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Foreign Aid & the Global Economic Crisis

April 1, 2009

The global economic crisis is having far-ranging effects, as we hear every day. One place that might be impacted severely is ODA, or official development assistance. ODA is financial assistance provided by the world’s wealthiest countries to the world’s poorest. Those recipient countries might soon feel more pain As of 2008, ODA totaled U.S. $80 billion. And today many analysts forecast that ODA will fall by 10 percent or more. What results are likely to emerge?

At the G-20 in November 2008, members pledged their commitment to maintaining, or even increasing, ODA levels. But the G-20 is meeting again this week, and history shows sharp reductions in ODA following financial crises. The United Nations Development Programme (UNDP) reports that development aid usually falls relative to trends by 30 percent to 40 percent during recessions. Each country that has suffered a financial crisis has made a drop in their assistance overseas. This was the case for Japan in 1990 after the real estate and stock market bubble burst. After the “Nordic Crisis” of 1991, Norwegian overseas development assistance fell by 10 percent, Swedish ODA by 17 percent, and Finnish ODA fell by 62 percent.

Source: Center for Global Development

Source: Center for Global Development

It is, of course, difficult to predict exactly what the full extent and duration of the fall in ODA in donor countries will be. After the Nordic crisis, the international aid levels of Sweden and Norway recovered within eight years. However, Finnish and Japanese overseas development aid levels still have not fully recovered, even after almost  two decades. Because of bureaucratic inertia, the current crisis’s effects may not be fully felt until 2010. And when it comes, the decline in ODA may well linger for five years or more.

The United States contributed $21.75 billion to global development in 2007, making it the world’s second largest aid contributor after the European Union. Speaking in November 2008, former President George W. Bush pledged that “The U.S. is committed … to international development … regardless of the ebb and flow of markets.” And President Barack Obama says he is doubling U.S. overseas development assistance from 2008′s level of U.S.$25 billion.

How about the impact of the economic crisis on private aid – what some are calling “philanthrocapitalism?” In 2007, private giving from corporations, foundations, charities, and individuals totaled about $34.8 billion – exceeding official U.S. international development assistance by over $11 billion. Early indications point to significant falls – in excess of 10 percent – in private giving, particularly since private wealth in the form of financial assets in the U.S. and other developed countries has been drastically reduced.

Hope in the Long View

Painful as the current financial and economic crisis is, there is hope in the long-term. History shows that, over time, economic crises eventually pass. In 1994, Mexico began an economic crisis that it recovered from within three years. After the Asian Financial Crisis of 1997, most Asian countries recovered within six years. After the great depression of 1931, the U.S. economy recovered within eight years. Finally, over the last 190 years, the U.S. has grown at an average of 2 percent per year – a small percentage, but over a very large base.

Source: Center for Global Development

Source: Center for Global Development

Double Blow and Aid Effectiveness

The crisis underscores the paradoxical need to enhance aid effectiveness during times of economic downturn to help accelerate global economic recovery. The downturn has dealt a double blow to developing countries: giving is being restricted while, simultaneously, the negative economic impact has led to an increase in demands for the services and work of development and humanitarian aid agencies. More must be accomplished with even lower levels of aid.

One objective of overseas development assistance is to push economic growth through infrastructure, agriculture, other sectoral investments, or new technology. Other objectives are to strengthen education, health, environmental, and governance/ political systems; support relief and humanitarian work; and stabilize an economy following shocks.

The international economic crisis has fueled the debate on whether or not aid positively influences growth. Many accept that aid pushes growth, but the magnitude of aid’s impact on growth is affected by many factors, including endemic disease, poor geography, and conflict. In conflict areas, aid may have a positive impact even when overall growth is weak. The causality between aid and growth may be opposite to what is expected, since donors often direct more aid to slow-growth countries, while restricting aid to rapidly growing countries.

Once all these factors are taken into consideration, it’s possible to see a positive relationship between levels of international development assistance and a country’s growth. However, analyzing the relationship between aid and growth is extremely difficult due to the broad array of variables and circumstances. Thus the debate rages on over aid, the conditions under which aid works or does not work, and on what steps can be taken to make aid more effective. Complicating the matter, the emerging empirical evidence from research on aid and growth has shown further mixed and complex results; different studies’ conclusions vary depending on time frame, countries involved, and assumptions.

How to Improve Aid Effectiveness

Even as the debate rages on, current experiences and analysis indicate some important steps that donors must take to enhance aid effectiveness.

The past half-century of aid experience has made several lessons quite clear: First, aid is most useful in emergency relief and some health and education investments. Second, much aid has been wasted. Third, aid must focus on strengthening country policies proven to enhance growth – especially those that create and support conditions for increased private investment and entrepreneurship.

Moreover, donors must carefully select and focus on a limited set of countries that will receive their aid. Through stricter country selectivity, more substantial amounts of aid can be concentrated on the countries that need aid the most, and consistently, over longer periods of time.

Through painful experience, donors have learned that “reward” mechanisms of aid are far superior to the imposition of conditionalities. Indeed, recipient governments will undertake reforms only if they themselves desire such reforms. New “cash on delivery” aid mechanisms mean aid is tied to specific achievements on programs that recipient governments have decided for themselves to embark upon, and funds are released to countries which on their own achieve the agreed goals.

Furthermore, country participation and ownership, coupled with enhanced coordination among donors within the frameworks of national development priorities, are crucial to the success and longevity of aid-financed activities. Participatory mechanisms usually require enhanced roles for civil society and non-profit and non-government organizations.

Finally, impact evaluation and “results-based management” of aid is increasingly being introduced. This is crucial in teaching what works and what doesn’t, and to reduce waste of precious aid resources – now all the more scarce with a global financial crisis.

Selected References

Asian Development Bank, Country Partnership Strategy: Guidelines (February 2007).

Canadian International Development Agency, http://www.acdi-cida.gc.ca/index-e.htm

Commission on Growth and Development, The Growth Report: Strategies for Sustained Growth and Inclusive Development (2008).

Department for International Development, “How to Note: Country Governance Analysis” July 2008

Radelet, Steven, Michael Clemens, and Rikhil Bhavnani. 2006. “Aid and Growth: The Current Debate and Some New Evidence,” in Peter Isard, Leslie Lipschitz, Alexandros Mourmouras, and Peter Heller (eds.), Macroeconomic Management of Foreign Aid: Opportunities and Pitfalls, forthcoming, International Monetary Fund.

Roodman, David. October 2008. “History Says Financial Crisis Will Suppress Aid,” Center for Global Development.

Bruce Tolentino is The Asia Foundation’s Director of Economic Reform and Development Programs. He can be reached at btolentino@asiafound.org.

View all posts by V. Bruce J. Tolentino

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