Is foreign aid effective?

By ljusten @ 2021-01-14T00:30 (+15)

Summary

• The effectiveness of foreign aid as a mechanism of economic development in poor countries is still not clear. Some posit that there is correlation between growth and aid while others argue foreign aid has no impact on growth or even a negative impact. My review of multiple summaries indicates a slight consensus that aid does indeed have a positive effect on economic growth, although how much is even more unclear.
• There are many examples of effective foreign aid in areas like global health, humanitarian relief, funding for multinational institutions, and security. However, the effectiveness of individual programs varies widely. There are also many examples of projects that have accomplished no good or even caused harm just as there are many examples of shabby evaluation and data collection methods. Overall, the effectiveness of foreign aid projects resembles that of the charity landscape with some interventions orders of magnitude more effective than others.
• I did get the sense that there was trend towards more effective foreign aid. I mostly examined U.S. efforts which include the increased emphasis data collection and effectiveness, coordination of military and development activities, emphasis on country-specific solutions, and new measures to promote self-reliance among poor countries.
• There is a new view of foreign aid that focuses less on the traditional macroeconomic indicators and instead looks inside the "Black Box" of aid. They argue that economic growth is in no small part a function of a country's initial conditions like the strength of economic and political institutions, the presence of natural resources, and the relationship to donor countries. The development of Country Roadmaps by USAID is a good example of this narrower approach to aid efficacy.

Introduction

In my last post I provided an overview of U.S. foreign aid but avoided answering a crucial question: Is foreign aid effective? Considering the stakes (the world invested $165 billion into Official Development Assistance (ODA) in 2018 [1]), it's a crucial question and one that has been the source of long and controversial debate. Reading the literature I was amazed by the degree of polarization and even hostility among some of experts in the field:

don’t let the skeptics fool you with their shouted and erroneous claims that there is no evidence that aid works. [10]

Jeffrey Sachs [is]… the world’s leading apologist and fund-raiser for the aid establishment… Sachs suffers from [an]… acute shortage of truthiness… [2]

This post provides my overview of the aid effectiveness controversy, explains why it's so difficult to come to a consensus, and summarizes the lessons we've learnt throughout. 

The findings and opinions I present in this post are derived entirely from expert summaries and commentary–– not from reading published journal articles of which there are many. References directly to academic papers can be found within the articles I cite.   

Aid effectiveness: Two views

In the aid effectiveness debate there have long existed two opposing views [2]:

View 1: Official assistance is ineffective and can even harm poor countries. 

View 2: Aid is effective especially when directed towards specific interventions like health programmes.

Most proponents of View 1 point to aggregate or macro level findings that show very little or no positive correlation between development assistance and economic growth in poor countries [2][3][4]. In any sense, they say, the findings that do show a positive correlation show only small increases in growth on and are not robust. Others go so far as to declare that the foreign aid status quo is harmful because it fails to address the fundamental obstacles to growth like corruption and weak free-market institutions, instead fostering dependency and rent-seeking behavior [4][5][6]. A more pessimistic and sometimes bordering conspiratorial spin on View 1 argues that foreign aid is a strategic weapon used powerful countries to wield influence with no intention of assisting the development of poor countries [7][8]. 

To be clear, most of those who hold View 1 still advocate for foreign aid in some form like targeted humanitarian aid. William Easterly is one of the most vocal skeptics of the world's foreign aid strategies but still argues for effective local level programs. In his book titled The White Man's Burden: Why the West’s Efforts to Aid the Rest Have Done So Much Ill and So Little Good, Esterley actually points to the  familiar example of  insecticide-treated bed nets distribution for protection against Malaria as an example of the kinds foreign aid needed. 

Proponents of View 2 argue that there is evidence of a positive correlation between foreign assistance and economic development, but how much is still unsure [9]. The Economist writes:

Supporters of [increased aid] can take comfort in the growing evidence that aid boosts growth; but they have more work to do to demonstrate that it boosts it by more, and at lower cost, than the alternatives.

It's important not to set too high of expectations for the impact of foreign aid on growth. Economic growth ultimately depends on stable governments and institutions with a strong development plan in place. Foreign aid serves a variety of military and humanitarian objectives that only indirectly affect economic growth.  

Looking beyond economic growth, foreign aid projects have also increased important measures of health and wellbeing. Aid interventions like PEPFAR and USAID's malaria initiative have helped reduce global aids and malaria deaths by half since 2000 [10]. There are other examples of successful education and food security campaigns by USAID programs. 

View 2 argues that critics of foreign aid really just make the case for why foreign aid has not worked better and not that it has completely failed [11]. 

