Assessing Aid: What Works, What Doesn't and Why

The report, Assessing Aid: What Works, What Doesn't and Why, finds that, due to a wave of economic reform in developing countries in the 1990s, three out of four people afflicted by absolute poverty—nearly 2 billion people—live in countries where more foreign aid would speed up poverty reduction. But while the list of countries that can use aid effectively has risen, foreign aid has fallen to 0.22 percent of donor countries' GDP in 1997 - its smallest volume since it was first institutionalized with the Marshall Plan in 1947. Taking into account inflation, financial aid from rich countries to poor countries is one-third lower today than in 1990.

"It is ironic and tragic that the volume of aid is declining just as the environment for effective aid is improving," says David Dollar, the lead author of the report and a senior World Bank research economist. "By increasing financial assistance to poor countries with good policies and decent institutions, we could help hundreds of millions

of the poorest people in the world to improve their lives, and those of their children."

The report finds that if yearly aid flows were increased by $10 billion—less than the amount necessary to restore annual aid flows to the level of 1990—this would raise an extra 25 million people out of poverty if the new funds were targeted to poor countries with sound economic management. However, the same $10 billion in aid, allocated across-the-board in the way that aid is currently distributed, would lift only seven million people out of poverty. "Donor countries could do a better job of allocating aid, focusing a larger amount on poor countries with sound policies," Dollar said.

Assessing Aid uses a broad definition of sound policies and institutions that closely correlates with economic growth and poverty reduction. These include: open trade, secure private property rights, the absence of corruption, respect for the rule of law, social safety nets, and sound macroeconomic and financial policies.

In poor countries that score well on these indicators, one percent of gross domestic product (GDP) in aid money translates into a one percent decline in poverty, a similar drop in infant mortality, and roughly half a percent growth in national income.

According to the report, in 1996, 32 countries with poverty rates above 50 percent had policies and institutions that were better than average for all developing countries. These include countries as diverse as Bolivia, China, Ethiopia, Honduras,India, Kyrgyz Republic, and Uganda.

In these countries, every dollar of foreign aid attracts two dollars of investment, because aid increases the confidence of the private sector and helps to provide public services that investors need, such as education and infrastructure. But in countries with unfavorable business conditions, aid fails to attract investors. This is one reason that aid

money has little impact in countries that lack sound policies and institutions. For more information call Phil Hay, 202-473-1796, or fax 522-2633 or e-mail phay@worldbank.org. Stock No. 61123 (ISBN 0-19-521123-5) US$30.00. To order copies on-line visit www.worldbank.org/html/extpb/assess.htm or call 703-661-1580, fax (703) 661-1501 or e-mail books@worldbank.org.