Foreign AidForeign Aid(Concessional financial flows)(Concessional financial flows)

Foreign sources of financeForeign sources of finance

1.1. Concessional financial flows: Foreign AidConcessional financial flows: Foreign AidLower interest rates, longer repayment Lower interest rates, longer repayment

periods.periods. Soft loans / Grants (gifts)Soft loans / Grants (gifts) Public: Official Development Assistance Public: Official Development Assistance

(ODA). (ODA). By an individual country (bilateral aid), or by By an individual country (bilateral aid), or by

international organizations (multilateral aid).international organizations (multilateral aid). Loans / GrantsLoans / Grants

Private: NGOs Private: NGOs → grants→ grants

2.2. Non-concessional lendingNon-concessional lendingSame terms as in the commercial Same terms as in the commercial

banking systemsbanking systems Public: multilateral organizations: Public: multilateral organizations:

World Bank, IMFWorld Bank, IMF Private: commercial banksPrivate: commercial banks

3.3. Private investmentPrivate investment FDIFDI Foreign portfolio investment: Inflows of Foreign portfolio investment: Inflows of

financial capital that is invested in the financial capital that is invested in the local stock and bond markets of LDCs.local stock and bond markets of LDCs.

• Foreign finance can help LDCs to Foreign finance can help LDCs to address three constraints:address three constraints:

1.1. Insufficient domestic savingsInsufficient domestic savings

2.2. Insufficient foreign exchange earningsInsufficient foreign exchange earnings

3.3. Insufficient technical skills, managerial Insufficient technical skills, managerial skills & technology can be skills & technology can be supplemented by the transfer of supplemented by the transfer of foreign skills & technology into the foreign skills & technology into the LDC.LDC.

Foreign Aid: Concessional Foreign Aid: Concessional loans & grantsloans & grants

• Largest share: ODA, including Largest share: ODA, including bilateral and multilateral bilateral and multilateral soft loanssoft loans (25%) and (25%) and grantsgrants (75%). (75%).

• Donor countries: most of OECD Donor countries: most of OECD countries, some OPEC countries and countries, some OPEC countries and some Eastern countries.some Eastern countries.

• Multilateral organizations providing Multilateral organizations providing ODA:ODA:– UN agenciesUN agencies– Single-issue funds (eg: global fund for Single-issue funds (eg: global fund for

AIDS)AIDS)– International Development Association International Development Association

of the World Bankof the World Bank– Regional development banksRegional development banks– IMF assistance for debt reliefIMF assistance for debt relief

• PurposesPurposes– Humanitarian aidHumanitarian aid– Debt reliefDebt relief– Development assistance:Development assistance:

•Financial support to sectorsFinancial support to sectors

•Financial support for specific projectsFinancial support for specific projects

– Technical assistance (doctors, teachers, Technical assistance (doctors, teachers, agronomists).agronomists).

• Donor motivesDonor motives1.1. Political & strategic motivesPolitical & strategic motives. Use of aid to . Use of aid to

support regimes considered to be support regimes considered to be ‘friendly’ to the interests of the donor ‘friendly’ to the interests of the donor governments.governments.

2.2. Economic motivesEconomic motives. Assistance to countries . Assistance to countries with strong economic ties, such as Japan, with strong economic ties, such as Japan, with aid directed to neighbouring with aid directed to neighbouring countries with trade and investment links. countries with trade and investment links. Tied aid: recipients must spent a portion Tied aid: recipients must spent a portion of the borrowed funds on the purchase of of the borrowed funds on the purchase of g+s from the donor country.g+s from the donor country.

3.3. Humanitarian & moral motivesHumanitarian & moral motives• Short term emergency assistanceShort term emergency assistance• Long-term development assistance on Long-term development assistance on

debt relief and poverty alleviationdebt relief and poverty alleviation

• Political & strategic interests Political & strategic interests predominatepredominate

Factors limiting the effectiveness of aidFactors limiting the effectiveness of aid1.1. Tied aidTied aid. In the context of bilateral aid: . In the context of bilateral aid:

recipients must spend part of the recipients must spend part of the borrowed funds on g+s from the donor borrowed funds on g+s from the donor country.country.