Opening the "Black Box" of foreign aid: a third view

More recently a third view of foreign aid has emerged that I find to be the most compelling. View 3 acknowledges that a positive relationship between aid and economic growth across all poor countries is not robust. Instead it has shifted focus to examining effectiveness on a country by country, program by program basis. They argue that economic growth is in no small part a function of a country's initial conditions like the strength of economic and political institutions, the presence of natural resources, and the relationship to donor countries. Developing plans for individual countries and examining other indicators of growth like infant mortality, health, and education provide the most actionable path towards more effective foreign aid. 

This view appears to be guiding USAID's reform efforts which include distinct country roadmaps meant to put poor countries on the "Journey to Self-Reliance." There has also been progress on the issue of coordination between developmental and military goals in a region. Different government players pursuing different security, development, and relief goals have long been a barrier to a coherent objective for foreign aid. In 2018 USAID and the Department of Defense released the first of its kind joint "Stabilization Assistance Review" based on lessons from Syria and Iraq to better coordinate responsibilities. Mark Green, the then-acting USAID Administrator said of the report [14]: 

[The Stabilization Assistance Review] also helps us because it delineates mission parameters as quantifiable objectives as opposed to really open ended good intentions.

My impression is that these there a trend towards more effective and evidence based approaches to foreign aid. It's a goal shared pretty much universally between the three views of foreign aid and one that is resulting in some positive concrete actions by donor countries and multinational organizations. 

The micro-economic lens of aid

The micro level picture of foreign aid is one of widely varying program effectiveness much like the charity picture we understand in EA. There are many examples of effective programs like the PEPFAR and malaria initiatives mentioned earlier. But there are also many other examples of ineffective, poorly executed, or even harmful programs. GiveWell states that international aid "comes with serious risks that projects will accomplish no good, or will even cause harm." See GiveWell's Failure in international aid article for examples:

 A development program in Lesotho aimed to help local people with crop and livestock management, as well as building roads so they could access markets. However, few of the people in the region were farmers, and conditions were not good for farming. Harsh weather destroyed pilot crop projects, and the roads allowed in competitors who drove the existing local farmers out of business.

There are also credible concerns over corruption and weak political institutions that may be supported by foreign aid. Djankov et al. (2008) argues that aid has had statistically significant harmful effects on democratic institutions in poor countries.  

Overall there has been progress on program effectiveness and evaluation but almost everyone agrees: there is a need for improvement. The Millenium Challenge Corporation was an example of the kind of evaluation and reporting efforts that should continue to guide USAID's transformation. 

The macro-economic lens 

Measuring economic development as a function of foreign aid is extremely difficult. The fact that the there is still no clear answer to the aid effectiveness debate is testament to the challenges of building empirical models that capture economic growth. The models, metrics, and definitions used to measure a countries growth due to foreign aid have improved throughout the decades but remain shaky. I got the sense that there existed a kind of pendulum swing in the aid effectiveness debate with each new study showcasing a different method, model, or dataset. 

Several factors make it difficult to establish causality between foreign aid and economic development:   

• The growth of an economy is extremely complex and idiosyncratic in ways that are difficult to capture with empirical models [4]
• The initial conditions of aid recipient countries vary drastically. The presence of war, natural resources, authoritarian leaders, religion, culture–– all of these factors influence development in ways that make extracting a broad causal relationship between aid and growth very difficult [4].
• Fiscal and monetary policies have a large impact on how directly foreign aid can affect growth yet they vary widely among poor countries.
• The purpose of foreign aid is not to solely to promote economic growth. Many countries pursue other objectives like global health and security as well that have at least an indirect effect of economic growth.
• Aid levels are often quite small relative to a country's GDP so we shouldn't necessarily expect the growth levels many papers deem significant. Aid inflows to sub-Saharan Africa have averaged around 5% of recipient countries GDP over the last 30 years which some studies have suggested is too little to make a significant impact on growth [4]. One well regarded study found the "overall increase in the growth rate accruing from aid inflows of 10% of GDP may only lie in the range of 1% to 2.5% depending on the share of aid that is invested and productivity impacts." [4]. They also calculated that an expected annual increase in the growth rate from past aid flows of around 0.1%.
• Poorly performing countries (in terms of economic development) may receive more aid precisely because of their poor growth performance while countries beginning to perform better on development may receive less aid. This perpetual skew in aid distribution would always bias towards a less positive or zero correlation between aid and development [4][9].
• The effects of foreign aid initiatives in health and education make work on very long time scales not captured by many models. Sometimes effective interventions even lead to numerical quirks like the one described in [4]:

Ashraf et al. (2008) demonstrate that the immediate economic impact of gains in life expectancy from disease eradication may be a reduction in per capita incomes due to increased child survival and the consequent increase in the ratio of the nonworking age to the working age population

I think there is a growing consensus that macroeconomic results need to be accepted with more humility. There is also a growing emphasis on the role of Private Cash Flows (PCFs) and Foreign Direct Investment (FDI) in poor countries economic development. Fragile states for example attract much less external financing than non-fragile countries which is one reason that the U.S. has stepped up its aid to fragile states [11][12][13]. 

