EC3040 Economics of LDCs Module B Topic 4

1. EC3040 Economics of LDCsModule B Topic 4 Aid

2. Savings, investment, borrowing • In a closed economy, domestic savings=investment • But in an open economy this is not necessary in the short-to-medium term • Rational for a country to borrow as it builds up its capital stock (smooth consumption over time) • But • International financial markets can suddenly shut down • Inflows of capital can boost real exchange rate and thereby slow export growth

3. Long-term equilibrium in simplest Solow model Y sY δK K Stationary point

4. Table 10.2

5. Fig. 10.6

7. Fig. 10.3

9. Figure 15.2

12. What is ODA? Grants or Loans to countries and territories on Part I of the DAC List of Aid Recipients (developing countries) which are: (a) undertaken by the official sector; (b) with promotion of economic development and welfare as the main objective; (c) at concessional financial terms [if a loan, having a Grant Element of at least 25 per cent]. In addition to financial flows, Technical Co-operation is included in aid. • Grants, Loans and credits for military purposes are excluded. • Transfer payments to private individuals (e.g. pensions, reparations or insurance payouts) are in general not counted.

13. Who gives how much to whom? Donors • Bilateral Official (the biggest source) • Multilateral Official • About one-third of total official • Resources come from bilaterals • Additionally, non-concessional IFI flows are sizable • Private / NGOs / CSOs / Philanthropic foundations • Part of their funding also comes from bilateral official sources

14. Who gives how much to whom? Who are the main multilaterals? • World Bank’s IDA • Other regional IFIs (ADB,AfDB,IADB,CDB, etc) • UN Agencies (UNDP, UNICEF,UNHCR…) • New entities (Global Env Facility; …

15. ODA: 1990-2007: % of GNI and $ bn Source: OECD DAC

16. ODA: Real, Nominal, % of donor GDP, 1973-2004

18. Well below track agreed at Gleneagles Source: OECD DAC

19. Who gives how much to whom? Recipients • Part I countries • Part II countries (income too high – not counted as development aid No of donors per recipient No of recipients per donor

21. OECD DAC

34. Volatility of aid Celasun and Walliser, 2008

35. Volatility of aid Celasun and Walliser, 2008

36. …and why? Official reasons • USA • Japan • Others (mostly poverty, MDGs, Human rights Real reasons • May be more complex • Trade, security (USA to Afghanistan, Iraq, Pakistan), international diplomacy (Australia to neighbours: is biggest single donor to PNG) Public opinion favours Aid (even in US, if question is worded carefully) NB: Claessens et al. 2007: After fall of Berlin wall, bilateral aid responds more to economic need and the quality of a recipient country’s policy and institutional environment and less to debt, size, and colonial linkages.

37. Does aid work to increase growth? Hmmm… not obvious

38. Fig. 14.5 top Optimistic view (Allow a nonlinear relationship)

39. Fig. 14.5 middle Pessimistic view (Confirmed by a straight-line relationship)

40. Fig. 14.5 bottom Conditional view (Nonlinear + other variables)

41. Be careful with regressions (Anscombe’s charts)

42. How might aid work to increase growth? By closing one of the two gaps thereby making needed investable funds in fx available to build capital stock By improving health/education, thereby enhancing worker productivity By being the vehicle through which technology is transferred (fx, ta, green rev) Radelet, 2006

43. Clear successes in health • eradication of small pox, • near-eradication of polio, • control of river blindness.. and other diseases, • spread of oral rehydration tablets to combat diarrhea, • dramatic increase in immunization rates in developing countries since 1970 Radelet, 2006

44. How might aid be ineffective or reduce growth? Might be wasted or spent on luxuries for the elite Might actually increase corruption Might keep bad governments in power Might prolong war Recipients might not have capacity to make use of aid Might result in offsetting reductions in saving (about ½?) Might have damaging side effects on incentives for investment or productivity (e.g. real exchange rate appreciation; free food vs. local farmers) Radelet, 2006

45. Might aid work only under some conditions? Characteristics of recipient country Recipient policies adopted (e.g. macro and trade policies); Civil liberties, institutional quality; type of government, warfare export price shocks, terms of trade Location in the Tropics Donor policies Ensure recipient ownership; monitoring; coordination Type of aid emergency and humanitarian aid (no link with growth) slow-burning aid (health, education, environment, democracy) aid directly aimed at growth (roads, ports, power infrastructure; agriculture). Radelet, 2006

46. Recent empirical studies on aid and growth • Burnside and Dollar (2000): aid works in countries with good economic policies. Hansen-Tarp (2004)..only outside the Tropics • Easterly Levine Roodman (2004): showed that these results were fragile, being sensitive to small changes in the data set. HT: 4 countries decisive • Clemens, Radelet and Bhavnani (2004): “aid that could plausibly raise growth within a few years (budget support, infrastructure, industry) in fact does” • Rajan and Subramanian (2005):aid has no significant effect on growth (bad instruments). Roodman, 2007

47. Which of the three is confirmed by data? Not the second – almost all studies in recent years find some growth effect: (especially when they allow for a nonlinear effect) So even if the bad mechanisms are present, the net effect of aid can be positive The third one (conditional) seems to be empirically the most promising, but evidence is fragile for policies not much evidence re donor policies slow-burn shows little effect—but that’s not surprising Radelet, 2006

48. The micro-macro paradox • Education aid  enrolment • Health aid  infant mortality • Conditional cash programmes school attendance, health • (Not all: even donors admit relatively high failure rates WB: 22%) Roodman, 2007

49. How to give aid • Principal-agent problems • Conditionality • Five fashionable ways forward

50. Principal-agent problems “A unique and striking characteristic of foreign aid is that the people for whose benefit aid agencies work are not the same as those from whom the revenues are obtained; they actually live in different countries and different political constituencies. This [separation] blocks the normal performance feedback process: beneficiaries may be able to observe performance but cannot modulate payments (rewards to agents) as a function of performance. Although donors are typically interested in ensuring that their funds are well spent, it is extremely difficult for them to do so, since there is frequently no obvious mechanism for transmitting the beneficiaries’ point of view to the sponsors.” Martnes (2004, cited in Radelet, 2006)