The role played by official development assistance (ODA) as a complement to other sources of financing for development, especially in countries that have the least capability to attract foreign private capital flows, is now well recognized. ODA can be used to enhance human capital and productive capacities by supporting education, health, public infrastructure, agriculture and rural development, and for enhancing food security. Despite the increasing importance to developing countries of foreign private flows, ODA is still a major source of external financing for many; particularly least developed countries, Small Island developing states and landlocked developing countries. In times of disaster, ODA helps to lessen the immediate suffering of the people affected but is also needed for reconstruction and rehabilitation.
The key challenge facing foreign aid globally and in Bangladesh is its effectiveness. Defining effectiveness is not as straightforward as it may seem on the surface. Views on effectiveness have evolved rapidly over time.
Foreign aid in its modern form originated in the early 1940s. Following the Second World War, the international economic system had collapsed. War-ravaged Europe faced a critical shortage of capital for physical reconstruction. The response was the commonly known Marshall Plan under which the USA transferred some 2-3 percent of its national income during the peak years to help reconstruct Europe. The achievements under the Marshall Plan created optimism about the effectiveness of foreign aid in other contexts. The attention of rich nations turned to the emerging independent developing nations in the 1960s.
From the early 1950s project aid became the dominant aid modality under which aid was increasingly disbursed for the implementation of specific investment projects and associated technical assistance. The multilateralism of aid was, at the time, seen as more efficient and less political than bilateral aid leading to considerable expansion of the activities of UN, World Bank, and other multilateral agencies.
Conditions changed abruptly towards the end of the 1970s with the onslaught of the second oil shock. The international debt crisis erupted. Macroeconomic imbalances became widespread among developing countries. Focus in development strategy and policy shifted to internal policy failure. Achieving external and internal balance was widely perceived as an essential prerequisite for renewed development. Trade, not aid, became the dominant slogan among many leaders and economists.
Reliance on market forces, increased outward orientation, and the role of the private sector, including NGOs, were emphasized by the World Bank and others. Bilateral donors and international agencies struggled with how to channel resources to the developing world. Quick-disbursing macroeconomic program assistance, such as balance of payments support and sector budget support, appeared an ideal solution to promote policy reform. Financial program aid and adjustment loans became fashionable and policy conditionality more widespread. The 'Washington Consensus' defined the conditions for effective aid flow.
Skepticism on the benefits of foreign aid by the early 1990s were fomented by a number of factors: (i) the persistence of economic crises in much of the developing world; (ii) geo-political changes following the end of the Cold War; (iii) the perception that policy conditionality was failing to promote genuine policy reform; and (iv) a growing fear that aid was generating undesirable dependency relationships. Bilateral and multilateral aid institutions were subjected to severe criticism with growing awareness in donor countries of cases of poor governance and 'crony capitalism'.
A consensus emerged in the 1990s that a renewed approach to development assistance was warranted. Out came the Millennium Development Goals (MDGs), directed explicitly at poverty reduction and addressing basic needs such as access to education, health and water. In this vein came many initiatives such as the Commission for Africa and the Jubilee Debt Campaign to cancel third world debts. The plight of the poor became a part of popular discourse and a cause of celebrities and politicians alike.
The elusive quest for aid effectiveness
Much research on the question of aid effectiveness has focused on quantitative measures of mega outcomes such as a country's economic growth or quality of institutions. These studies came to mixed conclusions over whether aid can effectively promote economic development, human rights, democracy, or countless other outcomes. The controversies were so rife that the empirics have been described as the “tyranny of numbers”.
Microeconomic evidence paints a reasonably positive picture. World Bank's Independent Evaluation Group (IEG) finds that the average rates of return to aid are generally above 20 percent. Aid interventions appear to have worked in helping improve outcomes such as better health, improved access to education and promotion of appropriate agricultural technology. Evidence based on randomized program evaluation techniques is also largely positive, indicating that aid-financed interventions can generate substantial benefits for individuals.
The most common approach to evaluating the macroeconomic impact of aid examines the relationship between total aid flows and the economic growth rate. Normally, this has been done with the expectation that, other things equal, countries receiving more assistance would grow more rapidly. Early prima facie evidence suggested the opposite: countries that received the most aid also grew relatively poorly—a paradox often referred to as the micro-macro paradox.
A large number of studies attempted to demystify this paradox. There is no necessary logical inconsistency between low growth and high aid inflows. When countries do well for a while, average incomes increase. Donors then tend to transfer less aid relative to GNI and may eventually withdraw. This implies that, over time, there is a marked tendency for the best performing countries to receive less aid relative to GNI and for the worst performers to receive more. A leading study out of the World Bank argued that although aid has no impact on growth on average, it can work as long as recipients pursue 'good' policies. This result appealed to many. It suggested how donors and aid recipients can learn from mistakes in the past and improve aid effectiveness in the future in a straightforward manner. However, the upshot of the studies that followed suggested aid “is probably not a fundamentally decisive factor for development”.
