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Development and the political economy of foreign aid.

Article Excerpt
I. Introduction

In a recent essay for the online magazine Cato Unbound, economist William Easterly (2006) described the failure of aid to the developing world in these terms:

This is the tragedy in which the West already spent $2.3 trillion on foreign aid over the last 5 decades and still had not managed to get 12-cent medicines to children to prevent half of all malaria deaths. The West spent $2.3 trillion and still had not managed to get $4 bed nets to poor families. The West spent $2.3 trillion and still had not managed to get $3 to each new mother to prevent 5 million child deaths.

According to Easterly (2001), the main problems with foreign aid have been: 1) an inappropriate development model based on the "financing gap," and 2) maladministration, caused by a lack of accountability for aid agencies to the people whom they are supposed to serve. He then proposes to reform the way foreign aid is administered so that it actually benefits the people whom it is supposed to help. This paper goes beyond Easterly's contingent critique of foreign aid to argue that aid agencies are essentially unreformable. Easterly's argument effectively treats the state as exogenous, assuming that political actors are trying to make aid programs work but failing simply out of ignorance. By contrast, this paper reviews research on the political economy of foreign aid and argues that both humanitarian aid and multilateral structural adjustment and development assistance through the International Monetary Fund (IMF) and World Bank have actually been designed to fail in their ostensible aims: if they were to be reformed along the lines Easterly suggests, they would lose their political raison d'etre. While publicly funded development aid has largely failed in its stated objectives, there is substantial evidence supporting the benefits of private foreign direct investment (FDI) and microlending. Both historical and contemporary evidence suggests that the most important pro-development reform that Third World governments can make is to structure their political institutions so as to facilitate credible governmental commitments to private property rights, contract enforcement, and competitive markets.

The plan of the essay is as follows. The next section reviews the economic evidence demonstrating the general failure of foreign aid to promote long-term development. The third section reviews the political science research demonstrating that failing aid agencies are actually "succeeding" in their political aims, and that government officials therefore have little reason to support fundamental reform. The fourth section reviews what we do know about the determinants of long-run economic growth. The fifth section concludes with implications for both developed and less developed countries.

II. Foreign Aid and Economic Development

Publicly funded foreign aid is offered in two forms: direct grants-in-aid and loans. Branko Milanovic (2006) argues that loans through the IMF and World Bank should not be considered "aid" since they have to be repaid, but this argument ignores the fact that these loans are offered at interest rates substantially below market--otherwise, governments would have no reason to accept them, given the policy strings attached (known as "conditionality"). Grants-in-aid are largely conducted bilaterally, government-to-government, or through United Nations agencies. Grants typically address imminent humanitarian needs such as famine and disaster relief, public health, and housing. The IMF and World Bank, which are principally funded by the G-7 developed countries, theoretically have different functions--promoting international financial stability and economic development projects, respectively--but since the collapse of the Bretton-Woods international monetary system in 1973, the IMF has broadened its mandate to cover any kind of assistance for governments trying to reform their economies (what the IMF calls "structural adjustment").

The evidence that foreign aid generally has not enhanced economic growth is well-known. In The Elusive Quest for Growth, Easterly shows that in the vast majority of countries, development aid has not increased investment share of gross domestic product (GDP), and growth in investment share of GDP has not caused subsequent increases in GDP per capita. In only one country (Israel) has development aid had the intended effects on growth. Defenders of aid, such as Jeffrey Sachs (1) and Steve Radelet (2006), point to specific successful projects in which aid was a component. However, it is impossible to draw any general conclusions from these experiences, for two main reasons: 1) in case studies, it is impossible to...

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