2007 Imani West Africa University Seminar

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WHY AFRICA SHOULD FORGET FOREIGN AID

By

Robert Darko Osei

Institute of Statistical Social and Economic Research

University of Ghana

Overview of Presentation

What is Foreign Aid?

What are the arguments for foreign aid

What are the trends in Foreign aid to Africa?

Has Aid Impacted on Africa Growth?

What is the evidence from the literature?

What is the extent of Aid dependency?

Is high dependency a problem?

Should and Can Africa wean itself from aid

Summary and Conclusion

What is Foreign Aid ?

“Aid is an international operation channelling tens of billions of dollars to developing countries each year and employing hundreds of thousands of people in a multitude of organisations” Hjertholm and White (2000)

‘ …the World Bank is estimated to employ thousands of people and also there are an estimated 40,000 expatriates financed by aid and working in Africa…’

The OECD-DAC defines Official Development Assistance (ODA) as capital flows to developing countries with these characteristics

From official sources – either a state or the local government or their executing agencies

It has as it main objective the promotion of economic development and welfare of the developing country

It is concessional in character – it should have a grant element of at least 25%

Why do Countries need Aid?

Idea that aid promotes growth (and development) can be traced back to the work of J. M. Keynes (1883-1946) who argued in the 1930s that governments can stimulate growth by increasing investments (Erixon, F., 2005)

These ideas informed the work of Hollis Chenery and Alan Strout in 1966 who developed the Gap theory

The premise of the gap-theory was a simple one LDCs can attain higher growth rates through increased

investments which is determined by savings (which is in turn determined by per capita income)

LDCs were in a ‘low-level equilibrium trap’ which can be broken by the use of aid

The two gaps were Foreign exchange gap – deficit between import

requirements for targeted production levels and foreign exchange earning

Savings gap – deficit between domestic savings and targeted investment level

These gaps constrain growth

Foreign aid fills both gaps and therefore promotes growth.

Aid Effectiveness Debate - Aid has been effective

Hadjimichael et al, (1995) – aid is effective if you account for non-linear relationship

Durbarry et al (1998) – aid is effective Hansen and Tarp (2000) – aid is generally effective Lloyd et al (2001) – aid impacts on long term private

consumption but not by as much as exports

Aid has been ineffective Boone (1996) – aid is ‘down the rat hole’ Dollar and Easterly (1999) – aid did not increase

investments in Africa Burnside and Dollar (1997, 2000) – aid only works in a good

policy environment Alesina and Dollar (2000) – political and strategic motive

dominates

Africa’s Aid Dependency

World Aid has increased over the years – from about US$1.4 to in 1960 to about US$12.3 in 2003

The level of aid to SSA has increased even more – from about US$2.6 to about 34.3 over the same period

The result is that by 2003, almost one-third of all aid comes to SSA, compared to about 15% in 1960

Aid Per Capita

05

10152025303540

US

$

World SSA

Proportion of Total World Aid to SSA

0%

5%

10%

15%

20%

25%

30%

35%

40%

%

US$9.2b

US$77.5b

2 GAP Theory - Some evidence

Whilst SSA savings and investments ratios have declined, that of the rest of the world has increased

The trends for SSA does not seem to support the Gaps theory

Unless aid is filling a foreign exchange gap which is induced by increasing importation of final consumption goods

However, this DOES NOT promote growth and sustained development in the recipient country.

Savings to GDP ratio

0

5

10

15

20

25

30

%

SSA World

Investment to GDP ratio

0

5

10

15

20

25

30

%

SSA World

GDP Per Capita in SSA Versus the World

The average wealth of SSA has remained unchanged whilst that of the World has more than doubled.

Real Per Capita GDP

0

1000

2000

3000

4000

5000

6000US$ (2000 P

rice

s)

World SSA

What Pattern is emerging?

