Adverse Effects of the Foreign Aid - Essay Example

?THE HARMFUL EFFECTS OF FOREIGN AID INTRODUCTION The dynamics of foreign aid is a complicated affair. Ideally, it is supposed to be an altruistic initiative. However, aids are often granted to beneficiaries in exchange for something or tied with several conditions. Then, there is also the claim that foreign aid could give rise to numerous problems on the part of the beneficiary such as its incapacitating effect on people in determining and building their own solutions to their problems. These variables, among others, underpin the manner by which large amount of financial resources and other forms of aid could cause harm to recipient countries. An inquiry on this aspect, particularly one that investigates the causes of wealth and poverty, is an important economic task in the wider drive to solve the unequal distribution of wealth throughout the world. This is important because there is a need for meaningful measures to address the poverty incidence around the world. In a study by the World Bank, the low and lower middle income countries constitute more than half of the world's economies and that at least 1.1 billion people live by $1 dollar per day (World Bank 2005, 2007) This paper will investigate this theme, identifying a comprehensive list of problems that are either directly or indirectly associated with large aid. It is expected that through the information, corrective measures could be identified made so that the delivery of financial aid is effective and could achieve more meaningful effects. The Concept of Aid There is an inability on the part of poor and developing countries in terms of the generation of resources in order to achieve and maintain their targeted growth and development. For this reason, these countries depend largely on the influx of foreign capital. However, it was soon discovered that growth can be achieved on account of several more factors other than this variable such as the administrative, technical and managerial capabilities present in a country (Yongo-Bure, 2010, p.150). It is this circumstance that necessitated the need for foreign aid. There are two fundamental types of foreign assistance. The classification is determined according to aid motivations. These are humanitarian aid and development aid. Individuals, organizations and governments in order to assist people or governments experiencing distress, suffering, war, disasters and other emergencies provide humanitarian aid. For instance, governments could provide aid through the United Nations Office for the Coordination of Humanitarian Affairs (OCHA) in cases of emergencies that occurred as a result of natural disasters. Development aid is the main focus of this paper. It is the financial and other resources provided by wealthy countries to low-income states in order to help spur economic development, reduce poverty, improve governance, solve population explosion, expand access to basic education and healthcare, protect the environment, promote stability in conflictive regions, protect human rights, among other objectives (Tarnoff, 2010, p.3). It is distinguished from the humanitarian assistance by the fact that the intent to alleviate suffering and poverty is aimed at the long-term as opposed to the latter's emphasis on the short-term relief. Industrialized countries have institutionalized development aid through their respective Official Development Assistance (ODA). Financial resources are provided through different channels such as international aid organizations, non-government organizations and global bodies such as the UN and the World Bank. The flow of financial resources and the part of it that is normally called aid, wrote Singer and Ansari (1988, p.180), is only a part - and a comparatively small part - of the total aid relationship between rich and poor countries. This is because other types of aid could also emerge. For instance, there are those who argue that when a rich country opens up its market to the exports of low-income countries, it is providing a meaningful aid. Ideally, the effect of foreign development aid on economic growth may occur with two lags. One can turn to Nushiwat's (2007, p. 96) explanation for this aspect: in the first lag, foreign aid, at least initially, could have been used to build basic infrastructure and the basic industries. The increase in economic growth could have followed with a lag of at least one year. The second lag is between economic growth and domestic savings. At the early stages of growth, savings are not expected to increase significantly until income had increased sufficiently Currently, rich countries have a target of aid for specified list of impoverished states. This was the agreement reached through the 2000 United Nations Millennium summit, which aimed to end extreme poverty by 2015 (Garces-Ozanne 2011, p.27) This target is that 0.7 percent of the gross domestic product (GDP) is supposed to be doled out as aid for identified beneficiaries (Penn, p. 81). There are countries that meet and even exceed this target and there are also those that fail to reach the percentage mark. For instance, Norway and Sweden consistently exceeds their aid targets while countries like the United Kingdom and the United States provide 0.27 percent and 0.11 percent of their GDP, respectively (Penn, p. 81). Aid Motivations Ideally, foreign aid is provided with humanitarian rationales and motivation such as poverty alleviation. But this is not always the case. The United States, for example, has been known to dole out aid in exchange for cooperation, alliance, economic and political