Foreign Aid: Linkages to Governance and Growth

Introduction

Foreign aid was observed to be a form of interaction in the international society. It was evident within the context of developing nations. The role of foreign aid in assisting these countries meant freedom from a number of budgetary constraints. It was this freedom that could move the political and social arenas in such countries towards a certain direction. The behavior of stakeholders in the country such as government leaders and the elite could be influenced by foreign aid. There was a question as how the influence of foreign aid affected different countries. Foreign aid provided assistance. However, the extent and power of foreign aid needed to be analyzed in relation to the quality of governance of the countries, especially those that were pre-dominantly living below poverty line.

Since most countries were either recipients or donors of financial aid, there needed to be a certain measure as to the significant role financial aid played in the development of the countries. It was possible that not all countries utilized financial aid in the same manner or experienced the same level of benefits.

Was it more beneficial to live independent of other countries as much as a country could or was it better to benefit from financial aid? Financial aid could function as a significant source of assistance from countries that could not govern properly due to the lack of funds. On the other hand, financial aid could also be useless if the government of the countries were not equipped to handle such financial influx.

The real impact of financial aid needed to be examined based from the qualities of recipient countries. The question could be formulated to explore the relationship of the financial aid with the improvement of governance in such countries. Did financial aid improve the government system in such countries? Aside from providing assistance, what was the real influence of the donor countries in the governance of the recipient countries? Would the citizens of the country truly experience financial aid or was it limited to the political elites?

Article Summaries

Foreign Aid and Governance

            Busse and Groning (2009) wrote the study that questioned the significance of foreign aid in the improvement of governance in countries that needed assistance. Foreign aid was observed to be released to governments that were bound by financial constraints. This was given in order to give them the freedom to focus on other areas of governance such as law and order and fighting corruption in the country. This study was focused on the development of economic and social arenas in the country. There was a research gap when it came to the effectiveness of the provision of foreign aid in the improvement of the country’s governance.

            The research problem in this study revolved around the measurement of the impact of the official development assistance (ODA) on governance. The benefits of foreign aids were presented to be the indicators of the effectiveness of foreign aid for good governance. When it came to the impact of foreign aid, it could either be positive or negative. The paper covered both sides. It also introduced the moral hazard problems and rent seeking disadvantages that prevent improvement from domestic reforms. The impact was also analyzed in terms of the presence of high transaction costs that were preconditioned with the aid that receiving countries benefited from.

Overall, the paper was meant to address the gap in the research that would address the empirical analysis of the direct impact of ODA on the governance of the countries (Busse & Groning, 2009). Corruption, law and order, and bureaucracy quality were used as the indicators for the quality of governance (Busse & Groning, 2009). They were highly linked with government and addressing issues that were important in developmental issues.

            According to this research, when a country was opened to trade there was an observed improvement in the country’s governance (Busse & Groning, 2009). There should have been an enhanced freedom of the press and a larger population that were related to foreign aid. These should also have been evidence that related to good governance. These were observed in the initial provision of foreign aid. However, Busse and Groning (2009) also observed that an increase in foreign aid led to the worsening of governance. Aid could not be the sole cause for a the level of development assistance that a country truly received. The increase and decrease in the foreign aid for receiving countries reflected cautious effects on a country’s governance.

Donor countries needed to evaluate the current aid structures and aid effectiveness to foretell whether aid could effectively help the country or worsen its governance. Despite the positive effects and the assistance that foreign aid provided, the results of this study showed that there were potential drawbacks for financial aid for the quality of the country’s governance (Busse & Groning, 2009).

Corruption and Foreign Aid

            Werlin (2005) conducted the study “Corruption and Foreign Aid in Africa.” The overall research question for this paper was in the role of foreign aid in effectively or ineffectively eliminating corruption in the continent. The paper discussed the existing problem in the continent and it was not in the form of the lack of financial aid. Instead, poor countries suffered from the poor quality of governance. It revolved around the high rates of corruption in poor countries (Werlin, 2005).

            Despite the fact that superpower nations like the United States and other countries were extremely generous and would be more generous than they were now, this study showed how it helped little in the elimination of corruption in these poor countries

(Werlin, 2005).  Foreign aid, by itself, could not elevate the quality of life in poor countries. The absence of better governments made it impossible to help these countries despite the availability of financial aid.  Even if the financial aid was given to the country, corruption in the government could prevent this assistance from being used in projects that could be used in empowering the nation.

