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The economics of international aid

By Ravi Kanbur*
Cornell University
sk145@cornell.edu


This Version: November, 2003

Posted with permission of Ravi Kanbur
[Download complete version - 226Kb ~ 1 min (31 pages)]     [ Share with a friend  ]

Abstract

This paper presents an overview of the economics of international aid, highlighting the historical literature and the contemporary debates. It reviews the “trade-theoretic” and the “contract-theoretic” analytical literature, and the empirical and institutional literature. It demonstrates a great degree of continuity in the policy concerns of the aid discourse in the twentieth century, and shows how the theoretical, empirical and institutional literature has evolved to address specific policy concerns of each period.

Introduction

“[T]he decade of the 1990s was marked by a strong and lingering case of ‘aid fatigue’ influenced by the rising fear that foreign assistance was generating aid dependency relationships in poor countries. The issue of the effectiveness of aid conditionality was also critically debated.” (Thorbecke, 2000, p47).

“Foreign aid programmes for providing economic assistance to less developed countries have fallen on hard times. The nominal amounts of aid pledged by developed areas have recently been falling and the real values of economic assistance have fallen even further. This is due in part to the diversion of attention of the donor countries to other foreign policy issues. It is due partly to their increased preoccupation with their own domestic problems. There has, however, also been a growing disenchantment with the potential for development in the poor countries and also with the role which foreign aid can play in development. Optimistic expectations of rapid growth in less developed countries have given way to skeptical evaluations of their actual performance. The contribution of foreign aid to development has also been evaluated more skeptically and its possible disincentive effects are now emphasized.” (Bhagwati and Eckhaus, 1970, p 7).

“The foreign aid program, as an instrument of United States foreign policy, is now ten years old. To it has been committed upwards of 70 billion dollars, a sum representing around 25 percent of the national debt, and the annual appropriations have been a major factor in the recurring budgetary deficits of the federal government. Despite this massive effort, its success is questionable….In consequence, the Administration’s budget for foreign aid has met increasing criticism. Congressional support, at one time overwhelming, has steadily diminished. Disclosures by investigating committees of waste and extravagance in the administration of the program have added distrust, and it is not surprising that the whole concept of foreign aid has aroused anxiety among the electorate.” (Groseclose, 1958, p 25).

International aid, or development assistance, is defined by the OECD to “include grants and loans to developing countries and territories which are: (i) undertaken by the official sector of the donor country, (ii) with the promotion of economic development and welfare in the recipient country as the main objective and (iii) at concessional financial terms (i.e. if a loan, have a grant element of at least 25 percent)” (Hjertholm and White, 2000, p100).1 Whatever the definition, it might surprise the reader to see the similarity in the three assessments given above of international aid, or “foreign aid,” over a period spanning four decades. But ever since its modern inception after the Second World War, international aid has raised a number of constant themes in the policy arena, in particular its underlying rationale and its actual effectiveness in aiding development in recipient countries. Moreover, international aid looms larger in public discourse than its magnitude would seem to justify. An indication of this is that polls in rich countries often show people to believe foreign aid to be several multiples of its actual level.2

Associated with these policy themes have been a number of recurring analytical issues that essentially boil down to two basic questions:

  1. What does a transfer of resources do to the well being of donor and recipient?


  2. How can and should resource transfer be conditioned to enhance the objective function of donor and recipient?
These two questions run through this overview of the economics of international aid. The paper will consider the history of aid and aid making institutions (Section 2), the theoretical analysis of aid (Section 3) and, the empirical analysis of the impact of aid (Section 4); Section 5 concludes.


Footnote:

* Paper prepared for the Handbook on “The Economics of Giving, Reciprocity and Altruism,” edited by Serge Christophe-Kolm and Jean Mercier-Ythier, North-Holland.
  1. While this definition is generally accepted, there are of course many nuances to these criteria, and analysts do deviate from them as they need to. Thus Krueger, Michalopoulos and Ruttan (1989) include in their definition the non-concessional loans by the World Bank, and some include loans from the IMF (concessional or not) also in this category.
  2. Raffer and Singer (1996) refer to US polls showing that people believe the share of development assistance in the federal budget to be of the order of 15 percent, when the actual figure is less than 1 percent.


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