objectives. The US aid program and its development depicted a focus on security and political leverage in international arena. The modern underpinnings include the country's anti-terrorism drive, which resulted in the focus of aid delivery on the conflictive regions such as the Middle East. However, recent trends show a return to the view that poverty and lack of opportunity are the underlying causes of political instability, which result in the rise of terrorist organizations and creates a breeding ground for insurgencies (Tarnoff, p.3). This development is seen to shift or, at least, modify the focus of US aid targets presently and in the future. One of the best assistance frameworks was that of the Swedish government's. Its assistance to Central and Eastern Europe (CEE) was financed in order to support several countries in these regions that are transitioning in their struggle to become de facto sovereign states (Hassler, 2003, p.3). It is clear that although there are identified less altruistic aspects in Sweden's aid policies, the pattern and nature of aid as well as policy pronouncements depict a general objective of giving aid primarily to help poor people in impoverished countries. All in all, there are numerous purposes why aid continues in steady stream towards low-income countries. In addition to self-interest, which typified much of the American policy, there are several others as well. Leeson's (2008, p.41) work provided an outline of most of these. He explained that "at one time, donors designed foreign aid to transfer resources from taxpayers in rich countries to government of poor countries with the goal of filling the 'investment gap'." Then, the focus shifted to donating for the purpose of bridging the human capital gap. Leeson (p.41) finally identified that, today, aid is used by the development community in order to curb population growth, which many believe as the cause of poverty. IS AID HARMFUL? There are numerous academics and economists who argue that aid is harmful. The most prominent of these was those by P.T. Bauer, which were subject to numerous other interpretations. The main argument is that aid encourages the concentration of power in government, which result to the following adverse effects: it discourages private saving and foreign commercial loans and direct investment; it encourages capital flight; it tends to politicize the developmental process (Dacy, 1986, p.35) What is worse is that the government would come to rely on aid, which could prove damaging in the long-term. Once foreign aid is discontinued, the government would no longer have the resources to sustain domestic economic and social programs, leading to a retardation of the country's growth rate. The main point of this criticism is that aid will never help an economy that will not prosper without it in the first place. Another dimension the role attributed to the government in the aid failure theme is the way recipient governments (often considered local elites) could pursue anti-developmental behavior, undermining the positive impact potential of aid. These behaviors could include outright misuse of funds by corrupt officials as well as the potential adverse impact of aid on taxation (Mavrotas, 2010, p.38). A case in point is how several governments of poor economies with massive unemployment rates are forced to adopt redistributive politics and populist programs in order for them to win elections. The donors, wrote Lahiri (2007, p.27), do not face this ground level reality, particularly in setting their objectives, that is why the aid intended for improvement, say, on infrastructure or health services, end up increasing the unproductive work force of a beneficiary state. The following case studies further demonstrate various forms of negative relationship between foreign aid and economic growth as well as the harm done in the process. Case Study: The Sub-Saharan Experience The sub-Saharan Africa is a recipient of steady and large amounts of aid mainly due to the extreme poverty and the numerous constraints to economic development. Most of the aid provided for this region is based on humanitarian considerations. A study by Hadjimichael (1995), investigating the effect of foreign aid assistance to the economic growth of the region, found a disturbing result. The regression estimates, which used pooled time series and cross-section data for 39 countries in the region between 1986 and 1992, revealed that the relationship between foreign aid and economic development is negative (Hadjimichael, p.1997). The researcher was able to provide the details for this phenomenon. In his multivariate framework, which mapped out several influences on growth for this region, the findings indicate an initial favorable aid impact on growth but the effect deteriorated to negative beyond a certain threshold. The study concluded that too much foreign assistance could hurt an economy because of the limited capacity to use and exploit the resources (Hadjimichael, p.1997). One of the evidences given is the manner by which foreign aid has to pass through the public sector, whose incapacities magnified the distortions and inefficiencies beyond certain level of inflows. Case Against Food Aid A specific demonstration of the harmful effect of aid in the context of Bauer's position is through the dynamics food aid community. This type of aid is important in times of emergencies, famine, civil strife. Besides this, there are instances wherein, food aid forms part of aid package provided for a country on account of its economic position, the absence of arable farming lands, overpopulation and