Promises, promises

from the Economist

From The Economist print edition
How reliably aid is given can be even more important than how much is given

DEVELOPMENT aid can be as fickle as fashion. Remember those white Make Poverty History wristbands, which briefly made compassion chic in the run-up to the Gleneagles summit in 2005? Memories of the pledge made by G8 leaders there to double annual aid to Africa by 2010 also seem to have faded with time. According to the OECD, on current spending trends annual aid will fall $14 billion short of the $50 billion African target—not a statistic to savour as today’s G8 leaders tucked into their eight-course banquet on the Japanese island of Hokkaido on July 7th. Once again, they vowed to honour their aid commitments to Africa, but they are not legally binding nor are they easy to pin down. As usual in the aid business, making promises is a lot easier than sticking to them.

Does that matter? After all, the effectiveness of such sweeping aid pledges has been questioned a lot lately. Last year, in his book “The Bottom Billion”, Paul Collier, an Oxford economics professor, convincingly argued that aid, on its own, was unable to make a big difference to the world’s poor. He saw it more as a way of stopping things from falling apart, rather than fostering growth. He and other scholars have argued that large disbursements are subject to the law of diminishing returns. Even at Gleneagles, aid sceptics warned world leaders of the dangers of “Dutch disease”—that a sudden windfall of hard currency could push up the exchange rate and damage a country’s export competitiveness.

A new paper, by Oya Celasun of the IMF and Jan Walliser of the World Bank, suggests that failing to honour promises can in fact be more harmful than not offering any money in the first place. The authors examined yearly aid commitments, not long-term ones of the Make Poverty History variety. They show how unpredictable such aid flows are. The paper finds that the average absolute difference between aid promised and aid given was equal to 3.4% of each sub-Saharan African nation’s GDP between 1990 and 2005. That is far greater than in any other region of the world. In countries that had experienced war, the fluctuations were particularly marked, partly because of shrinking economies: in Sierra Leone the swings were equivalent to 9% of GDP. It is also a myth, the authors show, that donors always give less than they promise: they are both capriciously generous, as well as capriciously stingy. During the same period, rich countries exceeded their yearly aid commitments to sub-Saharan Africa by an average of 1% of each recipient country’s GDP.

Aid-dependent countries have limited access to international financial markets to help smooth over the sudden bumps and pot-holes. And governments cannot easily use their domestic debt markets to absorb the shocks, because these are shallow and too much government borrowing crowds out private investment. Poor governments thus have to alter their spending plans in response to aid surprises. The study shows that the impact is not spread evenly over the governments’ investment and consumption plans, with damaging consequences.

In poor countries, government consumption is mostly composed of salaries, which are difficult to cut at short notice, not least for political reasons. Investment, meanwhile, is typically carried out near the end of the budget year. When the amount of aid does not live up to expectations, poor governments find it easier to cut investment rather than consumption. In Burkina Faso, for example, government budgets are allocated in January. To build a new school, the government must decide its location, plan its construction and examine tenders, a process that lasts until June, when the rainy season sets in. If, while builders anxiously wait for the rains to end, aid falls unexpectedly short, the easy option is to shelve the plans.

This would be less damaging if, during aid windfalls, poor countries made up for the foregone investment—but they do not. Investment spending has a long planning cycle, and is difficult to increase quickly. Governments instead take advantage of windfalls to ratchet up their consumption—but not the good sort, such as hiring nurses and teachers, which also requires plenty of advance planning. For 13 countries Ms Celasun and Mr Walliser looked at the relation between government spending and aid used to expand the budget (as distinct from aid earmarked for a project). For some countries, more than a third of such aid was prone to unexpected fluctuations (see chart). They found that for every aid dollar unexpectedly withheld, government investment fell by 12 cents, while government consumption remained stable. For every aid dollar unexpectedly given, consumption rose by 64 cents, while investment was unmoved. This is not proof of cause and effect; natural disasters or shoddy policymaking may lead to both unpredictable aid and higher current spending. But it is strong evidence for it.

Aid cannot always be predictable. It may suddenly pour into a country after an emergency. A country’s political situation may change so drastically for the worse that donors may have doubts about the use of the money. Frequently they attach conditions to aid disbursements that may require governments to implement policies (such as fiscal straitjackets) or to reach goals (such as higher school enrolment). Some of these conditions may be worth their cost in unpredictability.

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