2.4 Foreign Aid and Economic Development in LDCs
2.4.1 General Global Trends
Foreign aid is usually associated with official trend
development assistance, which in turn is a subset of the official development
finance, and normally targeted to the poorest countries (World Bank, 1998). One
may present a question then: How does foreign aid affect the economic
growth of developing countries? This is a question which has always drawn
the attention of many scholars over time may not be answered to universal
satisfaction. Papanek (1972) finds a positive correlation between aid and
growth. Fayissa and El-Kaissy (1999) show that aid positively affects economic
growth in developing countries. Singh (1985) also finds evidence that foreign
aid has positive and strong effects on growth when state intervention is not
included. One may suggest that foreign aid has an effect in eradicating poverty
in general.
Snyder (1993) shows a positive relation between aid and growth
when taking country size into account. Burnside and Dollar (2000) claim that
aid works well in the good-policy environment, which has important policy
implications for donors community, multilateral aid agencies and policymakers
in recipient countries. Developing countries with sound policies and
high-quality public institutions have grown faster than those without them,
2.7% per capita GDP and 0.5% per capita GDP respectively (World Bank, 1998).
By contrast, other people find foreign aid has negative impact
on growth. Knack, (2000) argues
that high level of aid erodes institutional
quality, increases rent-seeking and corruption,
therefore, negatively
affects growth. Easterly, Levine and Roodman, (2003), using a larger
sample size to re-examine the works of Burnside and Dollar,
find that the results are not as robust as before. Gong and Zou, (2001) show a
negative relation between aid and growth. Pedersen, (1996) argues that it is
not possible to conclude that the foreign aid has a positive impact on growth.
Morrisey, (2001) claims that aid works well conditional on other variables in
the growth regression; while other authors find no evidence that aid affects
growth in developing countries. By and large, the relation between aid and
economic growth remains inconclusive and is worth being studied further.
According to the Modernization theory, aid is found to have a
positive impact on economic growth through several mechanisms in that, aid
increases investment , aid increases the capacity to import capital goods or
technology , aid does not have an adverse impact on investment and savings, aid
increases the capital productivity and promotes endogenous technical change
(Morrissey, 2001). Papanek (1973), in a cross-country regression analysis of 34
countries in the 1950s and 51 countries in the1960s, treating foreign aid,
foreign investment, other flows and domestic savings as explanatory variables,
finds that foreign aid has a substantially greater effect on growth than the
other variables. He explains that «aid, unlike domestic savings, can fill
the foreign exchange gap as well as the savings gap. Unlike foreign private
investment and other foreign inflows, aid is supposed to be specifically
designed to foster growth and, more importantly, is biased toward countries
with a balance-of-payment constraint». He also finds a strong negative
correlation between foreign aid and domestic savings, which he believes
co-contribute to the growth performance.
Fayissa and El-Kaissy, (1999) in a study of 77 countries over
sub-periods 1971-1980, 1981-1990 and 1971-1990, show that foreign aid
positively affects economic growth in developing countries. Using modern
economic growth theories, they point out that foreign aid, domestic savings,
human capital and export are positively correlated with economic growth in the
studied countries. This is consistent with the economic theory of foreign aid,
which asserted that overseas development assistance accelerates economic growth
by supplementing domestic capital formation (Chenery and Strout, 1966). Between
1980 and 1989, the World Bank and the IMF gave an average of six adjustment
loans to each country in Sub-Saharan Africa, and almost as many to the
countries of Latin America, Asia, Eastern Europe, North Africa and the Middle
East. A similar strategy would be tried again in the 1990s during the second
Mexican debt crisis of 1994-1995 and then again two years later, after the East
Asia crisis of 1997-98. The operations were successful for everyone except the
patient. There was much lending, little adjustment, little growth and little
poverty reduction in the 1980s and 1990s. As the World Bank President Barber B.
Conable noted in his Foreword? to the World Development
Report of 1990?253 (WDR1990): «...for the poor in the poor countries
the 1980s was a lost decade». Easterly (2001). In this respect it
follows that foreign aid can be subjectively construed and this confirms the
interactionist view.
Snyder, (1993), taking country size into account, finds a
positive and significant relationship between aid and economic growth. He
emphasizes that «previous econometric analysis has not made allowance for
the fact that larger countries grow faster, but receive less aid». He also
claims that donors favour small countries for a number of reasons.
First, donors who are seeking support from recipient countries
find it better to provide aid to many small countries than to focus on just few
large countries. With the same amount of aid, the proportion of aid over GDP
will be bigger in small countries compared to that of larger countries and as a
result, give them more credits. Second, there is pressure on multilateral
donors to deliver aid to all member countries and due to their feasible project
size, small countries tend to receive more aid than they expected. Third, small
countries tend to have historical colonial relations with donor countries,
which are somewhat influential to donors? aid giving decisions. The last reason
is that trade normally has larger fraction of GDP in small countries than in
big ones and therefore, these countries may be gaining more weight in donors?
assessment.
On the other hand, persuaded by the Dependency Theory, Knack
(2000), in a cross-country analysis, indicates that higher aid levels erode the
quality of governance indexes, i.e. bureaucracy, corruption and the rule of
law. He argues that «aid dependence can potentially undermine
institutional quality, encouraging rent seeking and corruption, fomenting
conflict over control of aid funds, siphoning off scarce talent from
bureaucracy, and alleviating pressures to reform inefficient policies and
institutions». Large aid inflows do not necessarily result in general
welfare gains and high expectation of aid may increase rent-seeking and reduce
the expected public goods quality. Moreover, there is no evidence that donors
take corruption into account seriously while providing aid (Svensson, 1998).
The aid conditionality is not sufficient and the penalties are not hard enough
when recipient countries deviate from their commitments. In fact, there are
incentives for aid donating agencies to disburse as much aid as possible. This
hinders the motivation of recipient countries and raises the aid dependency,
which in turn distorts their development. Other scholars believe that different
types of aid have different impacts on growth.
In a country analysis of Cote d?Ivoire from 1975 to 1999,
Ouattara (2003) categorizes foreign aid into project aid, program aid,
technical assistance and food aid. Using a disaggregation approach with auto
regressive techniques, he finds that (i) project aid displaces public savings,
impact of program aid is almost neutral while technical assistance and food aid
increase public savings and project aid and (ii) to a lesser extent, program
aid, worsen the foreign dependence of Cote d?Ivoire while technical assistance
and food aid reduce the gap. However, the region is still facing economic and
social problems, among which the most serious one is the unemployment,
estimated at about 15% of the workforce.
There are twice as many jobless young people as in some
countries compared with regional average, requiring the creation of 4 million
jobs a year in the next few years in order to accommodate new entrants into the
labor market. The Iraq war and the ongoing Palestine-Israel conflict also had a
negative impact on the economic performance of the region in 2002. As a result,
regional economic growth fell from 3.2% in 2001 to 3.1% in 2002 with continuing
declines of investors? confidence, exports and tourism.
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