Effectiveness of Foreign Aid | An Analysis

Abstract

Critics of foreign aid contend that much of it is ineffective or even hinders development. They argue that risk aversion—being concerned more with disbursing funds than achieving results—discourages local innovation and that a presumption that funders and their professional staff know which strategies will succeed discourages local learning. They maintain as well that the aid system is cumbersome, costly to administer, difficult to explain, and rarely transparent. These and other problems have encouraged the donor community to emphasize country ownership and promote results-based programs. The answers to these questions may be less complicated than they appear. Many appropriate techniques, tools and successful practices are in fact close by, but they have been overlooked, are poorly understood, or need to be adapted to a different set of circumstances. If they can be harnessed properly, U.S. foreign assistance could have the serious multiplier effect that has always been its underlying goal.

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Controversies about aid effectiveness go back decades. Some experts charge that aid has enlarged government bureaucracies, perpetuated bad governments, enriched the elite in poor countries, or just been wasted. Others argue that although aid has sometimes failed, it has supported poverty reduction and growth in some countries and prevented worse performance in others. This new working paper by CGD senior fellow Steve Radelet explores trends in aid, the motivations for aid, its impacts, and debates about reforming aid. It begins by examining aid magnitudes and who gives and receives aid. It discusses the multiple motivations and objectives of aid, some of which conflict with each other. It then explores the empirical evidence on the relationship between aid and growth, which is divided between research that finds no relationship and research that finds a positive relationship (at least under certain circumstances). It also examines some of the key challenges in making aid more effective, including the principal-agent problem and the related issue of conditionality, and concludes by examining some of the main proposals for improving aid effectiveness.

Why This Issue and Why Now

Interest in finding new and better ways to facilitate development—and proposals for how to do so—are not new. Nor are the main reasons for constantly seeking improved solutions; basically, anything that can result in more progress and leverage the limited available resources more effectively is beneficial both for the countries concerned and for the international community of institutions seeking to help them. Lately, discussion of this subject and of particular options that appear especially promising, has become much more prominent. There are several reasons for this, and they are important here because they go to the heart of questions that are fundamental for any investigation of possible new approaches to anything. Those questions are: What are the overall objectives being sought? What would the new options be aimed at achieving? Why are the existing options not sufficient? And what would a change from old to new options be expected to produce in benefits (after also taking into account the costs of the change)? One reason for the heightened search now for new options is that the current situation is widely felt to be inadequate. The prevailing levels of financial flows for development, domestically within developing countries and externally from donors and other partners, and the current mechanisms and practices for mobilizing and utilizing those flows are seen to be insufficient to meet the needs of developing countries to reduce poverty and achieve higher levels of development at the pace that they and the international community would like. Business as usual—it has often been said, whether at Monterrey, Group of Eight (G-8) meetings, or countless other “summits”—will not be enough to tackle critical problems fast enough.

Inevitably, given the diversity of these and yet further factors, the question of what the objective is in considering possible new approaches has no simple answer, as the next section further illustrates. Clearly, though, the guiding principle for deciding which options deserve the most attention is which would produce the most net benefits after taking into account the associated costs, including any transition costs. This, however, is no easy task, as will be apparent below.

What Are the Options: A Brief Introductory Tour

The options for new approaches that come up most often for discussion are currently both numerous (one can readily list at least twenty-five) and diverse (ranging from purely public sector to purely private sector initiatives, with a raft of mixed schemes in between). Box 1 lists several of them.

What to Make of It All

Making sense of this heterogeneous multitude of proposals—to understand them better and how they relate to one another—is no simple matter. A logical place to begin is with the options’ objectives—that is, what they are aiming to achieve. This is a natural extension of the broader question, noted above, of why search at all for new approaches. For virtually all the options here, the underlying objective has two elements: a specific problem to be fixed, such as a disease or the effects of natural disasters for uninsured parties; and a financing “opportunity,” such as debt to be repaid (in the case of the polio debt buy downs) or the terms of lending (in the case of the local currency lending option). In some options, the originating problem to be fixed is more salient, as in the case of market interventions for key medicines. In others, the financing opportunity seems to have had more weight, as in the case of debt relief.

Either way, problems and opportunities should drive decisions about which options to pursue, rather than vice versa—that is, rather than starting with interesting “solutions” and then looking for problems to apply them to. Leading from problems to solutions seems, in fact, to be what the options so far have done, although not entirely.

