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

Introduction International Financial s like the World Bank and the IMF etc. extensively extends aid to the underdeveloped countries. Apartfrom international institutions, some developed countries such as the USA and UK etc. also provide financial assistance to poor countries such as Ghana and Nepal etc. for the promotion of economic development. Aid is basically provided to these countries' governments so that they may utilize these funds to strengthen the weaker sectors of their economies. Donors either institutions or countries have very little control over the use of funds. It depends on the government of the recipient countries as to the utilization of aid funds and grants. Foreign assistance in the form of aid plays vital role in development of an underdeveloped country to the extent that they are utilized properly. Government institutions have also a significant role in the utilizing this amount. Good government policies not only help country in its development but also help in utilizing the donors' money properly. This paper discusses the degree to which given aid finance is utilized for the growth depends on the effectiveness of recipient government's polices and institutions. Recipient Country's Policies and Aid Effectiveness 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. Role of Recipient Country's Policies in Aid Effectiveness 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 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 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. For example, if the goal of aid provision Dalgaard, Hansen, and Tarp "sufficiently poor economic management, on the part of the government, may render foreign aid ineffective." (2004, F192) Burnside and Dollar (2000) suggest that aid can be highly effective in reducing poverty and accelerating growth if the recipient country's policy with good policy; fiscal, monetary and trade policy. The author suggests that poor economic policies lead to no or little effect on economic growth and poverty reduction. Government policies can be judged by its budget surplus, low level of inflation, open and transparent economy and future prospects of economy (Dalgaard and Hansen, 2001). Indeed Government policies have a definite impact on the employment of aid fund. Government should show efforts to improve its budget surplus and inflammation should be controlled. There should be some growth potential in the economy. If the policies that are made take the recipient country towards the right direction, than the provided aid and assistance can promote economic growth in real terms. Government policies tend to have deeper impact on the use of aid and assistance and that may increase with the improvement in policies. Aid becomes more useful if it is allocated to those countries that are promoting good policies. It has been observed that aid became successful in the countries where the economic system is strong and government institutions have the eligibility to face all the challenges (Santiso, 2001). Government policies have wider impact on the development of a nation. Growth highly depends on the performance of government institutions. Aid gives a boost in the economic growth of a country but the condition apply here is the wise policies and strong financial institutions. Past experiences show that aid become useful if good policies are made and apply as well. Strong management and monetary policy are the factors that have a great contribution towards staunch macroeconomic development. Wise management of funds is very important in order to take good decisions. Clemens.and Radelet also assert that "the potential macroeconomic impacts of large aid inflows call for strong monitoring and wise management, not a curtailing of flows, as long as aid-financed activities are meeting their specified goals" (2003, p4). There should also be an efficient monetary policy so that the money supply remains in the secure hands and may not be misused. The steps are taken so that the given aid is utilized on the place for which it was given. Governments should bring reforms in their economic and financial activities so that aid may achieve the set goals. Assistance would be more effective if the policies of the recipient countries are effective. There are several poor countries in the world but the aid can only be fruitful if the policies of these countries are good. There are different economic policies adopted by various countries that affect the effectiveness of development finance towards these countries' economic development. (Collier. and Dollar, 2004). Economic policies prevailing in recipient countries have a deeper effect on the aids and assistance provided by the donors. It has been observed in various places i.e. Nepal, Burma and Afghanistan etc that lack of good policies are the reason behind the lack of growth and high poverty in these countries. It highly depends on the countries receiving aids that how to utilize the aid and bring down the level of poverty to a noticeable level. Poor economic policies and management of the aid money may result into unsatisfactory results in terms of economic growth. The proper use of external economic assistance plays a vital role in the economic stability of an underdeveloped country. Dalgaard, Hansen and Tarp also propound that "in particular, sufficiently poor economic management, on the part of the government, may render foreign aid ineffective" (2004, p191). As a matter of fact, aid becomes useless and show insignificant results if it is not utilized wisely. In order to have sufficient growth and poverty reduction, proper planning should be done. Ineffectiveness of government and corruption are the biggest enemy or hurdle in the way of development. All the aid being provided to the country may not be utilized properly due this factor. Collier and Dollar suggest that "aid allocation needs to take corruption into account because, even if aid cannot significantly reduce corruption, corruption can significantly impair aid effectiveness" (2001, p21). Any development would hardly be seen in the presence of corruption. It needs to be curtailed because it may not allow international aid to be effectively used. Due to a lack of policy improvement in the recipient country donors have become more reluctant as to the provision of loans and donations to certain countries. The government corruption is the factor behind the dishonest use of aid. Although the democracy is not the best system, still it is the most favorite system for the most of the people. Democracy really helps in reducing poverty (Collier. and Dollar, 2004). Most of countries have failed to bring desired improvements within the political structure of the state and circumstances, in general, remain to be