What are the key trends and objectives in the provision of aid? How does aid impact upon economic growth? How might aid flows exhibit better accountability and foster stronger growth? This paper from the Centre for Global Development takes an overview of the main debates on aid. It argues that donors’ motivations are sometimes unrelated to economic development, that aid has a variable relationship to growth and that greater selectivity of and participation by aid recipients could increase aid effectiveness.
Foreign aid is the provision of funding, technical assistance and commodities, as grants or subsidised loans, with the main objective of promoting development or welfare. Overseas development assistance (aid provided to low- and middle-income countries) has peaked recently in real terms, although worldwide levels still fall below the target of 0.7 percent of donor income.
While aid represents 2.8 percent of GDP in low-income countries, it accounts for just 0.2 percent in upper-middle-income countries. Rises in private capital flows offset the decline in aid to some developing countries in the 1990s. Donors have various motivations for giving aid: to fight poverty, advance foreign policy objectives, or support their own economic interests through “tying” of aid.
Although aid has various developmental objectives, economic growth has always been the main yardstick for measuring aid effectiveness. Three divergent views have emerged on the relationship between aid and growth:
- Aid generally promotes productivity and growth by increasing saving, investment and technological exchange in recipient countries, although returns diminish as aid increases. Aid can also positively impact on healthcare, education and the environment, even though much health-related aid has been squandered.
- Aid may undermine growth by encouraging corruption, postponing government reforms, reducing domestic saving, leaking from countries with limited absorptive capacity and undermining private sector investment and productivity. Models which propose this view tend to examine aggregate aid, rather than discriminating between emergency and development aid.
- Aid promotes growth under certain circumstances, depending on the characteristics of the recipient country, the procedures of the donor and the type of activity supported by aid. Determinants which promote growth include: recipients with good policies, strong institutions and ownership of aid programmes; untied aid flows from multilateral donors; and aid focusing on infrastructural and agricultural development.
Aid is beset by “the principal-agent problem”, whereby donor-country taxpayers’ awareness about aid effectiveness is hindered by their distant relationship to recipient country beneficiaries. Aid conditionality has also suffered from uncertainty about which policy conditions to impose and failed to influence recipient governments’ policies. Recent thinking has focused on selectivity, participation, harmonisation and monitoring in aid policy:
- Donors should choose recipient countries based on their current policies and institutions, rather than imposing prospective conditions for reform.
- Recipient countries (including NGOs and the private sector) should be permitted to take a more participatory approach in setting aid priorities and designing programmes.
- The heavy bureaucratic burdens imposed on recipients in reporting back to donors could be offset if donors coordinated their activities and pooled their funds.
- Decisions about renewing or re-allocating aid should be taken on the basis of detailed, early evaluation of specific quantitative targets.
