the vicious cycle aid in Kenya is in

right now. So when is foreign aid policy credible?

One of the ongoing challenges in Kenya was donor coordination, this mainly because of the

multiplicity of donors. Almost every Western donor country has been active, putting large demands

on the time of the senior government officials. While at the same time the government of Kenya

showed no effort to better coordinate donor activities.

In Kenya donors supported the Institute of Policy Analysis and Research to help set op local capacity

for policy formulation and analysis. This didnt have a large pay-off as long as vested interests

blocked any form of political reform. But it was an essential foundation for any political movement

which established for change and reform.

The large amounts of aid received, were given in return for policy undertakings. In the early 1980s

and in 1993 the land was in severe economic crises. In these periods the governments need for

foreign support was huge, especially financial support. This desperation did induce the government

to make agreements on reform programs. However, these agreements were most of the times not

implemented. Foreign aid can have an influence on the form of agreement reached and on the

agreed timetable for implementation, but whether implementation is carried out depends in the end

much more on domestic political and economic factors than on the donor presence.

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In the times large-scale aid was absent, the impact of poor economic policies was clear. The political

leaders felt that they had little choice but to undertake serious reform. So in the early 1990s they

introduced reforms such as liberalization of foreign exchange and foreign because relations between

government and donors strained and financing was in decline. Despite these intended reforms Kenya

failed to make foreign aid effective. In Kenya, study shows that policy failed to improve and in some

points even got worse, despite large amounts of aid given and series of adjustment loans and that

foreign aid was ineffective.

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Conclusions

Most observers conclude that foreign aid has at best been sometimes partially effective at promoting

economic growth and improving human welfare. In this article we have shown that current foreign

aid will remain at best partially effective at promoting economic growth and improving human

welfare.

First of all, history was always the one to learn from, and 50 years of foreign aid has taught us many

lessons for which we came up with new ideas for more effective foreign aid. However, it seems that

we have run out of ideas and fall back on old ideas. Jeffrey Sachs is the leader of the UN Millennium

Development Goals Project and author of The End of Poverty (2005). He is a profound planner who isconvinced that the end of poverty can be planned when there is enough money made available by

the rich countries for a big push. William Easterly(2006) however, describes it in his article as the big

push dj vu and claims that it is proven by the last 50 years of development aid that planning and

huge sums of money wont work. He argues that piecemeal efforts through trial and error with

accountability and feedback will provide success in development. The so called searchers approach.

There is no big universal solution to solve the problem of underdevelopment and poverty. It depends

on domestic sociological, economic and political factors.

Secondly, Burnside Dollar(2000) have shown in their paper that aids impact on growth is very limited

and can be counterproductive. However, they claim that when foreign aid is given to countries with

solid governments which conduct good policies aid is effective. This statement has been criticized by

numerous authors. For example Easterly(2003). He uses the same statistical methods with additional

data and shows that this claim cant be made for the entire period of foreign aid. Moreover, when

aid effectiveness is subject to good policies. How are these good policies to be defined? Moreover,

once these good policies are defined, how are these to be implemented in a developing country?

The problem with aid under the right conditions is that it is very unlikely for developing countries to

meet all of the required conditions for aid to be effective. Many developing countries suffer from

poor policies and do not have good governance. We argue that even in the case of policy reform aid

is not likely to contribute to economic growth. The literature showed us there is no ongoing

relationship between aid and reform. In most cases policy reform even sustained poor policies. This

is shown in the case example of Kenya. They were in a big economic crisis and try to reform policy in

order to receive aid from donor countries. This shows that donor pressure is a big problem and not

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the right way to handle the problem. Recipient and donor governments should work together and

there should be more coordination. This way both the donor and recipient know what to expect from

each other.

The case studies also show that in the end aid effectiveness depends on domestic political and

economic factors. The biggest problem here seems to be corruption and civil conflicts, which both

makes aid ineffective and can have an adverse income effect which reduces economic pressure for

accountability. We argue that donor countries should be more concerned with the political and

economic environment in the receiving country. Aid should not be given to countries with poor

polices, because they are not able to implement aid in the right way. When aid is given, donors

should coordinate and work together with the receiving government. Furthermore, donors should

not be too concerned with policy reform. In most cases policy reform doesnt mean the country is

ready to receive aid and use it the right way. Besides that, there is the dilemma whether foreign aid

stimulates good governance or whether good governance stimulates aid.

Thirdly, do these good policies actually matter if the aid allocation pattern is determined by other

factors? Alesina Dollar (2000). We argue that aid giving is not so much determined by altruistic

reasons for contributing to the development, growth and poverty eradication in poor countries.

Instead, historical, political and commercial motives seem to prevail. This is detrimental to the

effectiveness of foreign aid. Moreover, the economic motive of the 2-gap model Chenery

Strout(1966) lacks evidence and can be even counterproductive.

Lastly, despite the lack of likeliness one could say that if it sometimes works, aid should continue.

Amongst several authors Boone (1996) has criticized on that by showing the counterproductive

effects of foreign aid.

We are convinced, that it is clear that its not likely that current foreign aid giving is actually working.

Therefore, due to the enormous costs and the possible counterproductive effects other ways shouldbe found to actually help the developing countries. This is a subject outside the scope of this article,

but the answer can be found in small piecemeal efforts through accountability and feedback.

Furthermore, through NGOs who work with the local citizens.

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