            Werlin (2005) pointed out that a cost-benefit analysis of corruption was practically impossible in Africa because of the presence of secondary corruption. Moreover, corruption was perceived to make futile every aspect of policy implementation. This futility extended in the inability of political power to be exercised for the purposes of the country’s development. Werlin (2005) described Africa’s governance to be capable of staying afloat but incapable of going somewhere.

            Secondary corruption,  “the poor quality of the social relationships necessary for the functioning of institutions” prevented poor countries from benefiting from financial aid. It was false to assume that if foreign aid came the country’s development could soon follow. Instead, recipient countries needed to experience internal change before external assistance could make a difference. This study revealed how foreign aid, regardless of its noble motives for the poor countries, would not be able to help a nation as long as corruption abounds.

Foreign Aid, Growth and Policy

            Moreira and Bayraktar (2007) wrote the paper according the macroeconomic framework that linked foreign aid, public investment, and growth. This was a paper that made use of an experimental policy analysis to gauge whether the adoption of this policy could benefit the subject country. The impact of increasing foreign aid was analyzed in terms of the trade-offs between growth and poverty reduction in Niger. The study was based on an existing model that studied the linkages between foreign aid, public capital, growth, and poverty reduction.

The model was related to the link between aid and public investment, as well as the in flows of foreign aid. The study utilized partial elasticities that were related the growth of consumption with poverty (Moreira & Bayraktar, 2007). The model also discussed the policies that helped move the country in fostering economic growth and poverty reduction. The original model was revised in such a way that it reflected important characteristics of a low-income economy in the form of the disaggregation of domestic taxes for direct and indirect taxes.

            Evidently, the budget of the country received the greatest effect in terms of the increase in the budget. The higher inflow of aid was directly proportional to the permanent improvement of the fiscal balance in Niger (Moreira & Bayraktar, 2007). In the same manner, the increase in public investment was also related to the increase in private investment.

            The paper revealed that there was a link between foreign aid and public investment, growth and poverty reduction. The subject country was Niger. It was one of the poorest countries in the world. Despite this fact, if the governance could effectively manage the foreign aid that was provided by donor countries, long-term benefits could be observed from the influx of financial assistance (Moreira & Bayraktar, 2007). Foreign aid was the source of strong and sustained growth and poverty reduction in the country. It assisted the country to develop economically when the governance over the financial aid was just and efficient. It required a government that considered the needs of the public over their selfish monetary gains.

            This showed a potential for financial aid in developing countries. When countries constructed effective systems of governance, donor countries would develop a higher sense of confidence for such grants to be given to developing countries. It showed that when countries revealed that they could effectively invest the foreign aid resources into public investments, donor countries would be more confident to invest in such countries. This study could be described by the cliché that valued the importance of teaching a man to fish, instead of giving him fish constantly. It was important to help nations that took the first step towards development. This first step was usually in the form of the rise of equality and unity in the country.

Elites, Democracy and Financial Aid

            The study “Do Elites Benefit from Democracy and Foreign Aid in Developing Countries?” by Bjornskov (2009) addressed the growing concern over the lack of beneficial effects that recipient countries experienced from foreign aid. The political elites were observed in their roles in the futility of financial aids for poor countries. The income quintiles from the World Income Inequality Database were analyzed and associated according to the share of income.

            Most studies showed that financial aid was ineffective in providing significant assistance for poor countries. A literature review would attribute the failure of this process in helping poor countries. However, it was important to point out how these growth rates still benefited the poor countries in one way or another in terms of decreasing the skewed of income distribution (Bjornskov, 2009).

            This study was based on the question whether foreign aid actually trickled down to the poor or if the elites were the one ones that were able to experience its benefits. Research showed how politicians lived a life of a wealthy elite. They were perceived as the direct recipients of the financial support that was meant to be utilized by a nation. There were pieces of evidence to reveal that recipient countries limited the experience of alleviation to the elite of the society while the entire nation would not feel anything close to financial assistance.

            The problem revolved around the problem of how the elites steal the aid resources and utilize them for their personal comfort (Bjornskov, 2009). Despite the faint hope that the donor country could actually do something to reach the poor,  the development of the country was still dependent in the power of the elites in accessing the financial aid resources. There were countries that were pointed out wherein the country’s elite received a substantial amount of the financial aid for their personal use due to corruption.

