Emily Hennager
Department of Business & Economics
Northwestern College
Orange City, Iowa 51041 USA
712-707-7000 ehennager@nwciowa.edu and
Dr. Michael L. Avery
Department of Business and Economics
Northwestern College
Orange City, Iowa 51041 USA
712-707-7318 avery@nwciowa.edu
ABSTRACT
Poverty is identified as one of the most serious economic problems facing our world today and into the future. Although a global issue, the condition of poverty is relative to the economic conditions of a region, a nation or a locality; and is historically defined by a “poverty line”. The emphasis of this paper is not on definition, but on existence and response. The poor do not see a poverty line, they feel a lack of basic needs through hunger, homelessness, joblessness, or lack of education. Foreign aid is a multi-faceted method utilized in an attempt to reduce the condition of poverty and improve economic conditions.
Keywords: Foreign aid, poverty, economic conditions, economic assistance
POVERTY AS AN ECONOMIC ISSUE
Poverty is one of the most serious economic problems facing our world today and into the future. Even out of the world’s youngest citizens, “640 million children do not have adequate shelter,
500 million children have no access to sanitation, 400 million children do not have access to safe water 300 million children lack access to information, 270 million children have no access to health care services, 140 million children have never been to school and 90 million children are severely food-deprived” (State of the World’s Children, 2005).
These children and their families have just barely enough resources to survive. From an economic perspective, they are not able to save, invest or otherwise contribute to the economy. If they do manage to accumulate some savings, it is inconceivable to consider investing in their own entrepreneurial venture because the risk is too great. Because they have no capital, no training, and
(in most cases) very little education, they are unable to turn their talents and ideas into profitable businesses. In turn, poverty tends to perpetuate itself and the people have little hope for improving their economic situation.
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Poverty does not just affect those who are entrenched in it. It is a significant issue for a country where poverty is a problem because poverty is decreasing the country’s economic activity and taking away from its potential GDP. In addition, poverty creates a drain on resources that could be used for other projects. This also affects the world market because other countries are not able to export as much to that county (because those in poverty can’t afford the products) and other countries can’t import the goods that the country could potentially be making if its economy was operating at maximum efficiency.
POVERTY DEFINED
There is no single definition of poverty. The condition of poverty is a global issue, but is relative to the economic conditions of a region, a nation or a locality. Very simply, poverty may be defined a “the state of living in a family with income below the federally defined poverty line” (ECO,
2005). The World Bank suggests that “the most commonly used way to measure poverty is based on incomes. A person is considered poor if his or her income level falls below some minimum level necessary to meet basic needs. This minimum level is usually called ‘the poverty line’. Poverty lines vary in time and place, and each country uses lines which are appropriate to its level of development, social norms and values”(2005).
The emphasis of this paper is not on definition, but on existence. The poor do not see a poverty line, they feel a lack of basic needs through hunger, homelessness, joblessness, or lack of education. Foreign aid is a multi-faceted method utilized in an attempt to reduce the condition of poverty and improve economic conditions.
WORLD RESPONSE TO POVERTY
Because the effects of poverty are so widespread, developed nations support developing nations with foreign aid. The goals of aid can be varied, but almost always include an objective to decrease poverty. Robert Cassen (1994) says, “The purpose of aid is to transfer additional resources, beyond those that the recipient country could mobilize itself either domestically or through foreign trade” (p. 16). This aid can come in many forms and be measured in different ways. For example, it can be measured quantitatively (more resources) or qualitatively (better resources). It is this qualitative measurement that has proved a most important factor. Some advocates say that developing countries just need more resources. Yet the quality of the resources is important as well.
For example, educated laborers will be able to use resources more effectively. Therefore, changes in quality make investments more effective (p. 18-19).
Defining countries who need aid
First, it is important to distinguish between developing countries. These can be divided into several categories highlighting different situations. On one side, there are middle-income developing countries. Those in this category may need assistance in the form of technology, but normally do not need concessional finance. Next there is a wide range of lower middle to low-income countries.
These could use aid to increase the rate of development, but their survival doesn’t depend on it. On the lowest income level, countries lack even the basic elements for continued development, such as human skills and a secure political infrastructure. Agriculturally, many of them are declining, or at least stagnating, and they face many environmental problems (Cassen, 1994, p. 226). In these divisions, extremely large countries like China and India must be looked at separately because they have major areas of poverty, yet have well-developed sections as well.
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Multilateral versus bilateral aid
There are two main channels foreign aid can go through to reach a developing country. First, aid can be provided bilaterally . This means that a developed country, like the United States, allocates money to be spent on U.S. programs geared to benefit a specific developing country. The donor country has control of where the money is spent and how it is used. They are completely accountable for the program and are in sole control.
A second route to foreign aid is multilateral aid. This is money given by a developed country to an international development program. This program decides where and how the money is spent.
