More Profitable to Give than to Receive?

Every year billions of dollars in aidßow from rich nations to pooronesÑand right back again.

Grants and loans pay for machineryand equipment imported from the in-dustrialized world, construction over-seen by U.S., European or Japanese en-gineering Þrms, consulting work doneby international aid organizations and,not least, interest payments on previousloans. Meanwhile many of the nationsthat receive these enormous amountsof aid remain poor.

Development economists will imme-diately point out that this situation (ex-cept for the intractable poverty) is ex-actly as it should be. After all, if a coun-tryÕs needs can be met by its own or-ganizations and businesses, then it doesnot need help from abroad. Outside as-sistance should go to providing thosegoods and services that a country can-not provide for itself.

Furthermore, aid comes in the formof hard currencyÑyen, marks or dol-larsÑthat can be used only for buyinggoods from the industrialized world.Even if aid organizations wanted to givegrants in local money, they would haveto acquire it by trading their currency,and so the recipientÕs foreign exchangeposition would be precisely the same.

In theory, development aid works tothe beneÞt of both the donor and recip-ient countries: the recipient gets a dam,steel mill or banking system, and thedonor gets an immediate economic stim-ulus (from purchases of goods and ser-vices with the aid money) plus a newmarket if the development project pansout. Indeed, if the aid is in the form ofa loan from the World Bank or someother multilateral organization, the orig-inal money spent earns interest andmust eventually be repaid.

Historians can point to cases wherethe theory has worked wonders. Dur-ing the 19th century, for example, theU.S. was a prime recipient of foreignloans. Railroads, canals, mines and fac-tories were built with huge infusions ofEuropean capital, and U.S. trade withEurope enriched both sides. After WorldWar II, Marshall Plan dollars rebuilt Eu-rope, and the U.S. vaulted to preemi-nence in exports.

So why donÕt things work so well to-day? Candidate causes abound: corrup-

tion, incompetence and inappropriateprojects top the lists of people at fund-ing agencies. Recipients, meanwhile, of-ten complain about ÒtyingÓÑconditionson aid that dictate where the recipientcan buy goods or whom it can hire tooversee projects.

Such ties raise the suspicion that thepurpose of aid is largely to subsidizeÞrms in the donor country. Legislatorsin the U.S. and elsewhere often justifyforeign aid budgets on the basis of theeconomic beneÞts they will provide athome, and nations also use aid as alever to open commercial markets.

Economist Elliot Berg of DevelopmentAlternatives in Bethesda, Md., consid-ers such concerns ill founded. If theU.S. wants to subsidize U.S. Þrms, hesays, it can do so by building bridges inKentucky just as easily as by buildingthem in Indonesia. Furthermore, tyingallows donors to exercise control over

the direction of a project and can helpminimize corruption in the recipientcountry.

Although most bilateral aid (grantsand loans made directly from one na-tion to another) is tied, most multilat-eral aid (that dispensed by the WorldBank and other international organi-zations) is not. Indeed, when competi-tive bids are solicited for projects fund-ed by the World Bank, local businessesmay win jobs even if their bids are 15percent higher than those of more es-tablished international Þrms. This pref-erence helps to develop managementexpertise in the recipient country, evenif the local company still ends up pur-chasing most of its supplies on the in-ternational market.

Even without explicit tying, the re-quirements of donor organizations maystill shape development decisions. Wheneconomic oÛcials are determining theappropriate level of capital investmentin their country, says Jim Boomgard ofDevelopment Alternatives, it makes lit-

tle diÝerence to them what particularforms that investment takes. If Òthisyear the World Bank is into dams,Ó hesays, countries will propose building adam. If microenterprise loans are theorder of the day, they will set up ruralcredit cooperatives.

ÒThere is every incentive to draw upbig projects with little economic value,Ócomments George Ayittey, a Ghanaianeconomist now at American University.He asserts that dams, generators andsimilar large installations have oftenserved as Òvisible symbols of assistanceÓthat gladden the hearts of donors ratherthan helping recipients. And in the Þveyears or more that a project may taketo come to fruition, Òthings happen: thegovernment may be overthrown, a min-ister may be corrupt and demand 10percent of all contracts, or prices mayrise and $100 million becomes insuÛ-cient to complete the project, so it isabandoned.Ó

In addition to the potential for dis-torting investment priorities, this kindof decision making has dangerous so-cial consequences, according to GabrielRoth, a former World Bank economist.Regardless of whether a developmentproject succeeds or fails, he asserts, itwill increase the power of governmentoÛcials. The World Bank Òcaused aid toßowÓ for housing in Zambia, he recalls,Òand to no oneÕs surprise all the houseswent to supporters of the governingparty.Ó Roth contends that multilateralaid organizations should focus less onsimply transferring funds and more onhelping governments to create laws andinstitutions that assist investment.

Government-to-government loans,Roth says, are particularly dangerousbecause they must be repaid regardlessof whether the project they were in-tended to fund is successfully complet-ed. As a result, aid organizations havelittle Þnancial reason to lend moneyonly for viable ideas. Last year an inter-nal World Bank study reportedly foundthat the bankÕs proportion of Òprob-lemÓ projects had more than doubledbetween 1981 and 1991; it now standsjust under 40 percent.

In contrast to the railroad bonds ofthe 19th century, it is not the investorsin the industrialized world who bear theÞnancial risk of a project gone wrong.Rather it is the citizens of the nationthat received the aid.ÑPaul Wallich and Marguerite Holloway

More ProÞtable to Give Than to Receive?

THE ANALYTICAL ECONOMIST

142 SCIENTIFIC AMERICAN March 1993

ÒThere is every incentiveto draw up bigprojects with littleeconomic value.Ó

Copyright 1993 Scientific American, Inc.