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FOREIGN AID. EC 938 Professor Sharun Mukand. Foreign Aid. Why give foreign aid?. ENDING POVERTY?. Foreign Aid. Why give foreign aid? What factors affect Aid Effectiveness? Goals of Aid Organizations Recipient Incentives & Conditionality Donor Objectives

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Foreign aid

FOREIGN AID

EC 938

Professor Sharun Mukand


Foreign aid1
Foreign Aid

Why give foreign aid?



Foreign aid2
Foreign Aid

  • Why give foreign aid?

  • What factors affect Aid Effectiveness?

    • Goals of Aid Organizations

    • Recipient Incentives & Conditionality

    • Donor Objectives

  • Historical Evidence: Has Foreign Aid been Effective?

    • Burnside-Dollar(2000)

  • Alternative Viewpoints: How Aid Does Work

  • New Approaches to Making Aid Work

    • Private vs. Government Aid, Specific Aims vs. Broad Goals and Micro initiatives


Why give foreign aid
Why give Foreign Aid?

Altruistic Reasons:

  • Natural Disasters/Relief

  • Economic Development

  • Encourage Political Reform

  • Build new institutions

    Self-Interested Reasons (may also have altruistic component)

  • State Failure  has negative externalities (e.g. terrorism due to state failure in Afghanistan)

  • Military/Strategic Reasons

  • Media Coverage and Political Pressure

  • ………


How Much is a Seat on the UN Security Council Worth?

By Ilyana Kuziemko and Eric Werker

Journal of Political Economy


Aid and security councilmembership
Aid and Security CouncilMembership

  • There is a systematic relationship between UN Security Council (UNSC) membership and aid payments

    • Question is Why?

  • Possible Reasons for an increase in Aid Payments:

    • (1) Members of the UNSC trade votes for cash:

    • rotating members are able to extract rents during their time on the council. Thus rotating members could trade their votes for political or financial favors during the two years in which they enjoy a boost to their diplomatic importance.


  • (2) membership on the Security Council simply enables a country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

  • (3) a correlation might be driven by an omitted variable:

    e.g. a country’s becoming more integrated in the world community might increase both its probability of serving on the Security Council and its annual aid receipts.


How the unsc works
How the UNSC Works country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

  • The UNSC is made up of 15 total members, five of which are permanent and hold veto

    • Permanent (P5)

      • China, France, Great Britian, Russia and the US

    • Non-Permanent (Typical Makeup)

      • Five from Africa and Asia

      • One for Eastern Europe

      • Two from Latin America and the Caribbean

      • Two from West Europe, Canada, Australia, and New Zealand


Method of electing non permanent members
Method of Electing Non-Permanent Members country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

  • All of the ten non-permanent UNSC members must receive the nomination of a regional caucus and must then receive a 2/3 majority vote from the UN General Assembly

  • This means that only countries that can get the 2/3 vote (usually the most influential nations) are nominated

  • They are elected for two year terms, five at a time, and are not allowed to serve two consecutive terms


Data collection
Data Collection country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

  • Limit of Analysis to developing nations that are non-P5 members

  • ¾ of these nations received economic aid

  • ½ received military aid

  • Political Controls

    • Countries with a war of at least 1,000 battle deaths (International Peace Research Institute)

    • Whether or not the countries were dictatorships or free (Marshall and Jaggers 2002) (FIX)


Basic empirical strategy
Basic Empirical Strategy country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

  • Look within countries across time and measure how their aid changes as a function of UNSC status

  • Dependent Variables

    • Increase in aid (either US foreign or UN development aid)

  • Independent Variables

    • Whether it’s a member

    • Importance of Membership Year (NY Times)

    • Aid Patterns (Aid income before, during and after UNSC membership)


i country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.indexes countries

r indexes regions

t indexes years

SCMember is a dummy variable coded as 1 if country i is serving on the Security Council in year t,

X is a vector of time-varying political and economic controls for each country

W is a regional quadratic time trend

η is a vector of year fixed effects

μ is a vector of country fixed effects


The Timing Issue: country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

T0 refers to the year that the nation served on the UNSC

T-1 is the year before it’s elected

T1 and T2 are the two years of service

T3 and T4 are the two years directly following service


Results
Results country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

  • There is a positive correlation between membership on the UNSC and amount of aid received

    • US aid increases by 54% ($15m / year)

    • UN aid increases by 7% ($1m / year)

  • Important Years: When countries served during years that in which the UNSC received more attention

