Foreign Aid Dynamics

  8 min 37 sec to read
Foreign Aid Dynamics

Donor-created jobs have caused irrevocable damage to the psycho-social-economic attitude of the people as a whole.


Foreign aid is a relatively new concept in economics. The classics like Adam Smith, David Ricardo, and Stuart Mill for example, did not 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. 

The first legal statute dealing expressly with official aid was passed by Parliament in the UK in 1929. 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’.

In the US the first law dealing with foreign assistance came into existence with the adoption of the Marshall Plan in 1948. In January 1949, in 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’. In spite of Truman’s vehement allocution, aid commitments were considered temporary. In 1953, the Mutual Security Act explicitly stated that economic aid to US allies would end in two years; military aid was in three years.

In the early 1960s, 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 poor, underdeveloped, developing and catastrophe struck countries.

Academic research has guided foreign aid policy across the donor countries and most bilateral and multilateral agencies. In the 1990s, two research lines influenced aid policy.
•    Work on incentive compatibility and strategic behaviour persuaded aid officials in donor countries to become more flexible, and to incorporate recipient governments in the design and management of aid programmes. This approach received the name of ‘programme ownership’, and has been at the heart of improved relations between donors and poor nations in the last two decades.

•    New research on capital mobility and the international transmission of crises, resulted in a more nuanced and pragmatic view regarding the use of capital controls. Many agencies, including the IMF and the World Bank, supported a limited use of capital controls (especially controls on capital inflows) and so-called macro-prudential regulations, as a way of avoiding destabilising forces and currency crises.

Measure Success  
The Aid community and academic economists have used a battery of econometric methods to analyse whether aid is effective in the sense of generating higher growth and better economic outcomes. Some of these studies have tried to tackle issues of reverse causality, and have used a series of instruments in an attempt to deal with the fact that slower growth may attract additional aid.

Some research focused on whether aid only works under certain conditions, or whether a minimal degree of institutional development is required for international assistance to bear fruit. Many of these studies have considered nonlinear functional forms, and have investigated if there are meaningful interactions between aid and other variables, such as the degree of literacy, the level of corruption, the extent of macroeconomic stability, institutional strength, the quality of overall economic policies, and geography.

In general, most studies have relied on cross-country or panel data, and have attempted to distinguish between short and long-term impacts. A number of authors have used ‘Dutch disease’ related models to analyse the extent to which increased aid results in currency overvaluation, poor exports performance, reduced skills-ability-desire to perform, poor job market and host industry crises. Although the results from a large body of research have been fragile and inconclusive, it is just possible to say that there is a small positive, and yet statistically insignificant, relationship between official aid and growth. There is no clear relation running from more aid to faster growth; this is true even in countries with better policy environment and stronger institutions. 

Treating all aid as homogeneous, independent of whether it is emergency assistance, programme aid, or project-based aid, is misleading. It is necessary to break open the ‘black box’ of international aid, and deconstruct the causality chain that goes, in intricate and non-obvious ways, from aid to policymakers, to policies, and to country outcomes. It is important to determine the impact of aid on growth considering issues related to technical assistance, conditionality, level of understanding of the economy in question, and the government’s ability to implement specific policies.

International aid affects recipient economies in extremely complex ways and through multiple and changing channels. It 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.

Persuassive Narratives 
On the backdrop of the above, all foreign aid agencies, related host country ministries, most research bodies and project review bodies gloss over the success stories, reflect data scenarios to support whatever their current position and have non-disclosure of facts, over a certain timeframe.  A plethora of data, reports, reviews, counter-reviews, policy papers, academic and media write-ups and the like only add to the broken-eggshells effect of all this foreign aid. 

The funding landscape in Nepal mirrors this phenomenon, more now in the past decade than in the earlier decades of its beginnings. Donors have not only moved from grants to loans but have also become sector specific. World Bank Group is the lead donor in education, economic reform and agriculture sector, the Asian Development Bank has been the largest donor for road, energy, urban development and drinking water, the United Nations Country Team has been the lead partner for other social sector areas, USAID is the lead in health, EU in local development and UK in home affairs sectors. GTZ focuses on technical capability building, JICA, KOICA China and India on infrastructure, technical education, social change and rural development. 

Each of the above has success stories and impact quotients that would not have been achieved in their absence. Each sector has benefitted from foreign aid.  And yet, at most this success has a limited local significance, especially in the projects rolled out by USAID, DFID, Swiss Agency for Development and so on. 

The Aid Management Platform of the Ministry of Finance is an online tool to understand the persuasive narratives. Although it went live in the post-earthquake period to record precisely earthquake relief it now has broadened its purview to include foreign aid in all its dimensions.  It gives a perspective to the success and impact of the foreign aid dynamics in Nepal. With easy drop downs for news, publications, reports and dashboards it covers the work of all donors, in all sectors and regions, as well as comparative graphics and member access, this platform can be the ready reckoner for all players.  The irony here is that: even this tool is foreign funded by UNDP, DFAT (Aus), DFID, USAID and is implemented by Development Gateway of Washington DC !!

Aid flows have significantly increased over the last decade, albeit, it has become increasingly fragmented. There has been an explosion in the number of donors, and while the number of projects has multiplied, their average size has dropped. In the past decade, the aid environment has dramatically changed. Emerging economies (China, India, Saudi Arabia, Korea, Turkey, Brazil, Venezuela), which are still receiving aid from Western countries, have become donors themselves.  Nepal benefits from this, although, traditionally China and India have always been and remain to be the largest donors for developmental, humanitarian and social projects. 

Nepal too suffers from the micro-macro paradox, caused by the foreign aid dynamics. On the macro hand is the fungibility and the leakage of the aid into unproductive expenditure in the public sector, and on the micro hand, all donor agencies regularly report the success of most of their projects and programmes. Foreign aid success in Nepal is marred and ineffective because it tends to finance consumption rather than investments, it leans to individual motives rather than the other and most importantly, donor-created jobs have caused irrevocable damage to the psycho-social-economic attitude of the people as a whole.  Foreign aid, and the engaging donor organisations, are not seen as a ‘stepping stone to economic development and social well-being’ – it is taken as being the economic development and personal wellbeing.  Period.

Vaijayanti Khare is known for her dynamic engagements in the corporate, academic, social and development fields in Kathmandu over the past decade. Her writings are a reflection of her hands-on work, insights, studies, success and challenges.

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