the subjection to rigid economic or political sanction. While there are positive results in the achievement of set objectives, there are also several negative consequences. According to Unklesbay (1992, p.100): food aid reduces the pressure on recipient countries to make policy reforms; it tends to depress domestic farm prices, discouraging domestic agricultural production and reduces the introduction of agricultural technologies; food aid reinforces state hegemony; it promotes a shift in food consumption patterns from staples and indigenous food towards wheat and wheat flour; food aid disrupts international commercial channels. The Dutch Disease Foreign aid is also underpinned by the potential hazard poised by the so-called Dutch Disease. This is the consequence of large inflows of aid that could induce several adverse economic phenomena such as the real appreciation of currency either through inflation or nominal exchange rate changes - and the reduction of the competitiveness of a country's exports (IMF, p.9) This is critical since today, many economies depend on their exports for their economic development. The IMF provided several scenarios wherein foreign aid can lead to Dutch Disease. The most important of these occur when aid leads in the spending on nontraded goods and the resulting increase in relative price of these goods - that is, real appreciation - along with a shift of productive resources from the traded goods sector to firms producing nontraded goods (IMF, 2006, p.10). The adverse effect transpires according to the economic policy of a country. For instance, "if the additional spending is supported by the monetization of the increased foreign exchange received as aid (thereby giving the central bank more reserves as a cushion against future balance of payment needs), the increase in the relative price of nontraded goods will come about through inflation" (IMF, p.10). On the other hand, the IMF (p.10) also explained that once the monetary effects of the additional government spending are sterilized by selling foreign exchange, there will be no inflationary impact from money creation but the nominal value of domestic currency will appreciate.. In either of these situations, the country receiving aid, loses its competitiveness in the export market. Issue of Control The previous cases depict failures in aid objectives due to issues of fungibility and incapable implementing agencies. This does not mean, however, that capable implementation, typified by closely monitored aid program delivery will yield positive result. This was found in the US aid experience for Southern Vietnam. In the 1970s, massive aid was funneled to South Vietnam in an effort to spur economic growth in a wider attempt to gain advantage in the Vietnam conflict. The aid program was highly visible and, hence, was subject to intense scrutiny and criticism. In order to address these structural problem, hundreds of personnel were sent to South Vietnam in order to supervise, evaluate and monitor the disbursement of the aid package and ensure that the objectives of the program were satisfied. According to Dacy (p.35), alongside the Vietnamese officials engaged in economic matters, there were aid officials, instructing, coercing and giving friendly advice, all in all, serving as micro control points in the disbursement of aid. The allocation of aid was controlled, standards were set in the approval of economic programs and initiatives and the entire aid process were peppered with evaluators that scrutinized almost all stages and initiatives involved. With all these mechanisms of control, the aid program failed and inflicted serious damage to the South Vietnamese economy. There were two fundamental reasons for the failure: 1) it was a poor substitute for general policies, such as the coercion of the Vietnamese authorities to adopt flexible exchange rate system that could have permitted the price mechanism to give the proper signals for investment decisions; and, 2) it hindered the "economic Vietnamization", which should have placed responsibility for economic performance on the Vietnamese (Dacy, p.36). This area also highlights the mistakes made by donors and aid agencies. For example, De Waal explained how international non-governmental organizations (INGO), which serve as conduits for foreign aid could prevent the ability of poor countries to find and negotiate the solutions to their problems (De Waal 2002, p. 221). This is also supported by Penn, whose work argued that the aid industry is typified by an inane optimism that predicts all kinds of wonderful solutions from tiny drop of aid and that as a result, it could do more harm than good by distorting expectations especially with regards to what is possible, achievable and even desirable (p. 82). There is also the issue about the conditions often attached to foreign aid. An OECD publication reported that many donors are now responding to calls from developing countries to untie bilateral aid. The rationale behind this is that by removing restrictive conditions to aid, donors could provide reliefs to heavily indebted countries. OECD has identified successful untying of ODA to the least developed and heavily indebted countries such as Bolivia, Cameroon, Cote D'Ivoire, Ghana, Guyana, Honduras, Nicaragua and the Republic of Congo (OECD p.77) Absorptive Capacity Yongo-Bure (2010, p.150) introduced the concept of "absorptive capacity" in the discussion of foreign aid. He explained that this is the "ability of a country to employ both domestic and foreign capital productively in the sense that the resources yield some minimum rate of