    • US aid increased 160% ($44m / year)

    • UN aid increased 42% ($6m / year)

  • Aid is greatest during T0, T1, and T2; it falls sharply back to T-1 levels during T3 and T4


Extensions
Extensions country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

  • Autocracy / Democracy Analysis

    • The more democratic a nation is, the less benefit it derives from serving on the council

    • Dictatorships, on average, experience a fivefold increase in aid

  • Reasons

    • Possible reasons for this phenomenon are the fact that dictatorships can vote further away from the interests of their countries without domestic repercussions from their populace

    • This makes them more susceptible to bribery


Extensions 2
Extensions 2 country to bring its needs to the attention of the world community….i.e. the economic needs of developing nations gain salience when they serve as rotating members.

  • Developing countries can expect a 66% increase in aid from UNICEF and the UNDP follows a similar pattern

  • Increases from other agencies were not significant enough to be noteworthy

  • Reasons

    • The US has the largest influence over UNICEF and a large but lesser influence over the UNDP



Examples and importance
Examples and Importance and aid increases from both the UN and the US.

  • During the first Gulf War, nations that supported the UNSC resolution on war with Iraq received increased amounts of aid while Yemen, the one country to object received lesser amounts of aid

  • The importance of these findings are that they contribute to two debates:

    • Whether or not aid is effective

    • Whether or not the UN should be reformed


Discussion questions
Discussion Questions and aid increases from both the UN and the US.

  • In light of this evidence, do you think the UNSC needs to be reformed? If so how? If not, why not?

  • Do you think there is a problem in general with countries receiving aid based on their membership? Why or why not? What implications does this have for the future?

  • How effective do you think foreign aid is? Does it leave poor countries more reliant on their rich neighbors? Does it undermine domestic development? Is it worth the good it does in light of this?

  • What errors or biases do you think this paper had? Do you agree with its assertion that the US “controls” the UNDP and UNICEF? Do you think other P5 members should have been examined for their practices? Why or why not?


Mass media and foreign aid
Mass Media and Foreign Aid and aid increases from both the UN and the US.

  • Does News Coverage Government Policy with regard to Foreign Aid?

  • Correlation between news coverage and foreign aid does not prove causation. Why?

  • More intense disaster will have  more news coverage

  • More intense natural disaster  foreign aid more likely (on humanitarian grounds…)

  • How do you make a causal case that news coverage encourage?




Topic outline
Topic Outline during the Olympics (and hence gets crowded out of news cycle)?

  • Historical Evidence: Has Foreign Aid been Effective?

    • Burnside-Dollar(2000)

    • Two Gap Model

  • What factors affect Aid Effectiveness?

    • Goals of Aid Organizations

    • Recipient Incentives & Conditionality

    • Donor Objectives

  • Alternative Viewpoints: How Aid Does Work

  • New Approaches to Making Aid Work

    • Private vs. Government Aid, Specific Aims vs. Broad Goals and Micro initiatives


Optimists case for aid
Optimists’ Case for Aid during the Olympics (and hence gets crowded out of news cycle)?

  • Jeffrey Sachs: Poverty persists because:

    • Of Geographical factors:

      • Landlocked countries – trade less and dependent on domestic resources

      • Low agricultural productivity – rainfall dependent

      • Diseases – Many prevalent due to tropical climate

    • Too little Foreign Aid

      • Countries do not keep to their commitment of spending 0.7% of GDP

      • $400 billion on Military Spending annually vs. $5 billion on Africa


Raw correlation b n aid growth
Raw correlation b/n aid & growth during the Olympics (and hence gets crowded out of news cycle)?


Does foreign aid increase growth
Does Foreign Aid Increase Growth? during the Olympics (and hence gets crowded out of news cycle)?

  • Most influential recent work – Burnside and Dollar(2000) American Economic Review

    • Finding: “We find that aid has a positive impact on growth in developing countries with good fiscal, monetary and trade policies but has little effect in the presence of poor policies”

  • Basic Specification:

    where g=per capita growth rate of country i at time t, y=per capita income, a=(aid receipts)/GDP, p=vector of policies and z=vector of other exogenous variables that may affect growth and aid

    • 56 countries, six four-year time periods between 1970-1993

    • Basic Idea: If policies affect growth, and lump sum aid has a positive effect on growth, then policies should affect the effectiveness of aid for growth as well.



Impact of bd 2000
Impact of BD(2000) environ.