            The cause of the problem was not the absence of foreign aid but the presence of democratic checks and balances for politicians (Bjornskov, 2009). These checks and balances in most developing countries were often characterized to be either too weak and non-existent. These government needed to be checked in order to prevent associating with corrupt people.

            The redistribution of the financial assistance towards the poor classes of the society  needed to passed on by the representatives. However, the unfortunate cases would show how the funds stay with the government elites instead of undergoing a trickle down effect (Bjornskov, 2009).

            The political control of foreign aid pointed towards the existence of democratization and this would ultimately benefit the poor because of the presence of foreign aid (Bjornskov, 2009). Checks and balances would also be established for the government. Democratization of developing countries resulted in a less skewed distribution. The paper also addressed the moot relationship between foreign aid and income, as well as the link between democracy and inequality. In poor and unequal societies, the income distribution was more skewed.

Bjornskov (2009) combined factors that asked the question of whether elites in politics had the power to define the share of population and benefit from foreign aid in a relatively different amount from the rest of the population. The upper income quintile was classified as the economic and political elite of the country.

Checks and balances in society, as well as  democratic institutions were established in order to distribute financial aid for the people. Foreign aid that was given to relatively democratic countries was associated with  the higher level of income in the upper income quintile. The findings were unable to neither confirm nor reject that foreign aid enabled elites to steal the donor funds. Democracy was however closely associated with the distribution of national income which was in favor of the richer part of the population.

Aid and Growth

            Rajan and Subramanian (2005) inquired as to the influence of financial aid to the growth of poor countries. Research had shown that there was little evidence that reflected a significant impact in the impact in the development of the country. It was difficult to determine the reason why positive impact was hindered. Financial aid was something that should have been constantly perceived as positive and helpful for any country. It provided assistance in difficult areas, specifically in the financial sector. This paper was focused on the factors that prevented foreign aid from providing long-term growth for the poor countries.

            It was focused on two things that were seen as the reason why such a growth seemed too far from the reach of the recipient countries. The first reason was the characteristic of recipient countries. Most of the time, financial aid would go to countries that were struck with natural disasters. This would present a negative correlation between aid and growth (Rajan & Subramanian, 2005). Instead of using the aid to promote progress, it would be initially utilize to survive and rebuild what were destroyed by said disasters. On the other hand, it would also go to those that showed that they have used it well in the past and that they experienced persistent growth (Rajan & Subramanian, 2005).

            Rajan and Subramian (2009) found little evidence to support that there was a robust positive impact on growth from foreign aid. From a cross-sectional analysis investigation, the researchers found some evidence for a negative relationship in the long run between aid and growth within a 40-year horizon. They also found no evidence that aid could be of better use if better policy was in place or if there was an improved institutional or geographical environment (Rajan & Subramanian, 2005). There was also no sign that a certain form of aid was better than others. The findings did not directly indicate that if foreign aid did not work in the past that it would not work in the future. However, in order for aid to be more effective, aid apparatus in terms of its delivery, recipient, form and conditions, would need to be reconsidered. They also presented the importance of being aware of hindrances to growth from aid support in order to avoid them in order to improve effectiveness.

Financial Aid, Public Investment, Growth and Property Reduction

            Agenor and his colleagues (2004) conducted a study on the framework that captured the link of between foreign aid, the level and composition of public investment, growth, and poverty reduction. In this study, foreign aid had different types. It was through food and non-food assistance, while public investment was viewed as the budget for education, infrastructure and health.

            The study was created as a response to the growing controversy in financial aid. There were studies that reflected on how financial aid contributed to the growth of a country’s gross domestic product (GDP) given they had good fiscal and trade policies (Agenor et al., 2004).  In the same manner, public investment was also considered in terms of how it increased private capital formation. There was an existing research gap that this study wanted to address and it was in the linkage of foreign aid, public investment and growth.

            Using a quantitative macroeconomic framework Agenor and his colleagues (2004) analyzed this linkage in the context of the typical low-income country. It was a model that was focused on the fiscal and supply-side effects of aid with the stock and flow effects of public investment, taking into account the potential congestion effects that were related to the utilization of public services. The increase of aid and aid-funded levels of public investment with the allocation of public investment were perceived to produce growth and sustain poverty reduction.

