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

New Study Finds Aid Cuts Poverty and Attracts Private Investors Under Right Conditions
Available in: Português, Español, Français
Press Release No:99/1987/S

Contacts:  Phil Hay (202) 473-1796
Lawrence MacDonald (202) 473-7465
TV/Radio: Cynthia McMahon (202) 473-2243

Washington, November 10, 1998  Foreign aid has been highly successful in reducing poverty in countries with sound economic management and robust government institutions, according to a new World Bank report released today. The list of countries that now meet the criteria for using aid well has increased dramatically in the 1990s. Yet aid has fallen to its lowest point in more than 50 years, at a time when it could be helping hundreds of millions of people escape a hand-to-mouth existence, the study says.

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 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, 1 percent of gross domestic product (GDP) in aid money translates into a 1 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.

The report finds that 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.

Aid, however, is more than just money. The report argues that aid is actually a combination of money and ideas, or knowledge. In countries that lack the policies and institutions to make good use of large financial flows, aid agencies can sometimes help foster a climate for successful reform without offering large-scale financial assistance, for example, by providing advice and sponsoring forums in which government officials can learn from other countries.

In Vietnam in the late 1980s, for example, home-grown reform efforts to open the economy to trade and private businesses received no financial support from the World Bank and the International Monetary Fund (IMF). Instead of providing large financial transfers, donors helped Vietnam in other ways. Sweden and the United Nations Development Programme provided training and technical assistance, and the World Bank contributed staff time to offer policy advice - all aimed at helping Vietnam to learn from more successful countries in Southeast Asia.

By 1992 Vietnam had relatively sound policy for a low-income country; and large-scale financial flows commenced. This sequence - ideas first, money when the country is ready to use it well - proved very effective. Of the world's 40 poorest countries in 1986, Vietnam enjoyed the highest growth over the next decade. A 1998 study of households first surveyed in 1992 found that the number of poor households had fallen from more than half to about three in ten.

In contrast, the report says that foreign aid has also been, at times, an unmitigated disaster. Large financial flows to countries that lack sound policies and institutions have had little impact. In Zambia, for example, foreign aid increased steadily starting in 1970 to about 11 percent of GDP in the early 1990s. But policy deteriorated throughout this period. Assessing Aid concludes that despite a series of structural adjustment loans from the World Bank and the IMF, there was no substantial improvement in policy until a new government came to power in the early 1990s.

"Providing significant amounts of money has not made much of a dent in poverty in countries with weak management," the report concludes in its final chapter. "It is possible to assist development in countries with weak institutions and policies, but the focus needs to be on supporting reformers rather than disbursing money."

The report finds little evidence to support the notion that an inadequate policy and institutional environment can be overcome by targeting assistance to specific activities - such as health or education. This is because like other money, aid dollars are fungible. For example, Assessing Aid finds that one dollar of assistance targeted to rural development raises rural development spending by just 11 cents. This is not because of corruption. Rather, if donors fund particular services - schools or rural roads - this frees up the government to use the money that it would have spent on these for other priorities.

"A dollar's worth of aid to education may lead to little or no additional spending on education," says Lant Pritchett, co-author of the report and a principal economist at the World Bank. "Donors are more or less financing whatever the recipient government chooses to do." Because of this, the report recommends that donor countries and institutions should consider the recipient country's overall public expenditure program when providing aid. This is standard practice at the World Bank.

But while targeting money to particular types of activities has little net impact on spending in the favored sectors, projects can often be valuable if they open the way for systemic change throughout an entire sector.

In Pakistan, for example, where traditionally few girls attend school, donors worked with local communities to identify ways of raising girls' enrollment. The government provided money to start new schools on the condition that local communities promised to raise girls enrollments to a specified level. The local community associations, which had control over hiring teachers, often hired female teachers for these new schools. Female enrollment jumped.

In such instances, projects can be a valuable "testing ground" for new and promising initiatives that can then spread on their own to other areas that are not directly covered by the project, the report says.

Assessing Aid is the seventh in a series of Policy Research Reports that are designed to bring the results of World Bank research to a broad audience. Previous studies have focused on issues such as privatization of state enterprises, public pension reform, and the AIDS epidemic. The studies are not statements of World Bank policy. They provide information to prompt debate about the appropriate policies to address global problems.

Even so, the report's recommendations echo key initiatives of World Bank Group President James Wolfensohn, who has urged the development community to go "beyond projects" to an integrated view of development.

"In a global economy, it is the totality of change in a country that matters," he said in a recent speech to the governors of the World Bank and the IMF. "We must build on the work we have already begun, to move from a project-by-project approach, to an approach that looks at the totality of effort necessary for country development, that takes the long view, that asks of every project - how does this fit into the bigger picture?"

Efforts are also underway, in the World Bank and other development institutions, to channel funds to poor countries with sound policies. For example, the International Development Association (IDA), the World Bank's soft loan facility for the world's poorest countries, already uses rankings of policy effectiveness in allocating its funds. The resulting allocation of IDA funds is very close to the "poverty efficient" allocation that the report recommends, that is, the allocation of aid dollars that would have the maximum impact on reducing poverty.

In his foreword to the report, Joseph Stiglitz, Senior Vice President for Development Economics and Chief Economist of the World Bank, calls on recipient countries and development institutions to go further in this direction. "The recipient countries must be moving toward sound policies and institutions," he says. "Development agencies must shift away from [focusing on] total disbursements and the narrow evaluation of the physical implementation of projects to create high impact aid."

Stiglitz also urges citizens of wealthy countries to continue to support and boost their share of foreign aid. "The good news is that both bilateral and multilateral aid agencies are transforming themselves and cooperating together to become more effective," he writes. "The bad news is that just as aid is poised to become its most effective, the volume of aid is declining and is at its lowest level ever."

Development experts outside the Bank have warmly received the report. Alberto Alesina, a professor of economics at Harvard University, has called it "the best and most comprehensive book on the effect of foreign aid."

Jan Willem Gunning, Director of the Centre for the Study of African Economies, University at Oxford, has written, "If donors are serious about using development aid to help people grow out of poverty they should read this book before doing anything else. The evidence presented by the authors shows that aid effectiveness can be vastly improved through simple, but radical, changes in aid policies."

Nancy Birdsall, Senior Associate at the Carnegie Endowment for International Peace and a former vice president at the Inter-American Development Bank calls the book a "refreshingly frank assessment of the World Bank and the larger aid business [that is] essential reading for the policy community dealing with the reform of aid and international institutions."





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