Recent theoretical exercises give further weight to the need for modest expectations regarding the magnitude of the possible impact of foreign aid on growth. Overall increase in the growth rate accruing from aid inflows of 10 percent of GDP may only lie in the range of 1 percent to 2.5 percent depending on the share of aid that is invested and productivity impacts. Thus, at the levels of aid seen by most countries, these effects may be very difficult to distinguish from business cycle fluctuations and external shocks.
Research attention also has been given to long-run determinants of growth that have a cumulative but often no immediate impact on the rate of income growth. Changes in human capital, such as education and health, percolate only slowly at the aggregate level and exert a positive influence on economic growth with a substantial lag. Where aid has been used primarily to boost social spending, as advocated under the MDGs, it may be inappropriate to investigate the aid-growth relationship under anything other than a time horizon of 30-40 years.
The discussion about whether foreign aid works takes place in two platforms. On the research platform, it appears in papers full of technical language and numbers. Outside, the arguments are plainer and the audience broader, but those academic studies remain a benchmark. It is far easier to evaluate a school-building project, say, on whether the school was built and children filled its seats than to determine whether all aid, or large subcomponents of it, improved national school enrollment or made the economy grow faster. On balance, the quantitative approach to exploring grand questions about aid effectiveness, which began 50 years ago, may be worth pursuing further. The biggest challenge is to show not just that aid went hand-in-hand with economic growth, but caused it.
It may well be that many of those countries where aid works the best are among those that need foreign aid the least. In contrast, countries that do not have good policies need help to bring them on track. Such real-world dilemmas remain unresolved. The past decade has seen enormous changes in the world economic environment and the economic systems in place in many countries. Using past performance as an indicator of future performance is especially dubious in this environment, given the existing limited understanding of the interplay between aid, macroeconomic policy, and political economy variables. In sum, the unresolved issue in assessing aid effectiveness is not whether aid works, but how and whether we can make the different kinds of aid instruments work better in varying country circumstances.
Aid effectiveness in Bangladesh
Bangladesh was heavily dependent on World Bank and other donor financing through its first two decades of independence. Foreign assistance reached 5-10 percent of GDP, averaging about US$1.5 billion per year through the 1980s and increasing toward the end of that decade to about US$2.5 billion, or 10 percent of GDP, in 1990. ODA flows have since declined, remaining in the range of US$l.0-1.5 billion. With sustained GDP growth, ODA relative to GDP is now less than 2 percent.
Different surveys and assessments conclude that aid effectiveness in Bangladesh is less than it could be due to a number of structural, procedural and capacity problems. The traditional development administration is a rule-based hierarchy, which relies heavily on rigid and complex procedures to achieve envisioned results. It values compliance instead of creativity and input-orientation instead of results-orientation. It rarely fosters efficiency and innovation. Numerous agencies are directly involved in programming, budgeting, and project implementation. The complexity of the process contributes to delays and efficiency loss and reduces transparency and accountability.
Aid effectiveness should be approached in the wider context of development effectiveness. A holistic approach going beyond the level of policy dialogue, joint declarations and evaluations in the context of the global aid effectiveness agenda is needed. Many of the problems indicated above can only be solved in the longer term. But some efficiency gains could be made in the short to medium term by addressing challenges related to policy and procedural constraints. These challenges are interdependent. Trying to address specific procedural issues without enhancing institutional and individual capacities, for example, is unlikely to have the desired effect. Similarly, enhancing individual and institutional capacity gaps will not necessarily increase the overall institutional performance if structural and policy issues are not addressed. Hence, efforts to enhance aid management capacities and systems have to happen within the context of a wider policy reform that is well coordinated with ongoing initiatives.
Given the pressures the government faces from the general public regarding various types of developmental bottlenecks, it is hoped the government will be catapulted into action to assuage these problems. In that changed context, foreign aid can be a useful catalyst for reducing extreme poverty and boosting shared prosperity.
The work on aid effectiveness embodied in the Paris Declaration has been instrumental in changing the behavior of donors and recipient countries. Recipients have taken firmer control of their own development, through the preparation of Poverty Reduction Strategies which enables donors to align their support and facilitate harmonization efforts.
There are three key issues that still need to be addressed:
First, how do donors reconcile global challenges—which tend to lead to earmarked funding—with country development priorities? One way to do this is to ensure balanced funding between earmarked and non-earmarked aid channels.
Second, how do donors “broaden” their collaboration to include all providers of development assistance? They have to recognize that up to now some important providers have had limited opportunity to help shape the aid effectiveness agenda. They need to start bridging this gap.
Third, strong government leadership, as well as effective and efficient public institutions is crucial to ensure aid effectiveness. This is easier said than done. Yet, without it aid effectiveness will continue to remain elusive.
The author is Lead Economist, World Bank, Dhaka. Views expressed in this article are the author's own, not that of the World Bank.