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

Added: 05-07-2019

The article gives an account of the history of developmental aid and derives three different perspectives: (1) the view that aid harms recipient countries; (2) the idea that aid levels have been too low and a large push would help reduce poverty; (3) a view that there are a number of pitfalls, but also best practices that can lead to effective solutions.

poverty research perspective history aid dependency randomized controlled trial (RCT) structural inequality development foreign aid

Type Reading Time Author Date Source
article 11 minutes SEBASTIAN EDWARDS 11-28-2014 http://voxeu.org/
Type Reading Time
article 11 minutes
Author Date
sebastian edwards 2019-05-07 00:00:00 UTC
Source
http://voxeu.org/
Image by arek socha from pixabay syringe 1884779 1920
Key Takeaways
  • Developmental aid has a long history of academic research but also practical policy application, which has split into academics into three camps: ardent adversaries of aid, promoters of higher amounts of aid, and adherents to the view that projects should be analyzed in a more nuanced way. 
  • Aid seems to affect economies in different and complex ways, thus to truly study aid effectiveness requires looking, in detail, at the multiple types of aid involved as well as the specificities of projects, organizations, and countries both receiving and giving aid.

Summary

This article summarizes chronological milestones in the history of developmental aid and derives three distinct camps commonly found in the wider academic literature on the effectiveness of foreign aid.
    • 1929: Aid is firstly institutionalized with the adoption of a legal statute in Britain. 
    • 1948: In the United States, the Marshall Plan was the first touchpoint with developmental aid. 
    • 1950s - 1960s: The Harrod-Domar growth model and Lewis’ unlimited supply of labor model led to aid funds flowing into capital-intensive projects.* 
    • 1960s - 1970s: the Solow neoclassical growth model and basic needs approach in welfare economics led to social programs, direct poverty reduction and skill-building plus human capital.** 
    • 1970s: The dependent economy macroeconomic model shifted the emphasis more towards exchange rates and managing economies through ‘getting the prices right.’*** 
    • 1980s - 1990s: Anne Krueger and Jagdish Baghwati’s research program on economic openness and the importance of exports led to conditioning of aid on liberalization through tariff reduction and quota expiration. 
    • 1990s: aid policy was influenced by a string of research promoting the inclusion of recipient governments in the design and implementation - program ownership - and a new way of using capital controls due to international transmission of crises.**** 

In terms of econometrics, researchers have mostly looked at cross-country studies or panel data***** distinguishing between long-term and short-term effects of aid. Some have tried to analyze whether aid only works under certain conditions or if aid is related to other meaningful variables (e.g. the level of corruption or the quality of economic policies). 

Overall, the results have been “fragile and inconclusive.” At best, some indications are given that aid leads to higher economic growth although all types of aid are typically treated in one generalized form. 

In policy circles, however, there have been fierce debates that have created three distinct camps with a few prominent proponents:

    1. One camp argues that aid has been ineffective and rather harmful to recipient countries (Moyo, Easterly). 
    2. Another string of research ascertains that aid could work if it was disbursed in higher amounts (Sachs). 
    3. Some academics have more intermediate positions suggesting that aid should not be analyzed on an aggregate level, but instead focus on specific programs and their merits. 

All in all, aid seems to affect economies in different and very complex ways; aid agencies influence policies whilst the reality in countries affect the aid industry. According to the author, opening the “ ‘black box’ of developmental aid” by looking at its different forms seems key. However, the focus should not be on general conclusions but on very careful analysis of specific projects. 

Notes 

*Harrod-Domar growth model - a classical model explaining the origins for economic growth and arguing for capital investments to spur growth: http://www.romeconomics.com/harrod-domar-model-explained/

*Lewis unlimited supply of labor model - a classical economic growth model presupposing unlimited supply of workers in developing economies, which warrants capital investments to achieve growth: http://economicsconcepts.com/lewis_model_of_unlimited_supply_of_labor.htm

**Solow neoclassical growth model - the most standard economic growth model positing that the stock of capital as well as productivity improvements lead to economic growth: http://www.romeconomics.com/beginners-guide-solow-growth-model/

***Dependent economy macroeconomic growth model - an economic model splitting economic output into tradable and non-tradable goods and arguing for the exchange rate as a main determinant of growth: https://treasury.govt.nz/publications/wp/how-does-exchange-rate-affect-real-economy-literature-survey-wp-13-26-html#child-4

****Capital controls - any measure taken by a government, central bank or other regulatory body to limit the flow of foreign capital in and out of the domestic capital market: http://www.investopedia.com/terms/c/capital_conrol.asp

*****Panel data - data where multiple cases (people, firms, countries etc) are observed at two or more time periods: https://www.investopedia.com/terms/l/longitudinaldata.asp



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