• Higher import costs.Higher import costs.• Purchase of inappropriate capital intensive Purchase of inappropriate capital intensive

technologies & development and use of skills technologies & development and use of skills inappropriate to local developing country inappropriate to local developing country conditions.conditions.

2.2. Conditional aidConditional aid. Donors impose conditions . Donors impose conditions to be met by recipients to ensure that to be met by recipients to ensure that funds are used effectively.funds are used effectively.

a.a. Policies towards market orientation.Policies towards market orientation.b.b. Acceptance of projects decided by Acceptance of projects decided by

donors.donors.c.c. Detailed reporting on spending, Detailed reporting on spending,

timetables, priorities.timetables, priorities.

ProblemsProblems with conditional aid: with conditional aid:1.1. The preferences of the government or The preferences of the government or

population group are not considered.population group are not considered.2.2. Policy prescriptions by donors may be Policy prescriptions by donors may be

incorrect:incorrect:– May not fit in with the government’s prioritiesMay not fit in with the government’s priorities– May undermine government’s authorityMay undermine government’s authority

3.3. Aid volatility and unpredictabilityAid volatility and unpredictability. . – Makes it difficult for recipient Makes it difficult for recipient

governments to implement policies governments to implement policies that depend on aid fundsthat depend on aid funds

4.4. Uncoordinated donorsUncoordinated donors → → inefficiencies in the use of aid resourcesinefficiencies in the use of aid resources

5.5. Aid substitutesAid substitutes rather than complements rather than complements domestic resourcesdomestic resources → not enough effort → not enough effort to increase revenues through taxation.to increase revenues through taxation.

6.6. Aid may not reach those most in need. Aid may not reach those most in need. Aid resources are not allocated on the basis Aid resources are not allocated on the basis

of the greatest need for poverty alleviation:of the greatest need for poverty alleviation: Bilateral donors guided by political & strategic Bilateral donors guided by political & strategic

interests.interests. Recipient country’s gov may not be committed Recipient country’s gov may not be committed

to poverty alleviation or lack expertise to design to poverty alleviation or lack expertise to design a poverty alleviation strategy.a poverty alleviation strategy.

7.7. Aid associated with corruption.Aid associated with corruption. Misuse of aid funds by recipient countriesMisuse of aid funds by recipient countries

Aid vs Trade debateAid vs Trade debate

• Three different perspectives:Three different perspectives:1.1. Trade, not aidTrade, not aid

2.2. Trade and aidTrade and aid

3.3. Aid for tradeAid for trade

Trade, not AidTrade, not Aid

• Proponents: development should be Proponents: development should be based on an expansion of int’al trade based on an expansion of int’al trade and increasing exports of LDCs, while and increasing exports of LDCs, while aid should be curtailed or aid should be curtailed or abandoned.abandoned.

• Failures of foreign aid:Failures of foreign aid:1.1. Aid is a breeding ground for corruption, Aid is a breeding ground for corruption,

as funds are misappropriated by as funds are misappropriated by corrupt leaders.corrupt leaders.

2.2. Aid substitutes for rather than Aid substitutes for rather than complements domestic government complements domestic government revenues. Governments lose incentive revenues. Governments lose incentive to increase tax revenues and increase to increase tax revenues and increase efficiency of tax system efficiency of tax system → dependency → dependency on aid funds.on aid funds.

3.3. Aid does not reach those most in need.Aid does not reach those most in need.

• Countries need international trade: Countries need international trade: Success of East Asian countries: Success of East Asian countries: int’al trade contributes to growth int’al trade contributes to growth and development.and development.

• BUT: on the condition that DCs BUT: on the condition that DCs eliminate their trade barriers and eliminate their trade barriers and protection of their agricultures.protection of their agricultures.