Results-Based Sequencing of Loans and Grants

As noted above, the “results-based sequencing of loans and grants” option is essentially an extended and broadened form of the “debt buy downs” employed successfully in the polio eradication campaign. In that case, a coalition with prominent grant funding from the Rotarians and the Bill and Melinda Gates Foundation helped countries pay off (hence “buy down”) debt from loans from the World Bank that were needed by those countries to mount intensive efforts to wipe out polio. The extended or broadened form combines the original concept with results-based (i.e., output-based) conditioning of support on performance. Here is how it works. A developing country’s government and an external funder together work out a program of support, under which the government undertakes to reach certain goals by specified dates (e.g., improve antimalaria programs and achieve a particular reduction in malaria deaths). The external funder agrees to support the work through either a loan (e.g., from the World Bank) or a grant (e.g., from a bilateral donor or a philanthropic institution). So far, this is nothing new, but here comes the difference.

A third party—most likely another grant financer but conceivably a lender—is part of the deal from the outset, committing to provide additional support when and only when the specified targets have been attained. The additional funding can be thought of as supporting the next phase of the work or ensuring the sustainability of the program or, as was the case in the polio eradication campaign, providing funds to pay off a part or all of the initial loan, if there was one. All three parties gain from this scheme. The country gets the money up front that is needed to do the work, and then has the assurance of more to follow if the work is properly completed. Its government gets other benefitsas well, including possibly the prospect of paying off some debt, always a popular move with voters. The initial external funder has greater prospects of seeing their support result in the desired outcomes. And the third-party financer can tell its overseers that its money will be released only when the results it is intended to support have already been achieved. Also, if it puts the money aside at the start of the whole endeavor, the value of that capital grows over time up to the point (e.g., five years later) when it is drawn down. There can also be benefits in the form of increased harmonization among donors, to the degree that the linking together of aid flows in results-based sequences results in closer partnership, with the country, in coordinating what programs are supported and how. But this harmonization aspect is also one of the challenges that must be solved to make this sequencing option successful and suitable for scaling up, because donors have thus far found that aligning themselves together in their development work is far from an easy undertaking.

A second challenge is getting grant financiers on board with sufficient funds to achieve significant impact. Despite the early examples set by the Rotarians and the Gates Foundation, the foundation world has been slow to follow. Bilateral donors, especially in Europe, have not yet shown much interest, but should; because they would gain a lot in terms of the objectives they are seeking in their assistance programs. Today, their traditional flows are having mixed results, with less leveraged effectiveness than could be achieved through results-based sequencing of aid. With so many donors now calling so strongly for more of a focus on results, there has never been a better time to pursue this option.

Conclusions

If the growing list of ideas and proposals for innovative approaches to financing is analyzed using frameworks like box 7-2 and concepts such as cost/benefit assessment incorporating political and other feasibility considerations, will we learn more than we know now? Will the current options become easier to understand and prioritize in terms of which deserve more research and/or immediate action, and which appear less promising? Will new options come to light, and be easier to spot and develop early on? Though this chapter merely scratches the surface of these questions, initial indications are encouraging.

The three examples described above—results-based sequencing of loans and grants, global development bonds, and investing in grassroots business organizations—demonstrate some of the vast variety of proposals that are emerging. They also reflect several more general points noted at the outset. All have potential, but verifying that potential would require testing them in practice and assessing their feasibility and impacts carefully. Furthermore, even if successful, none would obviate the need for other efforts as well, including existing initiatives and instruments and continued search for better ones. There is no silver bullet in this batch; each would help on some problems but would not solve all.

Another hypothesis suggested by the range of current options is that there has been an imbalance of attention thus far, with much focus on the public sector together with “official donors” and too little on options rooted in private sector activity. Yet the prospects for significant impact in accelerating development and reducing poverty may well be the reverse. The public–and–“official donor” sector options may have more limited impact than has been generally supposed, either because they will involve much smaller capital flows or will have difficulty getting widely adopted and implemented. The experience with the IFF, now funded by far fewer donor countries than had been hoped for originally, is an example. Conversely, the private sector options, with huge financial and organizational resources behind them, may have greater possible impact than they have been given credit for in the past.

A further general point underscored here is that the quest for innovative financing options needs to be properly and compellingly rooted in the overall objective of reducing poverty. This may seem rather obvious. But there is always the risk that fascination with instruments will weaken focus on the ultimate objectives that the instruments are intended to serve. The current “gold rush” for new financing ideas should not detract from appreciation of the need, in each developing country situation, to start first with a careful analysis of what the particular problems are in that society’s fight to reduce poverty, and then proceed to reasoned development of the appropriate solutions for each context.

References

World Bank, (2005). Global Development Finance: Mobilizing Finance and Managing Vulnerability. Washington, DC: World Bank.

DAVID de FERRANTI, Innovative Financing Options and the Fight against Global Poverty: What’s New and What Next?, Brookings Institution