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International Financial Institutions: Governmental Policies and Aid Effectiveness - Article Example

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This article discusses the degree to which given aid finance is utilized for the growth depends on the effectiveness of the recipient government’s policies and institutions. Therefore, the article investigates the contribution of government management and monetary policies to the effectiveness of financial aid…
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International Financial Institutions: Governmental Policies and Aid Effectiveness
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Download file to see previous pages Foreign assistance in the form of aid plays a vital role in the development of an underdeveloped country to the extent that they are utilized properly. Government institutions have also a significant role in utilizing this amount. Good government policies not only help the country in its development but also help in utilizing the donors' money properly.
Existing research [e.g. Burnside and Dollar (1997), Mosley, Hudson and Verschoor (2004), Dalgaard, Hansen, and Tarp (2004), Burnside and Dollar (2000), etc.] suggests that academicians and scholars stress greatly on the importance of recipient country's policies in the effectiveness of aid. These authors regard aid as highly effective in poverty reduction and economic development only if the recipient country's policies are growth and development-oriented. This suggests that although aid can contribute a lot towards economic development and prosperity, the result could be entirely opposite.
Burnside and Dollar (1997) strongly opine that foreign aid leads to growth in poor countries with 'sound economic policies' (p4). The authors identify certain good policies that lead to long-term growth in recipient countries including "open trade regimes, fiscal discipline and avoidance of high inflation" (p5). They take an example of Botswana and Indonesia as countries that performed well after receiving foreign aid whereas the countries like Tanzania and Zambia could not perform well. They studied the provision of bilateral aid in the period of Cold War and found that foreign aid provided to countries with poor economic policies such as Tanzania or Zambia was thoroughly wasted whereas it could lead to growth and development in countries with good economic policies. They argue that "in a sound policy environment, aid attracts private investment, whereas, in a poor policy environment, it displaces private investment." (p5). Hence, if the recipient country's economic policies are good or growth-oriented, infusion of foreign aid can accelerate the process of economic development. For instance, if the existing policies of a recipient country accentuate open trade environment and encourage private investment, aid can be effective in removing the financial hurdles in the way of industrialization.

The element of good and bad government policy is highly evident in the literature. The concept of the good economic policy highlights the importance of aid allocation to the areas where it can be the most effective in bringing the desired results. Mosley, Hudson, and Verschoor expound that "the marginal aid dollar should flow to where its effectiveness is highest, under the joint influence of existing policies and levels of poverty, not necessarily to where it is high" (2004, F218). Hence, the policies of recipient government which are relevant to the process of aid allocation truly determine the extent to which aid becomes effective in poverty reduction and economic growth or is simply wasted on less important issues. ...Download file to see next pages Read More
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