Foreign Aid: Stimulant or Inhibitor of Economic Growth?

by Rajvir Kohli

Similar to a plague-like bacteria, the conversation surrounding the economic benefits of foreign aid (and the subsequent debate it has sparked) has spread to every corner of the globe.


Foreign aid and its inadvertent consequences have only recently become a matter of contention, for the progenitors of Economics (i.e. Adam Smith, John Mill, and others) offer little insight into the subject matter.


This article, through an academic purview, will aim to summarize the ever-growing controversy surrounding foreign aid, with a focus on its effectual impact on the environment.



To start, the ‘Sachs Camp’, championed by Professor Jeffrey Sachs of Columbia University, believes that developing countries are often stuck in incessant poverty traps; that is, persistent poverty attributable to self-reinforcing mechanisms perpetuated by a lack of initial capital.


These traps are exacerbated by the limited access to capital and credit markets in most LICs (low-income countries), extreme environmental degradation induced (inter alia) by climate change, and an overreliance on subsistence farming, thereby depleting agricultural production potential.


This dynamic is taken one step further in countries riddled with war and famine, for they often lack sufficient disease ecology and public healthcare infrastructure, resulting in a lack of morale among the population.


To actively combat such traps, Sachs recommends that aid agencies mutate into altruistic venture capitalists that are looking to fund developing countries. In doing so, these aid agencies (or in our case, developed countries) must meet all demonstrated aid required on part of the recipient - allowing individuals to garner the ‘critical mass’ necessary to raise themselves out of poverty.


It is argued that if those in poverty do not acquire this critical mass of capital, then they will “simply remain dependent on aid indefinitely and regress if aid is ended”.


For this reason, we cannot simply provide a crumb of aid and expect a reversal of poverty in Africa. According to Sachs,

“the poor start with a very low level of capital per person, and then find themselves trapped in poverty because the ratio of capital per person actually falls from generation to generation [due to the aforementioned poverty traps].”


This fall in capital is further accelerated when the rate of population growth is greater than capital accumulation – a prevailing sentiment in Sub-Saharan Africa.


Sachs’ core argument here is the fact that foreign aid could diffuse to fill the capital-hole in poor countries, thereby maintaining the substantial, long-term foreign assistance, which in turn could sufficiently lift households above subsistence.


Sachs, in his ‘The Case for Aid’ article, claims that the greatest aid-related breakthroughs in the past decade can be attributed to advances in public health, stating the falling incidence of HIV/AIDS resultant of the efforts of the Global Fund and the U.S. PEPFAR program. Regardless of the aforementioned case for foreign aid, two prevailing economists simply beg to differ.



Dambisa Moyo (a Zambian economist) in her famous book ‘Dead Aid’ sounds a clarion call for governments and international organizations alike: she notes the corruption, dependency, inflation, debt burden, and disenfranchisement that typically follow aid-based strategies.



This is exemplified by Paul Kagame’s post-genocide Rwanda, a country that finds itself weaning off aid as a stimulant to their economic performance.


Moyo also examined Jeffery Sachs’s strongest examples of aid-benefiting countries. She counters Sachs’ argument by concluding that their astonishing economic performance can be attributed to a tale of classical liberalism rather than an influx of foreign aid; that is, adoption of market-based and job-creating strategies rather than a dependency on aid.



Moyo’s views are propounded by Professor Easterly, an economics professor at New York University, who attempts to lay his arguments in facts rather than the ambiguous nature riddled in Sachs’ pro-aid policies. Professor Easterly claims that the “evidence is stark” for the perpetual futility of foreign aid in helping growth within African nations.


Instead, in alignment with Moyo’s views, he suggests that economic development occurs through a grassroots approach; involving a homegrown effort by entrepreneurs and social or political reformers within developing nations.


In Easterly’s eyes, corrupt and inefficient governments halt economic development. Sachs’ constant effort to theorize this truism away or his dismissal of the historical influence of colonialism on ‘ill-thought’ governmental policies in Africa is evidence of Sachs’ confusion, as suggested by Easterly.



Other developmental economists, namely Professor Collier (renowned British economist), take a more intermediate approach to the problem. They claim that the issue of aid is neither black nor white. In his work, ‘The Bottom Billion’, Collier argues that both critics and proponents of foreign aid have misused empirical and historical records, and in this way marred their arguments with hyperbole.


Collier suggests that over the last three decades, foreign aid has accelerated GDP growth by approximately 1% per year in most developing nations around the world; a figure that certainly justifies, to an extent, the case for aid.



However, Nobel laureates Abhijit Banerjee and Esther Duflo argue that the ethnographic arguments between Sachs, Easterly, and Moyo are unfounded and are missing the point.


