In stark contrast, corruption analysts estimate at least US$10 billion – nearly half of Africa’s 2003 foreign aid receipts – depart Africa every year.8 It is this ‘negative corruption’ which bleeds Africa’s public purse dry, and does nothing to address the continent’s desperate needs. It is truly tragic that while stolen aid monies sit and earn interest in private accounts abroad, the countries for which the money was destined have stagnated, and even regressed.
The cornerstone of development is an economically responsible and accountable government. Yet, it remains clear that, by providing funds, aid agencies (inadvertently?) prop up corrupt governments. But corruption is not the only problem emanating from aid. The deleterious effects of any new aid flows would be both social and economic.
Aid and civil society
Africa needs a middle class: a middle class that has vested economic interests; a middle class in which individuals trust each other (and have a court to go to if the trust breaks down) and that respects and defends the rule of law; a middle class that has a stake in seeing its country run smoothly and under a transparent legal framework; a middle class (along with the rest of the population) that can hold its government accountable. Above all, a middle class needs a government that will let it get ahead.
This is not to imply that Africa does not have a middle class – it does. But in an aid environment, governments are less interested in fostering entrepreneurs and the development of their middle class than in furthering their own financial interests. Without a strong economic voice a middle class is powerless to take its government to task. With easy access to cash a government remains all-powerful, accountable only (and only then nominally) to its aid donors. Inhibited in its growth, the middle class never reaches that critical mass that historically has proven essential for a country’s economic and political success.
In most functioning and healthy economies, the middle class pays taxes in return for government accountability. Foreign aid short-circuits this link. Because the government’s financial dependence on its citizens has been reduced, it owes its people nothing.
A well-functioning civil society and politically involved citizenry are the backbone of longer-term sustainable development. The particular role of strong civil society is to ensure that the government is held accountable for its actions, through fundamental civil reforms other than simply holding elections. However, foreign aid perpetuates poverty and weakens civil society by increasing the burden of government and reducing individual freedom.
An aid-driven economy also leads to the politicization of the country – so that even when a middle class (albeit small) appears to thrive, its success or failure is wholly contingent on its political allegiance. So much so, as Bauer puts it, that aid ‘diverts people’s attention from productive economic activity to political life’, fatally weakening the social construction of a country.
Aid and social capital: a matter of trust
Social capital, by which is meant the invisible glue of relationships that holds business, economy and political life together, is at the core of any country’s development. At its most elemental level, this boils down to a matter of trust.
As discussed earlier, among development practitioners there is increasing acknowledgement that ‘soft’ factors – such as governance, the rule of law, institutional quality – play a critical role in achieving economic prosperity and putting countries on a strong development path. But these things are meaningless in the absence of trust. And while trust is difficult to define or measure, when it is not there the networks upon which development depends break down or never even form.
Foreign aid does not strengthen the social capital – it weakens it. By thwarting accountability mechanisms, encouraging rent-seeking behaviour, siphoning off scarce talent from the employment pool, and removing pressures to reform inefficient policies and institutions, aid guarantees that in the most aid-dependent regimes social capital remains weak and the countries themselves poor. In a world of aid, there is no need or incentive to trust your neighbour, and no need for your neighbour to trust you. Thus aid erodes the essential fabric of trust that is needed between people in any functioning society.
Aid and civil war
According to the Stockholm International Peace Research Institute, ‘Africa is the most conflict ridden region of the world, and the only region in which the number of armed conflicts is on the increase.’ During the 1990s there were seventeen major armed conflicts in Africa alone, compared to ten (in total) elsewhere in the world. Africa is also the region that receives the largest amount of foreign aid, receiving more per capita in official development assistance than any other region of the world.
There are three fundamental truths about conflicts today: they are mostly born out of competition for control of resources; they are predominately a feature of poorer economies; and they are increasingly internal conflicts.
Which is why foreign aid foments conflict. The prospect of seizing power and gaining access to unlimited aid wealth is irresistible. Grossman argues that the underlying purpose of rebellion is the capture of the state for financial advantage, and that aid makes such conflict more likely. In Sierra Leone, the leader of the rebel Revolutionary United Front was offered the vice-presidential position in a peace deal, but refused until the offer was changed to include his chairmanship of the board controlling diamond-mining interests. So not only would it appear that aid undermines economic growth, keeping countries in states of poverty, but it is also, in itself, an underlying cause of social unrest, and possibly even civil war.
While acknowledging that there are other reasons for conflict and war – for example, the prospect of capturing natural resources such as oil, or tribal conflict (which, of course, can have its roots in economic disparity) – in a cash-strapped/resource-poor environment the presence of aid, in whatever form, increases the size of the pie that different factions can fight over. For example, Maren blames Somalia’s civil wars on competition for control of large-scale food aid.
