The Economics & Politics
of Foreign Aid
Chris Coyne
Department of Economics
George Mason University
1. Context
The Current Reality
• Low and lower-middle income countries
make up more than half the world’s
economies
– Low = $875 or less
– Lower middle = $876 - $3,465
• More than 1 billion people subsists on
less than $1 a day
• In some developing countries, more than
70 percent live on less than $2 a day
U.S. Foreign Aid
• Foreign aid is an essential part of U.S.
foreign policy
– “International aid is one of the most
powerful weapons in the war against
poverty. Today that weapon is underused
and badly targeted.”
- Human Development Report 2005
• There are five major categories of
foreign assistance
1. Bilateral assistance (35%) – Direct transfer from
one government to another
2. Assistance for U.S. Political and Security Goals
(22%) – nation building, War on Terror, War on
Drugs, etc.
3. Humanitarian aid (13%) – short-term immediate
relief
4. Multilateral aid (7%) - Aid given from a
government to an international agency (World
Bank, IMF, UNICEF)
5. Military aid (23%) – Provided to U.S. allies to help
them acquire military equipment and training
U.S. Assistance: Who Gets It?
• The U.S. provides assistance to about
150 countries
– Most are instances of bilateral aid
• From 1989-2009, the largest recipients of
U.S. aid were: Iraq, Egypt, Israel, and
Afghanistan
• For 2013, the top recipients were: Israel,
Afghanistan, Pakistan, Iraq, and Egypt
2. Has Assistance Worked?
• No consensus
“The international community’s response
to the catastrophic 2010 earthquake in
Haiti was one of the largest disaster relief
responses ever carried out ... So it may be
a bit disconcerting that, three years on,
the aid and development community still
can’t seem to agree on whether the effort
should be regarded as largely a success or
a failure.”
– Paulson and Murphy, 2013
• No consensus
“Our conclusions are depressing: Taking all
available evidence accumulated over 40 years
of research into consideration, we have to
conclude that the AEL [aid effectiveness
literature] has failed to prove that the effect of
development aid on growth is statistically
significantly larger than zero. We are forced to
conclude that aid has not, on average,
achieved its stated aims of generating
development.”
– Doucouliagos and Paldam, 2008
• No consensus
“We re-examine key hypotheses, and find that
the effect of aid on growth is positive and
statistically significant.”
– Mekasha and Tarp, 2013
Aren’t the Answers Easy?
(1) Identify Technical problem contributing to
poverty (e.g. Vitamin A deficiency)
(2) Make technological solution available (e.g.
Vitamin A capsules)
(3) Provide sufficient financing to scale up tech
solution to meet estimated needs (Required
financing = # Vitamin A deficient *Cost per
unit of Vitamin A)
(4) Repeat for all technical problems
contributing to poverty
(5) Therefore, aid financing  technological
solutions  the end of poverty
Why It Might Not be That
Easy
• Aid money does not spend itself, and
technology does not implement itself
• Humans spend aid money and
implement technology
Celebrities help spread
concern, but…
Tend to Ignore the EWoT
• Adaptability
–Function of:
• Knowledge
• Incentives
3. Why Might Aid Fail?
Econ 101
• Given scarcity:
– What should be produced and
in what quantities?
– How?
– For whom?
“The economic problem of society is . . .
not merely a problem of how to
allocate ‘given’ resources—if ‘given’ is
taken to mean given to a single mind
which deliberately solves the problem
set by these ‘data.’ It is rather a
problem of . . . the utilization of
knowledge which is not given to
anyone in its totality.”
– Hayek,
1945
What Can Aid Do?
• Aid can, in theory, increase
predetermined outputs
• Aid cannot solve the basic
economic problem required for
economic progress
• The difference between
increased outputs and
development
“Mulago’s [located in Kampala,
Uganda] experience is not unique.
Across Sub-Saharan Africa, ‘medical
device graveyards’ litter the empty
closets and spare corners of hospitals.
The World Health Organization
estimates that ‘a large proportion (up
to 70 percent) of equipment lies idle.’”
Political Competition…
•
•
•
•
Between recipient governments
Within the donor government
Between NGOs
Among special interests
•
Implications for those in need:
–
–
They have a weak or nonexistent voice
Those in need often do not receive assistance
Food for Peace
Food for Peace
“Growing, manufacturing, bagging,
shipping and transportation of nutritious
U.S. food creates jobs and economic
activity here at home, provides support for
our U.S. Merchant Marine, essential to
our national defense sealift capability,
and sustains a robust domestic
constituency for these programs not easily
replicated in foreign aid programs.”
– Letter to Congress and Obama Administration
from 60 U.S. food organizations
Food for Peace
“I’ve run these operations, and I know
that food aid often gets there after
everyone’s dead.”
– Andrew Natsios, 2013
Bureaucracy
• Discretionary budget
– Mission creep and hubris
– Waste
Unintended Consequences
A complex system has two
characteristics
•
•
•
Interconnected units or elements
Entire system exhibits properties
different from its individual parts
– Reinforce status quo, Corruption,
Political Instability, Dependency,
Escalation in conflict and human rights
violations, etc.
“The cause of this mess is no mystery.
Ever since Uganda began receiving
generous amounts of foreign aid two
decades ago, senior Ugandan politicians
and civil servants have been stealing
virtually every shilling they can get
their hands on … The US, Japan, and
Europe also poured in aid, and as they
did, ever more outrageous scandals
ensued.”
– Helen Murphy, “Murder in Uganda,” The
New York Review of Books, April 3, 2014
4. Institutions: The Key to
Economic Growth
An Illustration
Per Capita
Income (PPP)
= $1,800
Per Capita
Income (PPP)
= $28,000
Economic Freedom
• Economic Freedom means that people
are free to trade with others, compete in
markets, buy what they want, earn a
living in a job they choose, keep what
they earn, and own things privately
Economic Freedom and
Per Capita Income
Economic Freedom and the
Income Level of the Poorest 10%
Economic Freedom and
Life Expectancy
What Explains These
Outcomes?
• Entrepreneurship!
– A discovery process which entails:
•
•
•
•
Experimentation
Trial and error
Success and failure
Profit and loss
• Economic freedom (i.e., private property)
provides general and overarching rules which
allow entrepreneurs to be alert to ideas and to
bet on those ideas
The Difficulty of Picking
Winners
• Ken Olson, chairman/founder of Digital
Equipment Corp., 1977
– “There is no reason anyone would want a
computer in their home.”
• Fred Smith’s (FedEx) Yale University
Senior Project Grade – Remark from
professor:
– “The concept is interesting and well-formed, but
in order to earn better than a 'C,' the idea must
be feasible.”
Would You Invest?
5. Summing Up
The question that often arises
in discussions of
humanitarian issues:
What must “we” do to
end suffering?
The Myth of the “Man in
Charge”
Most people act as if there is an allpowerful person in charge of
development
•
•
•
But there is nobody in charge of
complex systems
The main effect of the “man in
charge” myth is a bias toward
unconstrained thinking
The Constrained Approach
•
Development as discovery
–
•
Removing barriers to discovery
–
•
Open ended vs. end states
Note that politicians in other countries
can do this if they so choose
What role for developed countries?
–
Inward vs. outward orientation