Aid fungibility, ownership and the effectiveness agenda

For many people, aid fungibility is a misunderstood topic—it is mostly confused with the idea of corruption. Aid fungibility, on the other hand, is the concept that when aid is given to the government, it alters its planned expenditure in such a way that the incoming aid is not spent in the sector for which it is intended. In their book Program Aid and Development, White and Dijkstra summarize aid fungibility very well: “Aid does not pay for the item it is accounted for but for the marginal expenditure it makes possible”. This makes many policymakers and development partners uncomfortable, leading to the introduction of new aid modalities and conditionalities over time to make sure that the partner country governments do not move funds around.

But let’s take a step back and really analyze if the alteration in the planned expenditure of the partner country's government is such a bad thing. Let’s say that the development partner gives money to finance a large-scale health project in one of the provinces of the partner country. The government itself, having limited funds, had planned to spend a portion of its development expenditure on health and education in the same province. Now with the new aid flow, the amount of money available for health increases significantly, while the budget for other development sectors does not increase proportionally. The partner country government, therefore, decides that it will reduce its own expenditure in the health sector but instead increase its funding to an alternative development sector, like education, leading to aid fungibility. This kind of fungibility would have a positive welfare effect since an increase in education expenditure will complement health spending.

We have found evidence of such positive aid fungibility in both Pakistan and Rwanda. Moreover, we also observed in another study of thirty-five low and lower-middle-income countries that in some cases sectoral aid fungibility does lead to improved welfare of the partner countries.

One could argue that many low and lower-middle-income countries lack the institutional strength and effectiveness to be trusted with the possibility of moving funds around in the presence of aid. Interestingly, our results indicated that effective government policies are not always necessary for aid fungibility to have a significant impact on aggregate welfare. This does not mean that strong institutions and effective development policies do not improve aggregate welfare; instead, our finding suggests that having strong institutions should not be considered a prerequisite for fungible aid to improve aggregate welfare.

A major advantage of this positive aid fungibility is that it can be used to target multiple SDGs. The development partners and partner country governments can take advantage of the complementarities that exist among various SDG indicators and can mutually agree on which SDGs they would be focusing on, i.e., if development partners are investing in health, the partner country government can divert its own funds that it intended to invest in health to another sector like social protection or education. This will lead to a more sustainable and long-term impact of the interventions since it is expected that better education or social protection facilities would lead to decreased usage of health facilities. In this sense, fungibility can be considered a policy tool to ensure that incoming aid and resulting funds are allocated in a manner that impacts multiple sectors positively.

At the same time, fungibility leads to increased ownership by the partner country's government of incoming aid and its allocation as it has a better understanding of its own development needs. This would, then, also be in line with the effectiveness principles, particularly with the principle of ownership, agreed in 2011 by 161 countries and will also allow us to “decolonize” the development assistance and fungibility debate by giving the power back to the partner countries. To ensure that ‘no one is left behind’—the motto of the SDGs—it is important that the plan for achieving the SDGs comes from the partner country governments themselves, which is through giving them the flexibility of planning and reallocating their expenditures whenever necessary, i.e., giving them room for aid fungibility.

Complementing our findings, evidence from the literature suggests that aid fungibility is not associated with irrational fiscal policies or low government effectiveness, nor does non-fungible aid have a higher impact than fungible aid.

We urge both policymakers and researchers to use our research as a starting point to consider fungibility as a policy tool for further improving aid effectiveness and the relationships between development partners and partner country governments.


The content of this blog article is based on the findings of the WIDER working paper 'Can fungibility of development aid lead to more effective achievement of the SDGs?

This post was originally published by the Global Partnership. Read the original here.

Dr. Zunera Rana is a lecturer and researcher at the Faculty of Social Sciences at Radboud University.

The views expressed in this piece are those of the author(s), and do not necessarily reflect the views of the Institute or the United Nations University, nor the programme/project donors.