            The framework that Agenor and his colleagues (2004) presented captured only the average effects of growth and it was possible that changes in the composition of public investment could produce higher levels of growth that were beyond the average. The study revealed that the labor market structure could be developed further if education played a greater role in the process. The model did not take into account how aid could finance investments for education, health or infrastructure. An extension of the model that was formulated in this research was related to public education input and higher investment’s impact on the level of pressure to increase recurrent expenditure (Agenor et al., 2004).

Conclusion

The significant problem for this research revolved around the effectiveness of foreign aid in providing assistance and positive impact for the recipient countries. Since foreign aid functioned to provide a great deal of assistance for countries that were in dire need of external help, it would be easy to assume that the impact of foreign aid would always be positive. However, it seemed that the studies that were presented in this paper exposed how foreign aid was insufficient in addressing the problems of poor countries.

The real impact of financial aid was examined in terms of the extent by which it helped poor countries improve in different areas. The areas of improvement that were revealed in the studies included governance, public investment, economic development growth and poverty reduction. These areas served as indicator for the effectiveness of foreign aid in the countries’ development.

Researches showed that there was an overall negative impact on the countries’ progress despite the presence of foreign aid (Busse & Groning, 2009; Werlin, 2005; Moreira & Bayraktar, 2007; Bjornskov, 2009; Agenor et al., 2004). Instead of helping the country progress into economic development, studies showed that the foreign aid served to be either futile or even preventive of development opportunities. At face value, this was an unexpected and almost an illogical effect from foreign aid. It seemed that no bad thing could emerge out of acts of assistance from other countries. The review of articles that tackled the relationship of foreign aid with these things revealed why this constantly occurred.

The increase in foreign aid did not translate to increase development of the recipient countries’ economy. Instead, the increase in foreign aid was related to worsening of governance (Busse & Groning, 2009). This was a sign of a country’s over-dependence on external assistance for survival. It meant the country could not turn the initial aid into something that could independently sustain them. The decrease in foreign aid due to a recipient’s country’s increase in economic development and its sustenance was the development that donor countries needed to evaluate and look for.

Wender (2005) revealed that corruption was a major hindrance to the proper utilization of foreign aid. It was necessary to have institutions to function well in order to take advantage of the aid that were provided for their country’s betterment. Recipient countries could not be able to benefit from such aid if the country suffered from internal disarray. It would be false to assume that foreign aid sparked development in the country. The proper management of the foreign aid received would lead to the country’s gradual development. However, when the government suffered from corruption external assistance would be an exercise in futility.

Bjornskov (2009) agreed with Wender (2005) and revealed the role of the political elites in hindering the proper utilization of foreign aid. Since they had access to such a power, it was possible that corrupt elite politicians would use foreign aid for their personal gain, instead of using it to fund the public investment of the country.

Rajan and Subramian (2009) also found little evidence to support that there was a robust positive impact on growth from foreign aid. In order to provide a make sure a positive utilization of aid, aid apparatus, aid delivery, forms and conditions and the recipient country needed to be reevaluated.  Moreira and Bayraktar  (2007) revealed that there was a link between public investment and foreign aid. Good governance was required in order to manage foreign aid, consequently, result to long-term benefits and sustained poverty reduction in the country.

Foreign aid was not the sole element that would bring about change for the poor countries. It had no power to change the internal problems of a country if the leaders of the troubled nations were corrupted. The lack of proper utilization would also leave foreign aid provision to be futile and sometimes even hindrance for the development of the country. The development of good governance and the management of foreign aid towards public investment presented more opportunities for effectiveness.

References

Agenor, P., Bayraktar, N. and El Aynaoui, K. 2004. “Assessing the Link between Aid, Public Investment, Growth, and Property Reduction.” World Banks’ Country Economic Memorandum for Euthopia: 1-66.

Bjornskov, C. 2009. “Do Elites Benefit from Democracy and Foreign Aid in Developing Countries?” Journal of Development Economics: 1-10.

Busse, M. and Groning, S. 2009. “Does foreign aid improve governance?” Economic Letters: 1-3.

Moreira, E. and Bayraktar, N. 2007. “Foreign Aid, Growth and Poverty: A Policy Framework for Niger.” Journal of Policy Modeling 30: 523-539.

Rajan, R. and Subramanian, A. 2005. “Aid and Growth: What Does the Cross-Country Evidence Really Show? International Monetary Fund: 4-46.

Werlin, H. (2005).  “Corruption and Foreign Aid in Africa” Elsevier Limited: 517-527.