The Economist (March 2002) rebuked U.S. Treasury Secretary Paul O’Neill for his scepticism about foreign aid, on the grounds that “there is now a strong body of evidence, led by the research of David Dollar, Craig Burnside and Paul Collier...that aid does boost growth when countries have reasonable economic policies”

Canadian International Development Agency : World Bank researchers “..provide compelling evidence that good governance and a sound policy environment are the most important determinants of aid effectiveness”

Millennium Challenge Corporation set up by U.S. Govt. in 2002 increased aid by $5 billion, based on country performance indicators. 3/16 indicators developed to award aid were based on BD(2000).

IS THEIR RESULT ROBUST??


Aid flows
Aid Flows environ.


Robustness of bd 2000 findings 1 william easterly 2003 journal of economic perspectives
Robustness of BD(2000) findings:1 environ.William Easterly (2003); Journal of Economic Perspectives

  • Larger Data set:

    • 1970-1997, rather than 1970-1993

    • More data points even for original period 1970-1993

  • Alternative Definitions of Variables

    • Aid:

      • Grants vs. Grants + ‘Concessional’ (low interest) loans (or Official Development Assistance, ODA)

      • Correlation between Grants and ODA = 0.933


Robustness of bd 2000 findings 2
Robustness of BD(2000) findings:2 environ.

Source: Burnside and Dollar(2000)

Source: Easterly, Levine & Roodman (2003)

  • Scatter plot of unexplained portion of economic growth against unexplained portion of interaction between aid and policy (i.e. Unexplained by other RHS variables in BD(2000))



Aid definition
environ.Aid’ Definition

Aid*Policy significant with ‘Grants’ definition of Aid & BD sample, but..

Not significant with ODA definition of Aid

Neither so for low-income countries, where the results should matter more.


Bd robustness 3 policy variables
BD Robustness – 3: Policy Variables environ.

Policy Variables: Budget surplus, Inflation rate, Openness to trade:

  • Openness:

    • Sachs-Warner index (0-1 index based on tariff barriers or socialist country or state monopoly of key exports or high black market premium) vs.

    • Black Market premium, Financial depth (M2/GDP ratio), Trade-GDP ratio

    • Use weighted averages of these variables, where weights depend upon how much of growth they explain in a regression without aid as an explanatory variable.

    • Growth: Real GDP growth per capita over

      • 4 years vs.

      • 8, 12 or 24 years


Policy definition
Policy Definition environ.

Defining ‘Openness’ Index in terms of Black Market Premium

% gap b/w ‘true’ value vs. official value of currency is evidence of barriers to free capital flows.

Aid*policy does not significantly affect growth!


Impact of bd 20001
Impact of BD(2000) environ.

The Economist (March 2002) rebuked U.S. Treasury Secretary Paul O’Neill for his scepticism about foreign aid, on the grounds that “there is now a strong body of evidence, led by the research of David Dollar, Craig Burnside and Paul Collier...that aid does boost growth when countries have reasonable economic policies”

Canadian International Development Agency : World Bank researchers “..provide compelling evidence that good governance and a sound policy environment are the most important determinants of aid effectiveness”

Millennium Challenge Corporation set up by U.S. Govt. in 2002 increased aid by $5 billion, based on country performance indicators. 3/16 indicators developed to award aid were based on BD(2000).

BUT THE EVIDENCE IS IN FACT, NOT VERY ROBUST (EASTERLY(2003))!


Aid agencies defining goals
Aid Agencies: Defining Goals environ.

  • Measuring Outcomes

    A donor organization’s sense of mission, then, relates not necessarily to economic development but to the commitment of resources, the moving of money. . . . The estimates of total capital needs for development assistance in relation to supply seem to have been the implicit standard by which donor organizations have guided their behavior and judged their performance . . . the quantitative measure has gained its supremacy by default. Other definitions of success and failure of development assistance efforts have been hard to come by.

    ---- Judith Tendler(1975)

  • Peculiar Incentive problem of Aid Agencies:

    • Spending one group of people’s money on another group of people..

    • ..where the beneficiaries have little voice on how the money is spent

  • Goals: “Development”, “Poverty Reduction” or “Growth”, but..

    • Over the short run, many factors other than aid affect growth

    • How do you measure this goal concretely?


Aid agencies goals 2
Aid Agencies’ Goals -- 2 environ.

  • If it is unrealistic to expect aid to affect growth over the short run, aid agencies have little incentive to set targets in terms of growth rates

  • and not surprising that they choose more observable measures – i.e. aid disbursements.

