Foreign Aid: Championed and Villified

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Peter Bauer, a prominent developmental economist, argued “there would be no concept of the Third World at all were it not for the invention of foreign aid” (The Economist). He opposed the idea that development aid could provide the capital needed to kick-start economic growth and fight poverty (Kristof). Aid, he argued, politicized economies and more often than not ended up in the hands of government officials. Contrary to Bauer’s beliefs, foreign aid is not fundamentally ineffective. While in its current form it has little effect on economic growth and may even hamper a country, foreign aid can be effective in certain situations if reformed and managed correctly.

Recent studies suggest that foreign aid may hamper a recipient nation in the long run by weakening local institutions and adversely affecting the country’s competitiveness. In a paper published in 2005, Raghuram G. Rajan, former chief economist at the International Monetary Fund (IMF), and Arvind Subramanian, a former IMF researcher, offer compelling evidence that aid appreciates the real exchange rate of a country thereby decreasing competiveness (Rajan and Subramanian). This appreciation has two root causes. Aid increases the price of resources in short supply such as skilled labor and land, raising costs for local business owners and increasing unemployment (Ibid). An inflow of foreign capital appreciates the nominal exchange rate, making the currency (and in turn the nation’s exports) more expensive. The appreciation of the real exchange rate pushes countries away from “export oriented labor intensive manufacturing.” An export oriented economy encourages sensible government policy by providing the incentive of significant economic growth; foreign aid could potentially eliminate this incentive (Rajan and Subramanian). Therefore, governments must spend foreign aid very effectively in order to offset the fall in competitiveness.

In the case of countries like Somalia, current foreign aid provides temporary relief but does not tackle the root causes of the country’s problems: establishing security, providing food and encouraging business (The Economist). The government must limit the influence of jihadists and secure the Kenya-Somalia border, the site of much terrorist activity. Somalia is a hungry country; according to the U.N., 80,000 Somalis may have perished in last year’s famine (Ibid). Efforts must be made to stabilize food production by making it safe again for displaced farmers to return to their farms. In order to encourage local businesses, foreign donors must invest in industrial equipment, telecommunications, and livestock by supplying capital for loans to medium sized companies. Only then does Somalia have a good shot at success.

While most of academia has concluded that development aid is usually ineffective, there remains much discussion over humanitarian aid. In an editorial published in the New York Times, Carol Giacomo, a member of the Council of Foreign Relations, argues that humanitarian aid helps advance stability abroad by providing food and medicine (Giacomo). For example, U.S. foreign aid was cut by $6 billion, or roughly 11%, in 2011, with further cuts looming due to recent efforts by Republicans to trim our budget (Ibid). Giacomo warns that such budget cuts, which represent a tiny portion of our multi-trillion dollar federal budget, would be “hugely damaging.” Indeed, there is evidence that humanitarian aid has had an effect: in the past 50 years, the number of children who die annually has gone down by 60% (Gates). Furthermore in the last decade the cost of fighting HIV and AIDS has gone down significantly (Emanuel). Nicholas Kristof, a Pulitzer Prize winning columnist for the New York Times, tentatively concluded that one-time interventions such as bed-nets and vaccinations are more likely to be effective than sustained efforts (Kristof). Rajan and Subramanian, however, challenge the notion that humanitarian aid is as beneficial as it is purported to be (Raghuram and Subramanian). In fact, it’s just as ineffective as bilateral or multilateral aid because governments “seem to view all forms of aid as going to a common pot and act accordingly” (Ibid).

Perhaps the way foreign aid is administered is at fault. The Center for Global Development, a Washington think tank, put forth a scheme called “Cash on Delivery” (Rosenberg). The idea is simple: donor countries only pay for projects when something good comes out. For example, the United States and Malawi would draw up a five-year plan to improve primary schooling that specifies a set of payments and what must happen for Malawi to get them (Ibid). After the contract is drawn up, the funder takes a “hands-off approach” which allows the recipient nation the freedom to accomplish the requirements on its own (Center for Global Development). Theoretically, “Cash on Delivery” should garner more political support at home for foreign aid than traditional aid would and also create a sense of accountability in aid-dependent countries (Rosenburg). This method is still untried so we cannot know how successful it can be. And, at the risk of sounding cynical, the entire premise of the “Cash on Delivery” is contingent upon the fact that the foreign government (organization, business, etc) is organized enough to accomplish the set goals in a legitimate manner. Back to the Malawi example, if test scores were used to determine the effectiveness of an education program, it would not be impossible for interested parties to alter test scores and escape the scrutiny of foreign auditors. Yet despite skepticism about the effectiveness of “Cash on Delivery” and foreign aid in general, it’s encouraging to know that we have not abandoned the desire to alleviate poverty worldwide.