Friday, September 09, 2005

Aid and growth

Hat tip to the New Economist (in turn indebted to Ben Muse): Can More Aid Make Poverty History? - from Finance and Development, an IMF publication.

My highlight: "Aid and Growth." Their study indicates that:

1. "Early Impact Aid" (for projects with immediate growth benefits) has a strong and positive effect on economic growth. Roughly put, a $1 increase in aid increases income by $1.64 (where future income follows are converted to current income equivalent, or "discounted.")

2. Aid works even in countries with bad institutions, though it probably works better in countries with good institutions.

These findings do not detract from the reality of aid wastage in numerous individual cases. (Think Philippines, Marcos, Bataan Nuclear Power Plant. Think of tinfoil dictators in Africa and Latin America.)

However, the salutary effects of aid on growth raises serious questions about why there is an apparent struggle by heavily indebted developing countries to repay their loans. (By design, development assistance is largely in the form of "soft loans" with typically lower-than-market interest rates with generous terms of repayment. That's why it's called "aid".) I checked out the study cited by the article (available here). Turns out that within their data set, early-impact aid accounts for 45% of total aid; 46% is accounted for by aid with long-term impact (not measured in their study). The remainder (8.6%) is humanitarian aid (often disbursed as grants.)

Perhaps long-term impact aid does not really have that much of an impact. This would go a long way to explaining why some countries struggle with repayment and clamor for debt relief. But I suspect another reason: inability to raise tax revenues from beneficiaries of growth, whether from short-term or long-term aid. Particularly for countries were budget and budget finance is prey to populism, there is a natural proclivity to accumulate a massive debt burden across the board, not merely in the form of foreign aid. Since there is virtually no prospect for relief from domestic debt (largely held in the form of Treasury bills, bonds, and other government securities), the onus of relief falls upon foreign debt. However such debt relief can only be temporary, unless the root cause of the problem - spending and revenue policies of debtor governments - is decisively addressed.

Are we back to institutions and growth again? You bet.

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