    • As recent as 2001, a World Bank publication ‘Ten things You Never Knew about the World Bank’ advertised ten accomplishments of the organization – all ten involved volumes of assistance for different purposes.

  • Question: How can scarce resources be directed away from less successful projects and towards those more likely to succeed?

    • Accounting for how Aid Money is spent

    • Imposing Conditions on Loans before they are granted (Conditionality):

      • Reward Good performance and Punish Poor performance

      • Reward self-motivated reformers more than countries on whom reform is imposed

    • Evaluating the effects of loans after they are completed.


Accounting for aid money the fungibility issue
Accounting for Aid Money: The Fungibility Issue environ.

  • “When a thing which is the subject of an obligation…must be delivered in specie, the thing is not fungible, i.e. that very thing, and not another thing of the same or another class in lieu of it must be delivered.” (OED)

  • If a donor gives aid for health, will it actually improve health in the recipient country?

  • If a donor gives aid for health, will it increase govt. spending on health at all? (Yes – but only in part)

  • …. NOT (necessarily) corruption! Govt. Could have

    • Emergencies, or even

    • Better idea of actual needs


Conditional aid
Conditional Aid environ.

  • ‘Conditionality’ becomes necessary because of Moral Hazard

    • Principal (Aid Agencies) and Agent (Recipient Govt.) have different goals – e.g., Govt. cares less about poverty reduction than Aid Agency: UAA = cR + v(cP) whereasUG = cR + θv(cP), θ<1

    • Principal designs a contract which is an Aid/Policy Combination {a,p}

    • Agent accepts/rejects contract and chooses actions in light of contract incentives.

  • Without Aid: There is some benchmark consumption of rich and poor, cR and cP

  • If actions were observable, conditional contract offered: {a,cP > cP}.

  • Even if recipient’s actions are not perfectly observable, similar contract can be given if recipient is risk-neutral.

  • Conditionality does not work because of Time Inconsistency


Time inconsistency
Time Inconsistency environ.

Occurs when it is not in the best interest of a player (donor/aid agency) to carry out a threat or promise that was initially designed to influence another player’s actions (recipient gov).

If economic policymakers lack the ability to commit in advance to a specific decision rule, they will often not implement the most desirable policy later on.

It leads to the “Samaritan’s Dilemma”: Charitable urge undermines beneficiary’s incentives to be prudent in actions


Conditionality in practice
Conditionality in Practice environ.

  • Conditions attached to Aid about (low) budget deficits & inflation, non-interference in market pricing, privatization & Trade openness

  • Success Stories:

    • Mauritius, 1980-1994 – 4.3% growth in per capita income (seven adjustment loans)

    • Thailand (same period) – 5.3% per capita growth

    • Peru – did not first perform, but reformed in 1990s – going from -2.6% per capital growth (1980-90) to +2.6% per capita income growth(1990-94)

  • But what happens to countries that fail to grow?

    • Not much punishment -- After 15 adjustment loans between 1980-94, Zambia had inflation rate over 40%, almost over the entire period of the loans!


  • Un conditionality
    (Un)Conditionality? environ.

    World Bank Reports over the years:

    • 1984, Toward Sustained Development in Sub-Saharan Africa

      • “This optimism can be justified by recent experience in Africa . . . some countries are introducing policy and institutional reforms.”

    • 2000, Can Africa Claim the 21st Century?:

      • “Since the mid-1990s, there have been signs that better economic management has started to pay off.”


    Conditionality in practice 2
    Conditionality in Practice -- 2 environ.

    • “Over the past few years Kenya has performed a curious mating ritual with its aid donors. The steps are: one, Kenya wins its yearly pledges of foreign aid. Two, the government begins to misbehave, backtracking on economic reform and behaving in an authoritarian manner. Three, a new meeting of donor countries looms with exasperate foreign governments preparing their sharp rebukes. Four, Kenya pulls a placatory rabbit out of the hat. Five, the donors are mollified and the aid is pledged. The whole dance starts again.”

      ---- (The Economist, 1995)

    • “It seems clear that the lending cum conditionality process works well only when local polities have decided, largely on their own, possibly with outside technical help, to address their reform needs, effect certain policy changes sequentially, and approach the international community for financial help in getting there.” (Ranis, 1995)


    Ex post evaluation of projects
    Ex-post Evaluation of Projects environ.