For SSA Aid increased by about 41 fold Per capita output remained the same – the

2003 level was only 1.2 times the 1960 level For the World

The increase in aid was significantly less - about 19 times the 1960 level

Per capita output more than doubled Netting out SSA will make this finding even

Starker

The Tale of two SSA countries - Aid

Aid to Ghana has been consistently and significantly higher than that to Botswana

Aid to Botswana averaged about US$ 66 million annually compared to US$ 303 million for Ghana

Foreign Aid Flows

0100200300400500600700800900

1000US$ M

illion

Ghana Botswana

Highest aid to Botswana in 1989 was about $160m compared to $717 for Ghana

The Tale of two SSA countries – Per Capita GDP

It is not too difficult to see which country has performed better in terms of growth

GDP Per Capita (Constant 2000 prices)

0500

1000150020002500300035004000

US$

Ghana Botswana

Ghana’s GDP of $280 is marginally higher than

that of Botswana of

$253

Botswana’s GDPPC of over $3500 is about 13 times that

of Ghana which is about

$276

The Tale of two SSA countries – Pupil Teacher ratio

Pupil to Teacher Ratio

28 27 27 27 2730

34 33 32 31

05

10152025303540

1998 1999 2000 2001 2002

Num

ber

of Pupils per

tea

cher

Botswana Ghana

The Tale of two SSA countries – Persistence to Grade 5

Persistence to Grade 5

87 88

66 63

0102030405060708090

100

1999 2001

% o

f Cohort

Botswana Ghana

The Tale of two SSA countries – Births by Skilled Staff

Births by Skilled Staff - Botswana

77.587

98.5

0

20

40

60

80

100

120

1988 1996 2000

Births by Skill Staff - Ghana

40.2

43.844.3

38

39

40

41

42

43

44

45

1988 1993 1998

The Evidence is…

SSA countries have received almost a third of total World Aid

SSA’s growth and development have been anything but impressive

Ghana has been significantly more reliant on aid compared to Botswana

Botswana has performed significantly better than Ghana

Why is high dependency a problem for Development?

The fundamental reason is that aid is not always given with the ‘financing gaps thesis’ as the main motivation.

The other motives of aid (political and also strategic/commercial) can counteract the developmental objective

Also there are other effects of over-dependence It has a high toll on executive time Disincentive effect on government to be fiscally ‘responsible’ It breeds policy conflicts – these conflicts are usually between

the true owners of the development process and the ‘development partners’

High dependence results in volatility having a greater negative impact on an economy

It can create and entrench ‘vampire’ elements in the economy – “Rather than seeing opportunities to produce goods and services more efficiently, entrepreneurs see hand-outs from donors as the easiest route to wealth” (Erixon, 2005, p-15)

An Important part of the solution is to reduce aid dependency

Can Africa Wean itself from Aid?

How can Africa achieve the twin objective of Reducing aid dependency

+

Sustaining Higher growth rates ?

There are two approaches that have been implicitly suggested by the Debate

Gradualist/Optimist policy option Shock/Pessimist policy option

Gradualist/Optimist Option

aid in the medium term to transform the economy

Reduce aid as economy is transformed and growth is increased and government revenue increases

Key proponents are Jeffrey Sachs, Bono, Henrik and Hansen, Morrissey, UNDP, G-8

But outcome depends on whether transformation will actually take place plus the evidence does not support this option This prescription presupposes that the disincentive

effect of aid is more than outweighed by the aid effectiveness

Highlights of Gleneagles Summit

A doubling of aid by 2010 - an extra $50 billion worldwide and $25 billion for Africa;

Writing-off immediately the debts of 18 of the world's poorest countries, most of which are in Africa. This is worth $40 billion now, and as much as $55 billion as more countries qualify;

A commitment to end all export subsidies. A date for this, probably 2010, should be agreed at the World Trade Organisation's Ministerial in December. The G8 have also committed to reducing domestic subsidies, which distort trade;

Developing countries will "decide, plan and sequence their economic policies to fit with their own development strategies, for which they should be accountable to their people"

However, the last two objectives are more difficult to achieve with the proposed increase in the dependency on aid!

Shock or Pessimistic Policy Option Make the reduction of aid an explicit policy – Some

have suggested we give ourselves 5 years maximum Forces us to generate more resources from within Forces the policy maker to be more prudent We can pursue a national development strategy with

minimal interference We devote more time into thinking about our policy

options and the strategies that will help us achieve our objectives

Some of the proponents include :Erixon F., Mensah S. This prescription presupposes that the disincentive

effect of aid more than outweighs the aid effectiveness

Conclusions

The correlation between aid and development outcomes is weak

The debate should begin to shift away from ‘aid effectiveness’ to ‘optimal options for development’

The World Bank (2004) estimates that a reducing tariffs and subsidies would allow developing countries to gain nearly $350 billion in additional income by 2015 compared to the $75 billion level of aid that we mentioned earlier.

Africa stands to gain more than it will lose if it reduced considerably its dependence on foreign aid

End of Presentation