Trade Trade andand Aid Aid

• International trade and an export International trade and an export orientation are indispensable to growth orientation are indispensable to growth and development, but not enough by and development, but not enough by themselves in the case of LDCs.themselves in the case of LDCs.

• Foreign aid has not failed. Many of its Foreign aid has not failed. Many of its weaknesses (tied aid, conditional aid, weaknesses (tied aid, conditional aid, lack of coordination, volatility) are the lack of coordination, volatility) are the responsibility of donors and there is responsibility of donors and there is pressure to correct these problems.pressure to correct these problems.

Foreign aid is necessary...Foreign aid is necessary...

1.1. ...to help LDCs to escape the poverty ...to help LDCs to escape the poverty cycle.cycle.

2.2. ...to increase provision of basic ...to increase provision of basic services. Aid can make resources services. Aid can make resources available for investments in health, available for investments in health, education and infrastructure, helping education and infrastructure, helping the poor to improve employment the poor to improve employment opportunities and improve their opportunities and improve their incomes.incomes.

3.3. ...to improve income distribution, by ...to improve income distribution, by focusing on the most disadvantaged focusing on the most disadvantaged groups.groups.

4.4. ...for growth. Aid makes possible ...for growth. Aid makes possible increased investment and increased investment and consumption levels. consumption levels.

Mozambique, Tanzania, Uganda, which Mozambique, Tanzania, Uganda, which rely heavily on aid, have achieved high rely heavily on aid, have achieved high growth rates.growth rates.

5.5. ...for the achievement of the MDGs....for the achievement of the MDGs.

6.6. ...for debt relief purposes. Aid helps ...for debt relief purposes. Aid helps countries reduce their debt burden countries reduce their debt burden and releases resources that can be and releases resources that can be used for poverty reduction and used for poverty reduction and economic growth and development.economic growth and development.

Int’al trade may be of little Int’al trade may be of little useuse

1.1. Elimination of agricultural subsidies Elimination of agricultural subsidies would have mixed effects for food would have mixed effects for food importers (Africa): positive for importers (Africa): positive for producers, negative for consumers.producers, negative for consumers.

2.2. Countries may have little to export:Countries may have little to export:– Limited access to creditLimited access to credit– Difficult to move into production of Difficult to move into production of

goods that can be exported.goods that can be exported.

3.3. Geographically isolated countries Geographically isolated countries and communities: no access to and communities: no access to markets, urban centres or to ports markets, urban centres or to ports → unable to compete in international → unable to compete in international markets. markets.

• Investments in communications and Investments in communications and transportation are necessary to benefit from transportation are necessary to benefit from trade → aid can provide the resources.trade → aid can provide the resources.

Aid for tradeAid for trade

• Consensus among development Consensus among development economists: economists: In order to benefit from from int’al trade, In order to benefit from from int’al trade,

LDCs must have the institutional capacity LDCs must have the institutional capacity to increase their exports.to increase their exports.

• A portion of aid should be used to A portion of aid should be used to support the development of institutions support the development of institutions that improve a country’s abilities to that improve a country’s abilities to export.export.

• Institutional constraints:Institutional constraints:– High transport costs due to poor High transport costs due to poor

transport networkstransport networks– Limited access to creditLimited access to credit– Poor power supplies Poor power supplies → higher production → higher production

costscosts– High administrative costs (border procedures)High administrative costs (border procedures)– Lack of capacity to meet technical and Lack of capacity to meet technical and

sanitary standardssanitary standards

• Aid and trade policies should be Aid and trade policies should be integrated.integrated.

• The aid for trade would be ‘in The aid for trade would be ‘in addition to’ and not a replacement addition to’ and not a replacement for ODA.for ODA.

• Efforts to address institutional Efforts to address institutional constraints to trade should also focus constraints to trade should also focus on middle income developing on middle income developing countries, which do not qualify for countries, which do not qualify for ODA funds.ODA funds.