the same as before. The corruption in various underdeveloped countries is one of the strongest reasons for it. The change of political system is necessary for the allocation of aid in these countries. In order to do so, democratic procedures should be introduced as it has a great potential to control poverty and increase the growth level to a desirable extent. Democracy is the system in which people are empowered by means of their electoral representatives so they can better utilize aid and use it for the betterment of their people. The donors, on the other hand, want their money to be spent on particular area that they think must be groomed. Donors can make sure by working with government as to whether the funds are being utilized properly and as per requirement or not. However, it largely depends upon governmental policies that where they employ these funds. Good government policies provide better outcomes that not only impress donors but also yield useful results in terms of their economic growth as well (Collier. and Dollar, 2004). The government institutions should not only work efficiently but also effectively to make the most of available resources. There is only one way to justify is the outcome. Donors are keenly interested to know that the results are even satisfactory and to what extent it can be seen in it. Countries that follow up with good economic policies get better results compared to those who do not. The ratio of investment is also higher in those countries where there is consistency in policies. The countries that are lacking in good policy making are not eligible of getting the maximum of it. Efficient institutions are the backbone of any country without which it cannot survive. Healthy institutions also reflect the good and strong policies of countries. Collier.and Dollar also says that "in a good policy country aid has twice as much effect on the quantity of investment as in a poor policy country" (2004, pF268). There are several African countries i.e. Ghana and Uganda that bring the reforms and used the given aid in the result-oriented sectors. On the other hand there are countries i.e. Congo and Nigeria that remained unsuccessful in establishing good policies (Collier and Dollar, 2004)). Governments can use aid effectively if they establish policies that support utilization of international finance towards economic growth. There is an example of countries like Ghana and Uganda that brought changes in their policies and as a result they utilized the aid in an effective manner. Apart from this point, there is no valid proof that reflects any positive relationship between aid and recipient country's policies. If we remove the aid equality constrained from multilateral and bilateral parameters, there would hardly be any thing supporting the concept that recipient country's policies promote aid effectiveness (Ram, 2004). This view relates to the point that the policies of recipient countries do not very much affect the aid effectiveness. Aid usually remains more successful in the progressive countries. These are countries having eager for growth enabling them to utilize the foreign aid for the purpose of development in a better manner. According to Country Policy and Institutional Assessment (CIPA) that can be measured through dividing it in four components i.e. macroeconomic policies, public sector management, structural policies and social inclusion (Santiso, 2001). These countries may also have the potentials to grow as well. If the government polices are going parallel with the economic development, it will definitely endeavour to utilize that sum of amount given as aid. The government can introduce good policies in several fields like it may establish policies to improve macroeconomic condition and the enhancement of public sectors through institutionalizing. After all it will not be wrong to state that growth may only take place in presence of wise government policies. Donors have very little control over the international finance extended to the underdeveloped countries. It largely depends on the recipient country's government as to how it uses the aid and to what sectors it allocates the finance. It may use it for the promotion of economic prosperity or it may use it for unnecessary expenditures like increasing the government official's salaries etc. Santiso also illuminates that "...the fact that aid works better in good policy environments appears undisputed" (2001, p14). It is highly important, therefore, that recipient countries adopt policies and procedures that could lead to effective utilization of international finance, and consequently promote their economic development. Besides, the donor countries as well as institutions need to play an active role in determining and overseeing the use of allocated funds in a certain country. Conclusion This paper elaborates that the extent to which aid extended by different institutions and countries can be utilized largely depends on its government policies and the performance of its institutions. Government policies have significant role in utilizing the large sums of money received by means of foreign aid. Wise management of funds and strong institutions may become helpful in the economic growth, being the ultimate objective of international finance. However it can be greatly argued that government policies may not have an imperative role in utilizing the aid funds for economic development and prosperity. A transparent economy may invite extensive foreign assistance, as donors have confidence that the funds would not go wasted in needless expenditures. The donor countries would also be assured that the recipient government may utilize it at the appropriate place where it may give better results, it is highly crucial and inevitable for any government to make institution stronger and capable of facing challenges of changing times. References Clemens, M. and Radelet, S. (2003), "The Millennium Challenge Account: How Much Is Too Much, How Long Is Long Enough" Working Paper Number 23, Center for Global Development, pp. 1-31 Collier, P. and Dollar, D.( 2004) "Development Effectiveness: What Have We Learnt ," Economic Journal, 114 (496), pp.244-271 Dalgaard, C.J and Hansen, H. (2001), "On aid, growth and good policies," The Journal of Development Studies, 37(6), pp. 17-41 Dalgaard, C.J, Hansen, H. and Tarp, F. (2004), "On The Empirics Of Foreign Aid and Growth," The Economic Journal, 114(496), pp. F191-216 Ram, R. (2004), "Recipient Country's 'Policies' And The Effect Of Foreign Aid On Economic Growth In Developing Countries: Additional Evidence," Journal of International Development, 16(2), pp. 201-211 Santiso, C. (2001), "Good Governance and Aid Effectiveness: The World Bank and Conditionality," The Georgetown Public Policy Review, 7(1), pp.1-22 Read More