    • WB reviews only 5% of its loans after three to ten years following the last disbursement (Meltzer Commission, 2000)

    • Besides, evaluation uses reports from the very people who implemented the project!

    • World Bank surveys of borrowing governments since the mid-1990s on how the bank has performed from the governments’ point of view not made public (Wade, 2001).

    • Potential Solution: Randomized Evaluation

      • Systematic, Scientific Evaluation of Aid Programs to assess which programs really work and put money there

      • Idea taken from Drug Trials

      • Treatment Group vs. (otherwise identical) ‘Control’ Group

      • Compare outcomes across both groups to determine effectiveness of intervention. (Addresses Selection and OVB Issues in evaluation)

        • E.g. Treating Intestinal Worm infection in Kenya


    Aid success stories
    Aid Success Stories environ.

    • Spectacular Success Stories:

      • Brazil Land Reform, Rural Electrification & Water Supply Program (2001)

      • Uganda (recently); South Korea, Taiwan

      • Eradication of Small pox

      • Near Eradication of River blindness

      • Family Planning, Life Expectancy & Infant Mortality

      • Green Revolution in Asia

    • Aid Optimists: Jeffrey Sachs, Bill Gates & some others


    THANK YOU! environ.


    Optimists case for aid1
    Optimists’ Case for Aid environ.

    • Jeffrey Sachs: Poverty persists because:

      • Of Geographical factors:

        • Landlocked countries – trade less and dependent on domestic resources

        • Low agricultural productivity – rainfall dependent

        • Diseases – Many prevalent due to tropical climate

      • Too little Foreign Aid

        • Countries do not keep to their commitment of spending 0.7% of GDP

        • $400 billion on Military Spending annually vs. $5 billion on Africa


    Model of foreign aid
    Model of Foreign Aid environ.

    • Two Gap Model (Chenery & Strout(1966))

      • Investment (required for Growth) vs. Domestic Savings

      • Import Requirements vs. Export Earnings

      • Based on Rostow(1960): Idea that aid-financed investment can launch an economy into ‘self-sustained’ growth.

    • g=(I/Y)/µ and I/Y=A/Y + S/Y, where

      g =growth rate, A= aid, and I, S, Y have the usual definitions

    • Key Assumptions:

      • Aid spurs Investment

      • µ: (ICOR) Stable, Linear effect of Investment & Growth

      • Are these assumptions justified?


    Does investment affect growth at a linear rate
    Does Investment affect growth at a environ.linear rate?

    THEORY

    • µ implies a Leontief-style production function (with fixed labor and capital per unit of output)....

      • ..but surely road-building in Nepal is more labour intensive than in the UK.

    • What would Solow say?

      • Investment will temporarily raise growth, only during transition b/w steady states.

    • Endogenous growth models

      • Growth depends not only on physical capital , but also technology, human capital, institutions etc.


    Effect of aid on investment
    Effect of Aid on Investment environ.

    • Boone(1996): Aid increases Consumption, not Investment

    • Easterly(2001):

      • Country-wise regressions for 88 aid recipient countries, 1965-1995

      • If Aid is effective in increasing Investment, coefficient on this variable should be

        • Positive and Greater than 1

        • Only 6/88 countries pass this test!


    Effect of investment on growth in aid recipient economies
    Effect of Investment on Growth in Aid Recipient Economies environ.

    EVIDENCE

    • Easterly(2001): Effect of Investment on Growth (annual data, 1965-1995)

      • 4/88 countries have coefficients positive & significant, with ICOR b/w 2&5

    • Countries with both positive effect of aid on investment, and of investment on growth

      • Only one – Tunisia!

      • If Zambia had converted all its A since 1960 into I, & I into g, per capita income of $20,000 by early 1990s! Yet..

        PRACTICE

    • Millennium Development Goal of cutting world poverty in half by 2015 specifically acknowledges being based on the two-gap model.


    Moving beyond the two gap model
    Moving Beyond the Two Gap Model environ.

    • There is very little robust evidence in support of the assumptions of the ‘two gap’ model of Aid giving works.

      • Aid does not seem to fuel Investment

      • Investment in Aid Recipient Countries does not seem to fuel Growth

    • Is Aid the problem, or is the way Aid Work is done that is the problem?

    • Examine the functioning of key characters in the Aid world

      • Aid agencies,

      • Recipient countries and..

      • Donor Countries

    • Is Aid ineffective because of inherent weakness in one or more of these links in the chain? Can these be fixed?


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