Unit 4 Macro: Overseas Aid and Economic Development - Benefits and Costs

Does aid help or hinder economic growth and development? This is the subject of a fierce debate in the development economics literature

• Aid has a range of economic, social, environmental and political objectives
  
• Economic development can take place without aid - China and Vietnam have both experienced sustained and rapid growth over nearly two decades without receiving much in the way of international aid payments measured as a share of their GDP
  
• Well directed and targeted aid can enhance a country's growth potential but the effects may not be seen for many years
  
• Aid that might help finance the building of a power station contributes directly to aggregate demand and increases supply potential
  
• Aid that is designed to put more children through school or humanitarian aid to vaccinate kids and prevent them dying will have an impact over a longer time horizon
  
• Different kinds of aid projects can affect growth at different times and to different degrees
  

Building the Case for Overseas Aid

1. Overcoming the savings gap: Aid provides a financial inflow for low income countries - it helps to overcome the savings gap. Also important in stabilising post-conflict environments - e.g. generate jobs to keep fighters away from conflict
   
2. Building the Capital Stock: Project aid can fast forward investment in critical infrastructure projects - an increase in the capital stock lifts a country's growth potential
   
3. Human Capital and Post Conflict Help: Long term aid for health and education projects - builds human capital and raises productivity. Aid combined with good policy can have lasting positive effects
   
4. Higher Growth and Trade Spillovers: Well targeted aid might add around 0.5% to growth rate of poorest countries - this benefits donor countries too as trade grows
   

Counter arguments – Limits / Disadvantages of Overseas Aid

1. Corruption: In poorly governed countries much of the aid is expropriated and leaves the recipient country.
   
2. Ruiling Elites: Aid can act as a barrier to true democracy - politicians pay more attention to aid donors than to their citizens
   
3. Aid dependency: A dependency culture on aid might be generated - the aid paradox is that aid tends to be most effective where it is needed least
   
4. Market distortions: Aid for example in the form of food aid in emergencies may lead to a distortion of market forces and a loss of economic efficiency
   

In the "The Bottom Billion" Professor Paul Collier from Oxford University suggests that, ceteris paribus, overseas aid may have added around 1% per year to the growth rate of the poorest countries of the world during the past 30 years. There are few economists who argue that aid has led to a reduction in economic growth of donor countries. Most of those who are critical of overseas aid focus instead on dependency and corruption. It is possible for countries to grow quickly without aid – but equally there are countries who were initially heavy aid recipients who have grown and developed and are now aid donors themselves for example South Korea.

The ceteris paribus assumption is important. Aid can provide a much needed injection of funds for some of the world's poorest countries and communities - but everything else is not equal. Many external factors may reduce or enhance the impact of aid on economic growth, for example the quality of government, the efficiency of financial systems and also the absence of conflict.

Key point: The contribution aid makes to growth differs sharply in countries at peace and countries in conflict

Critics of much of the aid that has gone to Africa in recent decades argue that a high proportion of aid has gone to low-income countries with poor institutional regimes. The UK Coalition government has a target of allocating 0.7% of GDP to overseas development assistance (ODA) - this target came into being in 1970 and has never been revised! But is it right to stick rigidly to such a target independent of what else is happening in both the domestic and the global economy? 0.7% of UK GDP is forecast to equate to around £15 billion in 2015. The government is also eliminating financial aid to India.

In a world of increasing resource scarcity, aid can also help achieve three important aims

• Helping to overcome skills shortages
  
• Funding to relieve infrastructure shortages
  
• Aid funded projects to help the poorest countries become more resilient to climate change
  

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