The donor country makes no decisions beyond the amount of donation. The donor country also never knows exactly where their money was spent (Paddock and Paddock, 1973, p. 257-258).
For the latter half of the 20 th century, the trend has gone towards multilateral aid. Arguments for multilateral aid say that it gives the developing countries more of a say in how aid is used and allows them to build up experts within their country. Also, some say multilateral aid allows the burden of financing aid to be shared more equally among developed countries. However, critics say that donor countries must rely on faith that the international agencies will use the funds wisely and appropriately, since the donor country has no part in the decision making process. Critics also say that developed countries support international agencies because if something goes wrong, the blame is on the agency, not the donor government (Paddock and Paddock, 1973, p. 257).
A call for a new approach
Critics of current aid policies, multilateral or bilateral, say that all the aid previously given has not dramatically impacted the world’s poverty. They say the economic situation will only improve through private investments. This wealth will then trickle down the economy and benefit even the poorest citizens.
Throughout history this debate has raged on how to help other countries, if we should help other countries and what forms of help are most beneficial. On April 13, 2005, two conferences, held in different parts of the world, clearly articulated the opposing sides of the foreign aid argument.
In Washington, the World Bank and the International Monetary Fund (IMF) called for foreign developmental aid to double in the next five years. This increase, they said, is the only way to meet the “millennium development goals” set out by the United Nations (UN) in September 2000.
These goals include reducing poverty, increasing education and improving health (Aversa, 2005).
In Nairobi, another request was being made—for exact opposite action to be taken. The New
Partnership for African Development (NEPAD) made a general request to the international community to stop foreign aid to Africa. Since over 50 years of aid to Africa has not solved its problems, NEPAD says its time for a new plan. They asked heads of state to encourage private investment in African firms and businesses (Mwai & Mugo, 2005).
Aid can help
Though the large amounts of aid have not eliminated poverty, studies have shown that foreign aid can be effective in improving the situations in African countries. One such study focused on the effect of food aid on children Ethiopia, where previous work shows that children who grow slowly during childhood have poorer psychomotor development and are less interactive. These adverse effects impact future development as well. They are more likely to start school late and complete fewer grades in school. Overall, lifetime earnings are decreased by 7% (Yamano, Alderman, &
Christiaensen, 2005, p. 273).
Due to droughts and other uncontrollable events that suddenly decrease household income, children in rural areas of developing countries are at a higher risk for stunted growth. Ethiopia has received huge amounts of food aid in response to their frequent droughts and crop damage over a
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number of years. The study finds that in areas where aid was received, children’s’ growth rates were better, consequently giving them advantages in psychomotor and cognitive development as well
(Yamano, et al., p. 274).
“Our empirical results indicate that the average value of food aid received in a community has indeed a large positive effect on early child growth,” reported the researchers (Yamano, et al.,
2005, p. 286). Though the researchers found positive correlations, they also observed the down side of aid: it doesn’t always get to where it’s needed. In the area of their study, about 1 in 5 villages received aid (116 out of 531) although almost all had experienced a drought (p. 276). Yamano,
Alderman and Christiaensen attributed this disproportionate allocation to “inflexible targeting rules”
(2005, p. 274-276).
In a similar way, Robert Cassen’s (1994) research “challenges the view that aid cannot help the poor because it sustains the political status quo which underlies poverty: on the contrary, it finds that aid is quite capable of going against that particular grain, if sufficiently determined to do so” (p.
229). Several recommendations are suggested to create situations where aid can be most efficient and effective. First, aid can be most effective at reducing poverty when it is distributed not only through channels directly aimed at poverty reduction, but indirect channels as well (p. 230). For example, roads and transportation systems need to be built and maintained. If the country doesn’t have the means to move resources to the places that need them most, it doesn’t matter how much food or goods is donated. They won’t get to where they need to be. Also, power systems and means of communication can indirectly help poverty as well.
Second, aid can be used to establish “productive activities whose outputs are consumed by the poor” (p. 230). By introducing a new crop, the people can grow it and consume it, providing both jobs and food. The concept can be applied to basic services as well.
Third, donors need to keep in mind recurrent costs when setting up projects. A new facility and program can create more harm than good if the developing country can’t afford to maintain it and keep the program going. This merely adds another burden on their already limited resources.
Fourth, donor countries need to realize that sometimes aid can actually hurt the poor, especially in the short run. In some cases, putting tractors on farms has decreased jobs. New building projects might use land that people lived on and now they have no place to go. When people start growing crops to sell instead of directly growing the food they eat, nutritional values actually decrease, despite the fact they have larger incomes. This is because their markets aren’t efficient enough to meet the demand for more purchased food.
Fifth, donors can sponsor research to help bring economic improvement to the area.
Research on new agricultural techniques can have a big influence on the lives of those in poverty.