According to them, the case for aid is situationally dependent – some aid projects are successful in reducing poverty, raising living standards, and introducing the domestic population to a world of prosperity, while others tiptoe on the border of failure. With that in mind, their research focuses on identifying the efficacy of certain aid programs through RCTs (randomized controlled trials) in the hope to quantify the arguments made previously.


The debate around aid, though historically fuelled by academic research (see the Harrod-Domar growth model and the ascendance of Solow’s neoclassical model of growth for further reading), has recently adopted a new angle.


In today’s day and time, ethical concerns are embedded within western thinking and justice systems; therefore, it is no surprise that they have found a stronger voice in public opinion and civil society. As a result, human rights are likely to be part of the new-age aid agenda.


The aforementioned example of Rwanda is a prime example of one such dilemma for western society. As McDoom puts it, “...the regime stands accused by the UN of promoting war in eastern Congo. Yet the same regime enjoys the moral distinction of ending the genocide whilst the world stood by — inaction that now weighs heavily on the bystanders’ consciences and that constrains their criticisms.”


While McDoom makes an excellent point, it would be excessive to say that all morality has been lost. This ethical predicament in the case of Rwanda has tested the quantity of aid received by the state.


Notably, the United Kingdom and its Department for International Development (DFID) suspended, restored, and then re-suspended monetary support for Rwanda. Its struggle in making such a complex choice depicts a telling story; one where the government is forced to decide between ‘to aid or not to aid’ regimes whose ethical records raise an eyebrow, to say the least.


Another argument that sparks debate pertaining to foreign aid is that it supports a frame-of-reference concerned with traditional performance indicators (i.e., growth, GDP, and inflation).


Aid, when considered in terms of a wider environmental context, transforms into the devil in disguise due to its destructive impacts on the environmental conditions of developing countries. In particular, when TNCs (transnational corporations) relocate their operations to developing countries to transgress environmental protection laws, they are essentially rewarding the purposeful blindness of the local government through aid.


Moreover, as Arvin, Lew, and Alai (2009) argue, aid may promote excessive and unsustainable development within a developing economy, leading to environmental degradation. They believe that this can be observed in the rate of exploitation of an economy’s natural resource base - unequivocally bringing into question the issue of time-preference in the use of environmental assets and who truly is benefitting from these decisions.


That being said, there is an abundance of evidence supporting the positive impact of aid in reducing the ever-growing strain on the environment within developing countries. This invariably supports Sachs’ view since long-term environmental wellbeing is a core component of economic growth and a pillar of sustainable development.


In 2017, Nordors found that “foreign aid has a negative effect on deforestation and decreases deforestation rates by approximately 14% on average [in parts of Uganda]”. However, a cornerstone of Arvin, Lew, and Alai’s argument (2009) is that environmental degradation in many developing countries can be (inter alia) associated with a lack of funds for clean-up and preservation, and therefore aid has a significant role to play in decelerating this degradation.


This is supported by [Figure 1] (an Environmental Kuznets Curve) which suggests that pollution levels rise in the early stages of development but eventually recede at the ‘turning-point’, which varies by country and pollutant type.



Figure 1: EKC


In today’s economically dynamic and politically charged world, one needs to ask themselves what matters truly deserve one’s attention. War, famine, ecological concerns, and human rights; the search for power and the quest of the hungry. Bringing together my argument, the impact of foreign aid is not just limited to developmental indicators anymore.


The direct impact it has on a country's economy, and in turn, its environmental consequences speak to the future of the next generation.

In order to ensure a brighter tomorrow, foreign aid needs to be considered in an inter-temporal context, rather than in its present simple static condition.


Sources

  • Geography Lessons: Correcting Sachs on African Economic Development. May 25, 2011. http://www.huffingtonpost.com/william-easterly/geography-lessons-correct_b_208879.html (accessed June 28, 2020).

  • Moyo, D (2010), Dead Aid: Why Aid Makes Things Worse and How There Is Another Way for Africa, London: Penguin Books.

  • Easterly, W (2009), “Sachs Ironies: Why Critics are Better for Foreign Aid than Apologists”, Huffington Post,

  • Banerjee, A and E Duflo (2011), Poor Economics: A Radical Rethinking of The Way to Fight Global Poverty, New York: Public Affairs.

  • https://unu.edu/publications/articles/to-aid-or-not-to-aid-the-case-of-rwanda.html

  • Bureau for Research and Economic Analysis of Development, Duke University, Durham, North Carolina 27708

  • Anderson R. M.& May R. M.. 1992Infectious diseases of humans: dynamics and control.New York, NY: Oxford University Press.

  • Arvin, Mak & Lew, Byron. (2009). Foreign Aid and Ecological Outcomes in Poorer Countries: An Empirical Analysis. Applied Economics Letters. 16. 295-299. 10.1080/13504850601018312.

  • https://www.investopedia.com/terms/p/poverty-trap.asp

  • https://www.intelligenteconomist.com/


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