return. This concept is an important in the analysis of the efficacy of foreign aid. If the absorptive capacity of a country is low, then the objective of aid fails, or that it, finally, leads to the problems and harmful effects on the beneficiaries. The factors that hinder the high absorptive capacity are: lack of knowledge of the natural resources in the country and of basic data on the economy; lack of appropriate technology (including the absence of research facilities; a lack of skills; a lack of managerial competence and experience both in the public and private sectors; and, institutional limitations that range from law and order to economic policy instruments and institutions, government administrative procedures and coordination (Yongo-Bure, p.151). This position is consistent with the observations and conclusions of other experts. For example, Eshaga (1971) maintained his prominent position, that: On the basis of the forgoing observations, it is clear that the net balances of cost or benefit of foreign aid will depend on the type of aid received (its direct and indirect costs) and on the use made of it (its direct and indirect benefits). Both the costs and benefits of aid will in turn depend largely on the character and policies of the governments in the donor and recipient countries which can vary from one country to another, for the same countries, from one situation to another (p.156). Conclusion There are studies that suggest how foreign aid could undermine the country-beneficiary and its people's ability to change their circumstance. This is clearly demonstrated in several cases cited by this paper. The most important include the increase in power on the part of the government, the over dependence on foreign aid, and the adverse impact as explained by the concept of the Dutch Disease. All these problems also reveal how the impact and the damage of aid for poor countries are determined by their absorptive capacities, which, in turn, are driven by numerous variables, a number of them, country-specific. The absorptive capacity framework explains the problems and negative impacts for foreign aid beneficiaries listed by this paper. The lack of competence and capability for example, led to wastage in the financial aid, which often fall prey to unscrupulous government officials. It provided insights with regards to addressing the pitfalls entailed in giving aid. With the identification of specific variables that limit absorptive capacity, it becomes easier for concerned parties to determine the solutions and the mechanisms that would ensure the efficacy of aid or that the aid reaches its intended destination and yield the intended outcome. More importantly, policy responses could be undertaken in order for the potential damage to be averted. This is crucial in the position that aid remains as an important strategy by which wealthy countries could help the poor in many parts of the globe. However, this should not be interpreted as a some form of support for excessive aid that leads to over dependence. According to Dedu, Staicu and Nitescu (2011, p.41), the foreign aid initiatives should not be oriented towards passive receiving but instead should emphasize "active fishing". This should be the operative concept behind foreign aid and its objectives. References Dacy, D 1986, Foreign Aid, War, and Economic Development: South Vietnam, 1955-1975. Cambridge: Cambridge University Press. Dedu, V, Staicu, G and Nitescu, D 2011, A Critical Examination of Foreign Aid Policy. Why it Fails to Eradicate Poverty? Theoretical and Applied Economics 4(557), 37-48. De Waal, A 2002, Famine Crimes: Politics and the Disaster Relief Industry in Africa. International African Institute. Eshag, E 1971, Comment on Griffin. Oxford Bulletin of Economics and Statistics, 33, 149-156. Garces-Ozanne, A 2011, The Millennium Development Goals: Does Aid Help? Tennesse: Journal of Developing Areas. Hadjimichael, M 1995, Sub-Saharan Africa: Growth, Savings, and Investment, 1986-93. Washington, D.C.: International Monetary Fund. Hassler, B 2003, Science and Politics of Foreign Aid: Swedish Environmental Support to the Baltic States. Berlin" Springer. International Monetary Fund 2006, The Macroeconomic Management of Foreign Aid: Opportunities and Pitfalls. Washington, D.C.: IMF. Lahiri, S 2007, Theory and practice of foreign aid. Oxford: Emerald Group Publishing. Leeson, P 2008, Escaping Poverty: Foreign Aid, Private Property, and Economic Development. The Journal of Private Enterprise, 23(2), 39-64. Mavrotas, G 2010, Foreign Aid for Development: Issues, Challenges, and the New Agenda. Oxford: Oxford University Press. Nushiwat, M 2007, Foreign Aid to Developing Countries: Does it Crowd-out the Recipient Countries' Domestic Savings? International Research Journal of Finance and Economics 11, 94-102. OECD 2009, OECD Journal on Development 2009: Development Co-operation Report, Issue 1. Paris: OECD Publishing. Penn, H 2005, Unequal Childhoods: Young Children's lives in poor countries. London: Routledge. Polak, J 1989, Financial Policies and Development. Paris: OECD Publishing. Singer, H and Ansari, J 1988, Rich and Poor Countries: Consequences of International Disorder. London: Routledge. Tarnoff, C 2010, Foreign Aid: An Introduction to U. S. Programs and Policy. Washington, D.C.: DIANE Publishing. Unklesbay, N 1992, World Food and You. London: Routledge. World Bank 2007. "Data and Statistics." http://www.worldbank.org World Bank 2005, World Development Indicators 2005. Washington, D.C.: World Bank. Yongo-Bure, B 2010, Economic Development of Southern Sudan. University Press of America. Read More