Foreign Aid

1
Foreign AidsImpact on Governance

• Maj Justin LeMire

2
Sources

• Stephen Knack Aid Dependence and the Quality
  of Governance Cross-Country Empirical Tests
• Sophal Ear Does Aid Dependence Worsen
  Governance?

3
Introduction

• Foreign Aid/Aid Dependence - Definition
• International Country Risk Guide (IRCG)
• Positive Influences of Aid
• Negative Influences of Aid
• Policy Implications
• Conclusion

4
Definitions

• Foreign Aid has long been justified as essential
  for development under incomplete market
  conditions in which investment is missing (hence
  the need for aid). Boone (1996)
• Aid Dependence - a specific condition that
  results from a pathology in the aid giving
  process
• Quality of governance is measured by subjective
  indices from the ICRG

5
ICRG

• International Country Risk Guide (ICRG)
• Analyzes the financial, economic and political
  environments in over 130 developed and emerging
  countries
• Provides insight into investment risks and
  business opportunities
• Gages the impact of current and future worldwide
  events
• Incorporates several economic risk factors to
  determine a countrys investment potential
• including loan default, delayed payment of
  suppliers credits, political leadership,
  inflation and international liquidity ratios

6
Six Dimensions of Governance
Control of Corruption (CC) Perceptions of
corruption, conventionally defined as the
exercise of public power for private gain.
Despite this straightforward focus, the
particular aspect of corruption measured by the
various sources differs somewhat, ranging from
the frequency of additional payments to get
things done,to the effects of corruption on the
business environment, to measuring grand
corruption in the political arena or in the
tendency of elite forms to engage in state
capture
Voice and Accountability (VA) Measures various
aspects of the Process, civil liberties and
political Rights, and independence of the media
Political Stability(PS) Measures the perceptions
of the likelihood that the government in power
will be destabilized or overthrown by possibly
unconstitutional and/or violent means, including
terrorism
Governance is the Traditions and Institutions by
which Authority in a Country is Exercised
Rule of Law (RL) Perceptions of the incidence of
both violent and non-violent crime, the
effectiveness and predictability of the
judiciary, and the enforceability of contracts
Government Effectiveness (GE) Perceptions of the
quality of public service provision, the quality
of the bureaucracy, the competence of civil
servants, the independence of the civil service
from political pressures and the credibility of
the governments commitment to policies
Regulatory Quality (RQ) Measures the incidence
of market-unfriendly policies such as price
controls or inadequate bank supervision, as well
as perceptions of the burdens imposed by
excessive regulation in areas such as foreign
trade and business development
Source Adapted from Kaufmann, Kraay, and
Zoido-Lobaton (1999b).
7
Positive Influence of Aid

• Aid is used for improving training and increased
  salaries for public employees Including police,
  judges, and tax collectors
• As salaries increase, more competent bureaucrats
  can be recruited and bribe solicitation reduced
• Improvements in the investment climate and higher
  tax collections in turn produce additional
  revenuesimproving the governments credit
  worthiness

8
Positive Influence of Aid

• Programs to strengthen the legal system, public
  financial management, and other responsibilities
  of the public sector
• Could also improve the quality of governance
  through conditionality effects
• The World Bank lends about 6 billion/year to its
  poorest members on highly concessionary terms,
  with allocations based in large part on the
  assessments of the quality of policies and public
  sector institutions
• These conditions can increase the incentives of
  aid-recipient governments to implement pubic
  sector reforms
• Aid can relieve pressure on recipient governments
  to establish the efficient policies and
  institutions necessary for attracting private
  capital

9
Negative Influence of Aid

• Aid can increase political instability
• Making control of the government a more valuable
  prize
• Political scientists argue that aid retards the
  development of a healthy civil society
  underpinning democracy and rule of law
• For example Rule of law in the west was
  critically related to monarchs needs for tax
  revenues. In turn, those who provided the
  majority of taxes, demanded accountability from
  the government
• Aid therefore reduces the governments dependence
  on its citizenry for tax revenues
• Can weaken the state bureaucracies of recipient
  governments
• Siphoning away scarce talent from civil service
  to be hired by the donor organizations

10
Negative Influence of Aid

• Aid represents a potential source of rents
• Creates adverse effects on the quality of the
  public sector and on the incidence of corruptions
• Rent-seeking - Takes the form of increased
  public-sector employment. Aid is then used for
  patronage purposes.
• Aid often times enables governments to undertake
  investments that would otherwise be made by
  private investors
• As rents available to those controlling the
  government increase, resources devote to
  obtaining political influence increase
• As aid expands, workers face incentive to
  reallocate time from acquiring knowledge and
  skills specific to manufacturing, toward skills
  useful for obtaining a share of aid revenues

11
Policy Implications

• The conclusions of Stephen Knack Aid Dependence
  and Governance
• Aid Variability If aid is highly variable over
  time within a country, dependence might be
  lessened in the sense that aid cannot be relied
  on as a stable source of funds
• Aid should be directed at quality of governance
  Establishing more meritocratic bureaucracies and
  strong, independent court systems
• Greater selectivity by donors Targeting aid to
  countries that take specific steps to reduce
  corruption, improve fiscal accountability, and
  implement merit based recruitment and promotion
  in civil service
• Depoliticizing the distribution of rents from aid
  funds Selective allocation of aid would reduce
  its propensity to politicize life, and thereby
  reduce the extent and intensity of political
  conflict

12
Policy Implications

• Emphasis on social capital Aid in the form of
  micro enterprise loans may improve government
  accountability in the long term by building up
  the private sector, thereby increasing the demand
  locally of r good governance
• Aid directly targeted to the start-up of small
  businesses is less fungible and more difficult
  for governments to expropriate
• Technological Advance The internet may mitigate
  the negative consequences of expensive technical
  assistance
• Ex The World Bank is developing a
  Knowledge-Sharing Program
• Interactive toolkits for governance assistance
• The intent is to improve the capacity of client
  governments, through better knowledge, to use
  donor technical assistance effectively, and where
  necessary to challenge donor-proposed solutions

13
Conclusion

• Foreign aid can help when used appropriately
• As donors our responsibility is to ensure that
  funds are used, not for corruption, but
  stabilization of a recipients economy
• Using the conditionality principle of aid does
  not seem to work because the lack of credibility
  of the punishment
• Therefore, using loans instead of grants may help
  induce some discipline and effective use of the
  funds, since they have to be returned