What we've learned

Despite the inconclusive results on the macroeconomic scale and the wide range of specific program effectiveness results (or lack-thereof), there have been a number of lessons learnt. 

Quoted from [4]:

1. We now have a better understanding of the difficulties involved in investigating whether aid stimulates growth on aggregate. . . . Methods that enable the analyst to deal with [factors like noisy and weak data; the high complexity and openness of the growth process; the endogeneity of aid; and the demographic implications of gains in social indicators] simultaneously, and thereby tease-out the ‘true’ impact of growth, are only beginning to emerge.
2. It is essential that one maintains appropriately modest expectations about the magnitude of aggregate returns to aid. As discussed above, theoretical exercises built on realistic assumptions tend to indicate small growth gains from the average volumes of aid that have been donated in the past (and which are likely to continue). . . . Such expectations are significantly smaller than those generated from the early generations of research on aid and growth. However, this message is not widely disseminated and needs to be absorbed by the wider policy community and general public.
3. It is important to recognise the multiple channels through which aid may have an impact on growth, as well as corresponding differences in the horizon over which aggregate effects may become apparent. Improvements in health, education and institutions can take a very long time (up to a generation) to cumulate into potential growth effects. . . . Countries with very different initial conditions and/or aid profiles may see very different responses to aid over time. Few studies, if any, have rigorously and explicitly taken this issue into account.

Like in the charity landscape, there have been lessons learnt on program evaluation and effective spending. There are encouraging signs of progress from organizations like USAID and The World Bank (see "Doing Business" as an example), but more progress is needed to implement best practice data collection and evaluation methods. 

In my U.S. foreign aid post, I compile several recommendations to increase the effectiveness of foreign aid at the national and international level.

So... Is aid effective? 

Overall, I believe that foreign aid is effective despite its flaws. There are areas where foreign aid has undoubtedly been successful like global health, humanitarian relief, peace and security, and funding multinational institutions. The view at the level of individual programs is similar to the charity landscape: widely varying effectiveness but trending in the right direction. 

On the macro level it's discouraging that we can't find robust evidence for foreign aid impact economic development, but we also need to be realistic about the amount of aid provided and the larger role of foreign institutions and governments in promoting growth. 

I think that the developments in the U.S. foreign aid strategy are encouraging; especially the increased the emphasis on conflict prevention and stabilization in fragile states. For foreign aid to be an effective mechanism of economic growth there must ultimately be sustained processes to "build physical capital and human capital, acquire technology, and nurture institutions that facilitate growth." [4]. Peace and stability seem vital to the sustenance of such processes.  

References

[1] https://data.worldbank.org/indicator/DT.ODA.ALLD.CD

[2] https://www.weforum.org/agenda/2014/11/how-effective-is-foreign-aid/

[3] https://www.weforum.org/agenda/2015/10/does-foreign-aid-boost-growth/

[4] https://www.un.org/en/ecosoc/newfunct/pdf/aid_effectiveness-finn_tarp.pdf

[5] https://www.independent.org/publications/tir/article.asp?id=638

[6] https://www.weforum.org/agenda/2015/10/does-foreign-aid-always-help-the-poor/

[7] https://en.wikipedia.org/wiki/Confessions_of_an_Economic_Hit_Man

[8] https://www.theguardian.com/commentisfree/2018/sep/02/as-a-system-foreign-aid-is-a-fraud-and-does-nothing-for-inequality

[9] https://www.economist.com/finance-and-economics/2014/08/14/aid-to-the-rescue

[10] https://www.brookings.edu/blog/future-development/2017/05/08/once-more-into-the-breach-does-foreign-aid-work/

[11] https://www.oecd.org/dev/34353462.pdf

[11] https://www.cgdev.org/blog/public-versus-private-flows-fragile-states-examining-external-financing-landscape

[12] https://www.cgdev.org/blog/us-aid-fragile-states-where-does-money-go

[13] https://www.cgdev.org/working-group/future-us-government-development-assistance-fragile-states

[14] https://www.devex.com/news/usaid-state-and-dod-to-release-first-ever-stabilization-assistance-review-92535