Furthermore, in an indirect manner, by lowering average incomes and slowing down economic growth (according to Collier, both in themselves powerful predictors of civil wars), aid increases the risk of conflict.9 In the past five decades, an estimated 40 million Africans have died in civil wars scattered across the continent; equivalent to the population of South Africa (and twice the Russian lives lost in the Second World War).
Beyond politicization of the political environment, aid fosters a military culture. Civil wars are by their very nature military escapades. Whoever wins stays in power through the allegiance of their military. Thus, the reigning incumbent, anxious to hang on to power, and manage competing interest groups and factions, first directs what resources he has into the pockets of his army, in the hope that it will remain pliant and at bay.
The economic limitations of aid
Any large influx of money into an economy, however robust, can cause problems. But with the relentless flow of unmitigated, substantial aid money, these problems are magnified; particularly in economies that are, by their very nature, poorly managed, weak and susceptible to outside influence, over which domestic policymakers have little control. With respect to aid, poor economies face four main economic challenges: reduction of domestic savings and investment in favour of greater consumption; inflation; diminishing exports; and difficulty in absorbing such large cash influxes.
Aid reduces savings and investment
As foreign aid comes in, domestic savings decline; that is, investment falls. This is not to give the impression that a whole population is awash with aid money, as it only reaches relatively few, very select hands. With all the tempting aid monies on offer, which are notoriously fungible, the few spend it on consumer goods, instead of saving the cash. As savings decline, local banks have less money to lend for domestic investment. Economic studies confirm this hypothesis, finding that increases in foreign aid are correlated with declining domestic savings rates.
Aid has another equally damag
ing crowding-out effect. Although aid is meant to encourage private investment by providing loan guarantees, subsidizing investment risks and supporting cofinancing arrangements with private investors, in practice it discourages the inflow of such high-quality foreign monies. Indeed, in some empirical work, it is shown that private foreign capital and investment fall as aid rises. This may in part reflect the fact that private investors tend to be uncomfortable about sending their money to countries that are aid-dependent, a point elaborated on later in the book.
An outgrowth of the crowding-out problem is that higher aid-induced consumption leads to an environment where much more money is chasing fewer goods. This almost invariably leads to price rises – that is, higher inflation.
Aid can be inflationary
Price pressures are twofold. Aid money leads to increased demand for locally produced goods and services (that is, non-tradables such as haircuts, real estate and foodstuffs), as well as imported (traded) goods and services, such as tractors and TVs. Increased domestic demand needn’t be harmful in itself, but a disruptive injection of money can be.
There are multiple knock-on effects. For example, take this very basic and simplistic story. Suppose a corrupt official gets US$10,000. He uses some of the cash to buy a car. The car seller can now afford to buy new clothes, which places cash in the hands of the clothes trader, and so on and so forth down the line, at each point putting more pressure on domestic prices as there are now more people demanding more cars, clothes, etc. This is at least an example of positive corruption. But in a poor environment, there aren’t any more cars, there aren’t any more clothes, so with increased demand prices go up. Eventually, there may be more cars and there may be clothes, but by that time inflation will have eroded the economy, all the while with even more aid coming in. Perhaps ironically, because of the deteriorating inflationary environment more aid is pumped in to ‘save the day’; we’re back on the cycle again.
As if that was not bad enough, in order to combat the cycle of inflation, domestic policymakers raise interest rates. But, at a very basic level, higher interest rates mean less investment (it becomes too costly to borrow to invest); less investment means fewer jobs; fewer jobs mean more poverty; and more poverty means more aid.
Aid chokes off the export sector
Take Kenya. Suppose it has 100 Kenyan shillings in its economy, which are worth US$2. Suddenly, US$10,000 worth of aid comes in. No one can spend dollars in the country, because shopkeepers only take the legal tender – Kenyan shillings. In order to spend the aid dollars, those who have it must convert it to Kenyan shillings. All the while there are only still 100 shillings in the economy; thus the value of the freely floating shilling rises as people try to offload the more easily available aid dollars. To the detriment of the Kenyan economy, the now stronger Kenyan currency means that Kenyan-made goods for export are much more expensive in the international market, making the traded goods sector uncompetitive (if wages in that sector do not adjust downwards). All things being equal, this chokes off Kenya’s export sector.
This phenomenon is known as Dutch disease, as its effects were first observed when natural gas revenues flooded into the Netherlands in the 1960s, devastating the Dutch export sector and increasing unemployment. Over the years economic thinking has extended beyond the specifics of this original scenario, so that any large inflow of (any) foreign currency is seen to have this potential effect.
Even in an environment where the domestic currency is not freely floating, but rather its exchange rate remains fixed, the Dutch disease phenomenon can occur. In this case, the increased availability of aid money expands domestic demand, which again can lead to inflation. Aid flows spent on domestic goods would push up the price of other resources that are in limited supply domestically – such as skilled workers – making industries (mainly the export sector) that face international competition and depend on that resource more uncompetitive, and almost inevitably they close.
