Building on success in development aid
In academic discourse, it has become almost ritualistic to begin a piece on foreign aid by highlighting the sharp controversies over its effectiveness as a tool to promote social and economic progress in developing countries. This has happened even though evaluations of development aid at project and sector levels have consistently pointed towards positive impacts. Instead, controversy has centered on the ability of aid to promote overall economic growth. In this domain, conclusions have varied from positive to perverse.
Aid promotes overall economic growth
This controversy is now receding, even if some dissonance can still be heard. The large majority of recent empirical studies find positive impacts with broadly comparable results for the effect of aid on growth. These studies suggest that receipt of foreign aid equal to 10% of GDP over a sustained period is expected to boost growth by approximately one percentage point on average.
The studies also emphasise that these growth impacts take a long time to materialize and that development assistance can have limited or even negative impacts on growth in the short run. For example, a successful drive to increase school enrollments may reduce the size of the labour force with negative implications for output. Similarly, successful programmes to reduce infant and child mortality initially have little effect on output while increasing population. The result is a relative decline in GDP per capita. In both of these cases, positive effects on output emerge with substantial time lags as a better educated and healthier workforce gradually emerges.
The finding of a positive impact, on average, of development assistance on growth is consistent with findings for other important socioeconomic indicators. Over the long-run, foreign aid has reduced consumption poverty; contributed to more rapid expansion of ‘modern’ sectors (industry) alongside a relative decline of agriculture’s share in GDP; enhanced aggregate investment; and increased government spending with generally positive implications for a range of social outcomes.
Why did it take so long to figure this out?
Both aid volumes and their associated impacts are not large enough to be easily identifiable in macroeconomic data. And these not-so-large impacts often take a long time to be realized. Detecting the contribution of aid is further complicated by large fluctuations in growth and other outcomes that have been an inherent part of the experience of nearly all developing countries, many of which have moved from low- to middle-income status. On top of this, observations of both the flow of aid funds to developing countries and the outcomes achieved (such as economic growth) are known to be imperfect. For these reasons, it is not surprising that the economics profession is only recently converging on broadly similar results.
The observed reality is that the development process is long and arduous, also when supported by effective aid inflows. The role of assistance in fomenting development has not been as potent as early advocates had hoped. Rather, development assistance has played a role in growth and development consistent with modern growth theory, meaning it has met realistic expectations.
The international development assistance architecture is adapting slowly to the new world
That is the good news. The international development assistance architecture can build on a record of success. The bad news is that this international architecture is, at best, adapting slowly to the new world it has helped bring about. In 1970, half or more of the world’s population could be categorized as deeply deprived with the very large majority of these living in poor countries. Today, that share would come in at about 10%. Of those, the large majority live in middle-income countries. In fact, the World Bank now categorizes only 31 countries as low-income, most with relatively small populations and none of them particularly populous (Ethiopia is the largest at about 95 million). However, the world is yet to devise a coherent approach to reducing absolute poverty in middle-income countries.
This is just one of the more obvious manifestations of the mismatch between the 20th century development assistance institutional designs, that still largely prevail, and 21st century needs. Another manifestation is the persistence of operational structures predicated on country conditions characterized by very low human capital, weak institutions, high aid dependency, and limited information circulation despite substantial advances in these areas, even in countries that are still categorized as low-income. In addition, shareholding structures in important international institutions are manifestly outdated. Partly as a result of this, the response to new challenges, not least climate change, is institutionally dispersed as many players prefer to invent new institutions rather than rely on the existing (outdated) architecture.
Large development challenges remain
At the same time, very large development challenges remain. Amid unprecedented global prosperity, more than 700 million people remain absolutely poor. Thirty-one countries remain mired in low-income status. Relative poverty has been increasing in many countries. Meanwhile, at the Conference of the Parties to the United Framework Convention on Climate Change which is currently taking place in Paris, developing countries are set to make serious contributions to climate change mitigation. They are seeking, quite reasonably, assistance in creating clean energy systems and in coping with the higher temperatures that are already baked into the climate system.
Now is a good time to rethink the international assistance architecture, building on lessons of success from the past while focusing on meeting the challenges of the future.
Research Brief | A Meta-Analysis of the Literature on Aid and Growth