ENGS 51 | HW 6 | May 29, 2012

Johnson

Foreign Aid: A Recipe for Poverty?

Mahmud Johnson President Obama recently announced the New Alliance for Food Security and Nutrition ahead of the G-8 Summit. As the wealthiest nation on earth, I believe the U.S. has a moral obligation to lead the fight against hunger and nutrition and to partner with others to end poverty,1 Obama said. But how far will the buck go? Indeed, discussions on foreign aid are often recast to focus on its supposed impact on growth in developing countries. Economists such as Dambisa Moyo and William Easterly have argued that foreign assistance is, at best, a Band-Aid solution to development challenges in impoverished countries. In her widely publicized and controversial book Dead Aid, Moyo goes as far as to claim that foreign aid is in fact the root cause of poverty in Africa2. Foreign aid was meant to stimulate economic growth and alleviate poverty in developing countries. It seems a fairly straightforward concept: rich countries provide much-needed financing to poor countries to help them meet their development needs. Why is there so much disagreement on aid effectiveness? Does aid really stifle development? To think more clearly about the relationship between foreign assistance and economic development, I will focus on Sub-Saharan African countries, and particularly the Cold War and post-Cold War periods. Foreign assistance during the Cold War years was characterized by geopolitical interests, and was hence driven by what I term strategic myopia. It is a well-known fact that the United States and other Western countries supported dictators such as Idi Amin in Uganda and Samuel Doe in Liberia, clearly out of strategic expediency. The aid money largely served to legitimize the corrupt and dictatorial regimes, and lengthen their stay in power. According to democratic theory, citizens elect their representatives and can vote them out if they do not perform as expected. Foreign aid during the Cold War era essentially distorted this logic: leaders could run absolutely inefficient governments and still manage to cater to the interests of their constituents. Furthermore, leaders could use the free money to build up large standing armies, which gave them the ability to rig elections and remain in office for as long as they wanted. As Cold War rivalries intensified, Western countries remained uncritical of political conditions in African countries, and continued to dole out large amounts in aid to secure
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http://www.businessweek.com/news/2012-05-18/obama-food-speech-puts-rising-global-hunger-threat-onhttp://online.wsj.com/article/SB123758895999200083.html

ENGS 51 | HW 6 | May 29, 2012

Johnson

their strategic allies in Africa. Such assistance reduced African governments incentives to build strong domestic institutions to promote investments, domestic manufacturing, vibrant private sectors, strong civil societies, and other such institutions necessary for long-term development. On the political front, large aid flows made the presidency highly attractive. As exhibit 1 shows, the number of coups and presidential assassinations remained extremely high across the continent until the end of the Cold War.

Exhibit 1: Source: Daniel N. Posner and Daniel J. Young, 2007, The Institutionalization of Political Power in Africa, Journal of Democracy 18-3 (July), pp. 128.

Such disincentives for prudent economic governance led to high levels of bureaucratic corruption, inefficiency, and economic stagnation in most African countries. Economic mismanagement, in turn led to the rapid depletion of aid money and increased the frequency at which dictatorial African governments requested new rounds of financing from their foreign counterparts ballooning their external debt stocks. Therefore, Dambisa Moyo is correct to claim, evidence overwhelmingly demonstrates that aid to Africa has made the poor poorer, and the growth slower. The insidious aid culture has left African countries more debt-laden, more inflation-prone, more vulnerable to the vagaries of the currency markets and more unattractive to higher-quality investment. It's increased the risk of civil conflict and unrest. But Moyo is correct only to a point: 1995. The end of the Cold War in 1991 saw a gradual shift in most African countries relationship with the West. Good governance is the new paradigm in vogue in international development circles. The U.S. no longer supports rogue regimes, and conditions for aid nowadays often involve reducing corruption, improving governance,

ENGS 51 | HW 6 | May 29, 2012

Johnson

and so forth. This shift in global geopolitics has in turn led to changes in political and economic outcomes in Africa. And this is where Dambisa Moyo and her ilk get left behind: they remain overly grounded in old data from 20- 30 years ago. They also focus too much on the average that they forget that Africa is a continent, and different African countries have different growth trajectories. In his book Emerging Africa, Steve Radelet divides African countries into three categories: the emerging countries (sustained economic growth for over 15 years), the threshold countries (high growth, but not sustained), and the oil exporters. The below graphs show the dramatic post-1995 takeoff I discussed earlier.

Exhibit 2: Number of democracies in Africa. Source: Steve Radelets Emerging Africa.

Exhibit 3: Debt-to-exports ratio. Source: Steve Radelets Emerging Africa.

Exhibit 3: Real median income. Source: Steve Radelets Emerging Africa.

ENGS 51 | HW 6 | May 29, 2012

Johnson

So what do the data suggest? Incentives matter; they affect perceptions, which in turn affect behaviors and outcomes. Currently, there are very few incentives for African governments to behave irresponsibly: they no longer have unbridled access to free aid money. Also, aid is increasingly tied to performance; President Obama invited the heads of state of four African countries that have a track record of promoting development through agriculture. This is a marked departure from the shady diplomatic relationships that characterized the Cold War era. The behavior of social systems is a function of its internal structure. The stark contrast between Cold War and post-Cold War politics in most African states shows how different incentive structures can affect macroeconomic policy. It also shows that while rational, utility-maximizing individuals can skew whole systems in pursuit of self-interest, incentives can be realigned to ensure optimal social outcomes despite peoples failure to oftentimes work toward the common good. The discord between positive relatively recent evidence and those put forth by Moyo et al. on aid effectiveness also demonstrates the difference between information flows and physical flows, and the lags inherent in complex systems. The world has heavily bought in to the apocalyptic African story over the last 2-3 decades. Despite the remarkable reforms and transformations that have been taking place in many African countries over the last 15-odd years, perceptions still lag. It will take quite a while for Africa to convince the rest of the world that it has moved past the disastrous 1980s period. And an argument can be made about causality and to what extent external aid is impacting economies in Africa. But one fact remains clear: most African economies are transforming at a remarkable pace, in spite of foreign aid.