Re-thinking Foreign Aid

CAMBRIDGE: Rich countries of the world give a considerable amount of foreign assistance to poorer countries every year, around $60 billion in net assistance. While this is not a particularly generous proportion of rich-country income (roughly one-fourth of one percent of their combined gross national products), it is a lot of money just the same. We might expect to get more results for this money, but in fact, most aid recipients are doing poorly in economic performance, and several studies have shown only weak links between foreign aid and improvements in living standards in the recipient countries.

The World Bank has recently offered one reason for this weak linkage: many aid recipients have poor economic policies, such as excessive state intervention in the economy, high levels of corruption, macroeconomic instability, and the like. The Bank rightly stresses that aid cannot work in an otherwise inappropriate economic environment. The Bank's solution is therefore clear: aid should be better targeted to those countries undertaking economic reforms and aid should be cut off when governments are mis-using aid or are otherwise highly corrupt.

This advice is fine, and to be supported, but it does not really go very far. There are at least two additional reasons why the assistance process is failing. The first is that most aid recipients are drowning in foreign indebtedness, with the money often owed to the very same governments and international agencies providing the "aid." Much aid, in fact, is simply the delivery of dollars for recycling to repay debts owed to the IMF and World Bank and rich-country governments. The "donors" do not cut off aid flows because they know that their past loans would fall into default if new money is not delivered to the countries to repay the old debts!

The second reason is that the aid delivery is itself highly flawed and poorly designed. For example, a considerable amount of aid is simply payments to domestic firms in the rich countries to sell unneeded products to the poorer countries. Thus "aid" is often a marketing device for low-priority goods from the rich-countries. And since a lot of the aid is in the form of loans rather than grants, the poor countries get even deeper into debt as they are encouraged to purchase supplies, products, and technical assistance from the rich countries.