Finally, the developing country must also agree, together with the developed country, that the situation needs to change. Spending more aid when the recipient government isn’t committed to changing the foundations that caused the economic crisis will create less than positive outcomes (p.
230). As in most situations, success is dependent on top level support.
Burnside and Dollar (2000) completed a separate study and also found a strong correlation between aid, growth and good governmental policies through a growth model using information from
56 countries and six four-year time periods (p. 847). After analyzing their calculations for each country, they found a positive correlation between the impact of aid on growth and the level of policy in a country and a negative correlation between impact of aid on growth and the level of aid (p. 857).
“Countries with good policies and significant amounts of aid…perform very well, better than can be explained by the other variable in the growth regression,” they reported (p. 848).
However, donors don’t necessarily give more aid to countries with progressive and/or productive policies. On average, good policy countries only received 12% more aid than those with less focus on development. However, when bilateral aid, multilateral aid and World Bank assistance were looked at individually, bilateral aid gave 10% more, multilateral aid gave 24% more and the
World Bank gave 30% more to countries with good policies (Burnside & Dollar, 2000, p. 863). It also showed that aid, especially bilateral aid, increased government consumption.
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Burnside and Dollar (2000) said, “Consistent with other authors, we found that on average aid has had little impact on growth, although a robust finding was that aid has had a more positive impact on growth in good policy environments. This effect goes beyond the direct impact that the policies themselves have on growth” (p. 864). In addition, making aid conditional on the soundness of the country’s policies would allow aid to have more of an impact on growth. In general, multilateral aid and the World Bank are better at this than bilateral aid.
Because the World Bank and multilateral aid have been shown to be among the most effective policies, it is important to have a more in-depth understanding of how they function.
The World Bank
The International Bank for Reconstruction and Development, commonly referred to as the
World Bank, is an agency of the United Nations, whose goal is to reduce poverty through sustainable growth. Many developing countries need money to initiate programs and actions to boost their economy but are unable to get them because of their financial instability and lack of inflow. If loans are available, higher risk results in a very high interest rate. The World Bank offers interest free loans, grants and technical assistance to these needy governments. Loans have a payback period of
35-40 years and include a 10 year grace period. The financing is for specific projects, such as an initiative to improve social services, protect the environmental protection, or promote economic growth that will increase the standard of living.
A small portion of the money for these grants and loans come from donations of member countries. The majority, however, is raised by selling bonds in the world’s financial markets (What is the World Bank, 2005).
The World Bank in Africa
The World Bank continually evaluates its work for effectiveness and efficiency. The
Operations Evaluation Department (OED) is in charge of providing accountability for the use of
World Bank funds and making recommendations based on those evaluations so that the institution can learn from past experiences.
A recent OED report evaluated capacity building in Africa. Capacity building is an emphasis on strengthening the public infrastructure so that further development can be built on that foundation.
This is a relatively new focus for the World Bank so it is an important time for them to evaluate results. The report found that by broadening its focus to include development of public sectors, the
World Bank has made its support more relevant to the needs and issues of the African nations.
However, there are other areas that need improvement, such as more coordination across sectors so that each project can tie together and learn from the lessons of the others. At the same time, the needs of individual sectors in different countries are unique, and World Bank planners must realize this and develop specific strategies for each site, while developing improved standards of quality assurance measurement (www.worldbank.org).
As in many programs, it is going well but there are always ways to get better. This shows that even one of the most efficient organizations struggles to make aid most effective.
International Monetary Fund
Another channel of multilateral aid is the International Monetary Fund (IMF), also tied to the
United Nations. At this writing, it is made up of 184 countries and works to monitor the global economy and provide multilateral assistance to countries in need. Though the IMF works closely with the World Bank, the fund has a distinct and separate mission that includes three main focus areas. First, the IMF monitors and provides advise regarding the economic policies of member countries in order to prevent economic crises in the world market.
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Second, the IMF lends money to member countries in order to make smoother adjustments to policy changes. Though both the IMF and World Bank lend money, there is a distinction between the lending. The IMF does not loan or grant money to specific projects. Funding is made available to the governments in order to get out of a financial crisis or prevent a crisis situation; and is conditional in that the receiving country must adopt the policies that will correct the problems. The loans are also relatively short-term (compared to the World Bank loans), with scheduled repayment in 2.5-7 years at market-related interest rates.
The IMF’s third focus area is offering technical assistance and different forms of training to governments and central banks in order to help them organize and implement the recommended policy changes.
The beginning of the IMF was a result of work done at an international conference in Bretton
Woods, New Hampshire in July of 1944. The international economic climate in the years preceding the conference was marked with protectionist policies, import restrictions and the economic instability of World War II. Also in semi-recent memory was the economic catastrophe of the Great
Depression in the 1930s. Initially, delegates representing 44 countries strived to create a forum where policies could be discussed and examined from a global perspective.