The IMF has stated that developing countries that rely on foreign capital are more prone to their currencies strengthening. Accordingly, aid inflows would strengthen the local currency and hurt manufacturing exports, which in turn reduces long-run growth. IMF economists have argued that the contribution of aid flows to a country’s rising exchange rate was one reason why aid has failed to improve growth, and that aid may very well have contributed to poor productivity in poor economies by depressing exports.
In other work, their research finds strong evidence consistent with aid undermining the competitiveness of the labour-intensive or exporting sectors (for example, agriculture such as coffee farms). In particular, in countries that receive more aid, export sectors grow more slowly relative to capital-intensive and non-exportable sectors.
Aid inflows have adverse effects on overall competitiveness, wages, export sector employment (usually in the form of a decline in the share of those in the manufacturing sector) and ultimately growth. Given the fact that manufacturing exports are an essential vehicle for poor countries to start growing (and achieving sustained growth), any adverse effects on exports should prima facie be a cause for concern.
Moreover, because the traded-goods sector can be the main source of productivity improvements and positive spillovers associated with learning by doing that filter through to the rest of the economy, the adverse impact of aid on its competitiveness retards not just the export sector, but also the growth of the entire economy.
In the most odd turn of events, the fact that aid reduces competitiveness, and thus the traded sector’s ability to generate foreign-exchange earnings, makes countries even more dependent on future aid, leaving them exposed to all the adverse consequences of aid-dependency. What is more, policymakers know that private-to-private flows like remittances do not seem to create these adverse aid-induced (Dutch disease) effects, but they largely choose to ignore these private capital sources.
As a final point, in order to mitigate the Dutch disease effects (and depending on their economic environments), policymakers in poor countries generally have two choices. They can (in a fixed exchange rate regime) either raise interest rates to combat inflation to the inevitable detriment of the economy, or they can ‘sterilize’ the aid inflows.
Sterilization implies that the government issues bonds or IOUs to people in the economy, and in return they get the cash in the economy. Through this process the government can mop up the excess cash that aid brings in. But, as discussed later, even sterilization has its costs.
Aid causes bottlenecks: absorption capacity
Very often, poor countries cannot actually use the aid flows granted by rich governments. At early stages of development (when countries have relatively underdeveloped financial and institutional structures) there is simply not enough skilled manpower, or there are not enough sizeable investment opportunities, to put the vast aid windfalls effectively to work. Economic researchers have found that countries with low financial development do not have the absorptive capacity for foreign aid. In countries with weak financial systems, additional foreign resources do not translate into stronger growth of financially dependent industries.
What happens to this aid money that can’t be used? In the most honest of outcomes, if the government did nothing with the aid inflow, the country would still have to pay interest on it. But given the policy challenges of large inflows discussed earlier (for example, inflationary pressure, Dutch disease effects), policymakers in the poor country must do something. Since they cannot put all the aid flows to good use (even if they wanted to), it is more likely than not that the aid monies will be consumed rather than invested (as before, thereby raising the risk of higher inflation).
To avert this sharp shock to the economy, African policymakers have to mop up the excess cash; but this costs Africans money. In addition to having to pay the interest on the aid the country has borrowed, the process of sterilizing the aid flows (again, issuing local-country debt in order to soak up the excess aid flows in the economy) can
impose a substantial hit to the government’s bottom line. Uganda offers a telling example of this. In 2005, the Ugandan central bank issued such aid-related bonds to the tune of US$700 million; the interest payments alone on this cost the Ugandan taxpayer US$110 million annually.
Naturally, the process of managing aid inflows is particularly painful when the interest costs of the debt the government pays out are greater than the interest it earns from holding all the mopped-up aid money.
Aid and aid-dependency
Corruption, inflation, the erosion of social capital, the weakening of institutions and the reduction of much-needed domestic investment: with official aid to the continent at 10 per cent of public expenditure, and at least 13 per cent of GDP for the average country, Africa’s continual aid-dependency throws up a host of other problems.
Aid engenders laziness on the part of the African policymakers. This may in part explain why, among many African leaders, there prevails a kind of insouciance, a lack of urgency, in remedying Africa’s critical woes. Because aid flows are viewed (rightly so) as permanent income, policymakers have no incentive to look for other, better ways of financing their country’s longer-term development. As detailed later in this book, these options, like foreign direct investment and accessing the debt markets, offer more-diversified and greater prospects for sustainable development.
Relatedly, in a world of aid-dependency, poor countries’ governments lose the need to pursue tax revenues. Less taxation might sound good, but the absence of taxation leads to a breakdown in natural checks and balances between the government and its people. Put differently, a person who is levied will almost certainly ensure that they are getting something for their taxes – the Boston tea party’s ‘No taxation without representation’.
Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa Page 8
