The second principle is that—among poor countries—more assistance should be allocated to ones that have reasonably good economic policies. This is another common-sense proposition, and it is supported by evidence that the impact of aid on poverty reduction is greater in a good policy environment. The kinds of policies that create a good environment for broad-based growth—private property rights, low levels of corruption, openness to foreign trade, macroeconomic stability—are the same policies that create a good environment for the effective use of donor assistance. Are there poor countries with good policies? Yes. There has been a worldwide wave of economic reform over the past decade, so that a growing number of low-income countries have reasonably good policies. Examples are Uganda, Vietnam, Ghana and India.
How do donors allocate aid among countries with different policies? Controlling for the level of poverty, donors gave significantly more assistance in 1996 to countries with mediocre policies than to countries with truly good policies. Donors actually discriminate against poor countries that have reformed. They may think that these countries can attract private capital and no longer need aid. In fact, the evidence is that this is exactly when financial assistance is most effective, helping the country provide critical public services that are complementary to private investment.
Two myths of aid
There are a number of reasons why donors continue to give a lot of assistance to countries with mediocre policies, and two of these reasons are based on fundamental myths of aid. Clearly, countries that are poor and have weak policies have enormous needs. One of the myths of aid is that donors can address some of the specific needs by directing their finance to particular projects or sectors: education or rural development, for example. The evidence shows, however, that aid is typically fungible. Even bad governments spend some resources on education. If a donor comes in and offers to take over some of this, it frees up the government to spend its remaining resources on other things. Thus, aid—even when targeted to particular services—is best thought of as funding the whole public sector. Which is why the overall quality of policies—including management of the public sector—is the key to effective use of aid resources.
The second big myth of aid is that donors can use conditionality to ensure that bad governments put good policies into place. In general, giving money to bad governments is likely to sustain them (which is the old conservative argument against any aid at all). Donors have tried to get around this problem by giving aid conditional on promises to reform. This whole approach is built up around the idea that there are large costs to reform that aid can finance, thus easing the path to reform. After twenty years of experience, we can say pretty clearly that conditionality has not typically led to successful reform. It has led recalcitrant governments to exaggerate the cost of reform and to get donors to “finance” the same reforms over and over again. A good example of this is Zambia under the Kaunda regime. Aid increased in tandem with a series of adjustment programs from the Bretton Woods institutions, while policy actually got continually worse.
Another good example is Kenya, where the same agricultural reforms were financed five times. Focusing a lot of aid on countries with poor policies and making much of it “conditional” has not typically succeeded in generating reform—it has simply wasted a lot of money that could have been used effectively elsewhere.
Aid and reform
One of the reasons why donors continue to resist the simple approach that we advocate is that they do not want to give up on the idea that they can promote good policies in the lagging countries. Case studies often suggest that aid has played a useful supporting role in countries that have successfully reformed, though the same studies also usually find that reform starts with some clear political movement and new leadership (Museveni in Uganda, Rawlings in Ghana, Vo Van Kiet in Vietnam).
It is instructive to look at the pattern of aid and reform in these three well-known cases of low-income reformers. In the pre-reform period, these countries were getting small amounts of aid, far below the average for low-income countries. In general this assistance was targeted to policy studies, training, study tours—inputs that create a useful foundation if serious reformers come to power. There was an absence of large-scale finance and of adjustment lending. Each country had an intensive three-year period of reform during which the volume of aid increased as policy progress was made.
During this period the leadership may actually welcome conditional aid—for a serious reform government conditionality is an opportunity to commit to certain measures and to signal its seriousness to the private sector. In each country there is a clearly identifiable third period in which it has reasonably good policy and is getting significant financial aid: our analysis shows that this aid will have a large impact on growth and poverty reduction, and should help sustain the momentum of reform.
But note two things about this third period: first, the volume of aid, while higher than in the past for these countries, remains below what many poor-policy countries receive (less than half of what Zambia was getting in the late 1980s); second, note that after a few years of good policy, aid actually declines, reflecting the donor tendency to discriminate against good-policy countries.
The path of aid in these three successful reformers is very similar to what we advocate: low when they have really bad policy and then increasing as policy actually improves. We advocate this approach not primarily as an incentive to bring about good policy, but simply for the practical reason that in a good policy environment aid has more of an impact on growth and poverty reduction. But—based on the evidence from these three successful reformers—it may well be that this approach to allocating aid is also the best hope for donors to have some positive impact on policy.
To sum up: even if donors have no effect on policy at all, they can have a significant impact on poverty reduction by targeting finance to countries that are poor and have good policy. Compared to current practice, this is a shift from financing promises to financing performance. And if donors adopted this approach, they are more likely to actually have an impact on policy. This approach forces donors—in poor policy environments—to focus on activities that may lay a foundation for reform. And it ensures that there is adequate finance in the good policy environments, where we know it has an impact on poverty and where—by increasing the benefit of reform—it may increase the likelihood that reforms are sustained.
RSS