Financing for the IMF mainly comes from quotas that each member nation pays. The quota is determined by the county’s relative size in the world economy. The countries with the five largest quotas are the United States, Japan, Germany, France and the United Kingdom.
It is important to note that the IMF’s primary objective is not development. They are primarily a monetary institution. Its goal is to strengthen the international market and ensure an environment where international trade can take place with maximum efficiency. However, poverty drains resources from developing countries and prevents the world from getting the most benefit from globalization. Therefore, the IMF works to create sound economic policies, which fosters sustainable economic growth, which in turn reduces poverty (What is the International Monetary Fund? (2004).
THE CONSEQUENCES OF AID
Though foreign aid has brought improvements, it has also brought unintended consequences as well. In Tanzania, for example, a multitude of different donors of bilateral and multilateral aid resulted in this single country’s issuance of 10,000 reports per year for all of its various donors.
Added to that is the fact that many donors had different accounting systems and fiscal years and yet expected Tanzania to submit reports according to the donor country’s system and calendar. In addition, the nation also had to host 2,000 visiting delegations that were there to see how the aid put to work (Janigan, 2005, p. 17).
With such “costs of business”, it is no wonder some are asking for aid to stop. Dr. Birahim
Seck, president of NEPAD, says he called for the halt of aid to Africa because the large amounts of aid have only made marginal increases in development. He believes private investment is the only way to make a true impact on the situation. “When African people have jobs, they can feed their families, they can afford quality health care for their children as well as good education,” he said at the conference on April 13, 2005 (Mwai & Mugo, 2005).
However, if the public sector infrastructure isn’t in place to provide adequate hospitals, the people won’t be able to buy healthcare, even if they have more money. Through the use of multilateral aid, governments are helped to improve policies that encourage sustainable growth.
Private investments are an important part in the growth. However, private FDI alone may not be able to pressure or advise the governments to make good policies, which is one of the key components of effective aid. Therefore, multilateral aid should be used in combination with private investments in development.
NEPAD is correct in pointing out that innovation is needed in our approach to aid. Our goals are not yet met. However, this should not be discouraging but rather challenging. Kaplan (1967)
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says, “In an imperfect world, a gap must be expected between the attainable and the attained. Yet if goals are not set out, progress is apt to be all the more retarded” (p. 394).
There is no claim that multilateral aid and private investments are the absolute best ways to help developing countries. These are merely the most popular options historically utilized, and most subject to comment and criticism. Debate and comparative study on sources and effects of aid should continue. It is through new ideas and future research that foreign aid effectiveness will improve and poverty can be reduced.
REFERENCES
Aversa, J. (2005, April 13). International lending institutions want to step up efforts to help poor countries. AP Worldstream.
Retrieved April 18, 2005, from EBSCOhost database.
Burnside, C., & Dollar, D. (2000). Aid, Policies, and Growth. The American Economic Review, 90,
847-865.
Cassen, R. (1994). Does Aid Work? Report to an Intergovernmental Task Force (2 nd ed.). Oxford:
Carendon Press.
Janigan, M. (2005, April 4). A Measure of Progress. Maclean’s, 118, 17 . Retrieved April 18, 2005 from EBSCOhost database.
Kaplan, J.J. (1967). The Challenges of Foreign Aid: Policies, Problems and Possibilities.
New
York: Frederick A. Praeger Publishers.
Mwai, E., & Mugo, Waweru. (2005, April 13). Nepad Calls for Stop to Reliance on Foreign Aid.
The East African Standard.
Retrieved April 18, 2005, from EBSCOhost database.
Paddock, W., & Paddock, E. (1973). We Don’t Know How: An Independent Audit of What They
Call Success In Foreign Assistance . Ames, Iowa: Iowa State University Press.
State of the World’s Children. (2004, December 9). Retrieved April 18, 2005 from the World Wide
Web: http://www.unicefusa.org.
What is the International Monetary Fund? (2004, July 30). Retrieved April 18, 2005 from the World
Wide Web: http://www.imf.org.
What is the World Bank? (2005). Retrieved April 18, 2005 from the World Wide Web: http://www.worldbank.org.
Yamano, T., Alderman, H., & Christiaensen, L. (2005). Child Growth, Shocks, and Food Aid in
Rural Ethiopia. American Journal of Agricultural Economics, 87, 273-288.
About the Authors
Emily Hennager is from Ames, Iowa and in her senior year at Northwestern College in
Orange City, Iowa. She is a Business Administration - Marketing major with a minor in
Corporate Communications, and eager to assume a position in corporate America.
Michael L. Avery is an Assistant Professor of Business and Economics at Northwestern
College. He holds a Doctor of Business Administration degree in International Management from Nova Southeastern University, and participates in community development activities in the Caribbean and Latin America.
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