Economic development and the effectiveness of foreign aid: A historical perspective

Sebastian Edwards of UCLA updates the evidence on one of the controversial topics on development  — Does foreign aid work?

He says there are three schools of thought:

Foreign aid is controversial in development economics. Three distinct camps may be distinguished:

  • One believes that official assistance is ineffective, and has harmed poor countries throughout the years.

This views official aid as creating dependency, fostering corruption, and encouraging currency overvaluation (Easterly 2014 and Moyo 2010). It also prevents countries from taking advantage of the opportunities provided by the global economy.

  • Another camp believes that aid levels have been too low, and that large increases would help reduce poverty.

This camp, however, believes we need a rethinking on the way in which aid is provided (Sachs 2009 and Stiglitz 2002). In particular, specific interventions, such as anti-malaria programmes, should be emphasised.

  • The third camp is less vocal, and includes authors such as Collier (2007), who has emphasised the role of a number of ‘traps’ in perpetuating destitution, and Banerjee and Duflo (2011) who argue that the use of ‘randomised control trials’ may help devise effective and specific aid programmes in the war against poverty and underdevelopment.[1]

These schools of thought have historical precedents.

What is the history:

Foreign aid is a relatively new concept in economics. The classics – Smith, Ricardo, and Stuart Mill, for example – didn’t address the subject in any significant way. If anything, classical economists thought that the colonies would catch up – and even surpass – the home country quite rapidly.[2] In Chapter VII of The Wealth of Nations, Adam Smith provides a detailed discussion on the “causes of the prosperity of the new colonies.”[3]

The first legal statute dealing expressly with official aid was passed by Parliament in the UK in 1929.[4] In 1940 and 1945, new laws dealing with aid to the colonies were passed in the UK. These Acts increased the amount of funds available, and made commitments for longer periods of time – for up to ten years in the Colonial Development and Welfare Act of 1945. More important, the Act of 1945 established that aid plans had to be prepared “in consultation with representatives of the local population.”[5]

In the US the first law dealing with foreign assistance came quite late, with the adoption of the Marshall Plan in 1948.[6] In his inaugural speech on 20 January 1949 – the so-called ‘Four Point Speech’ – President Harry Truman put forward, for the first time, the idea that aid to poor nations was an important component of US foreign policy. He said that one of the goals of his administration would be to foster “growth of underdeveloped areas.”[7]

In spite of Truman’s vehement allocution, aid commitments to poor countries were considered temporary. In 1953, when Congress extended the Mutual Security Act, it explicitly stated that economic aid to US allies would end in two years; military aid was to come to a halt in three years.

In the early 1960s – and largely as a result of the escalation of the Cold War – the US revised its posture regarding bilateral assistance, and, jointly with other advanced countries, founded the Development Assistance Committee (DAC) at the newly formed Organisation for Economic Cooperation and Development (OECD). The main objective of the DAC was – and continues to be – to coordinate aid to the poorest countries.[8]

Hmmm.. He then discusses the three schools which have followed..

His view is we should not look at a grand theory/narrative. Let it be case to case:

In Edwards (2014b) I discuss the effectiveness-of-aid literature from a historical perspective, and I argue that international aid affects recipient economies in extremely complex ways and through multiple and changing channels. Moreover, this is a two-way relationship – aid agencies influence policies, and the reality in the recipient country affects the actions of aid agencies. This relationship is so intricate and time-dependent that it is not amenable to being captured by cross-country or panel regressions; in fact, even sophisticated specifications with multiple breakpoints and nonlinearities are unlikely to explain the inner workings of the aid–performance connection.

Bourguignon and Sundberg (2007) have pointed out that there is a need to go beyond econometrics, and to break open the ‘black box’ of development aid. I would go even further, and argue that we need to realise that there is a multiplicity of black boxes. Or, to put it differently, that the black box is highly elastic and keeps changing through time. Breaking these boxes open and understanding why aid works some times and not others, and why some projects are successful while other are disasters, requires analysing in great detail specific country episodes. If we want to truly understand the convoluted ways in which official aid affects different economic outcomes, we need to plunge into archives, analyse data in detail, carefully look for counterfactuals, understand the temperament of the major players, and take into account historical circumstances. This is a difficult subject that requires detective-like work.

Much of development work should be like this. We keep making the same sets of mistakes saying just because it worked in x, will work in y as well..

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