ODI Logo ODI

Trending

What we do

Search

Newsletter

Follow ODI

The Macroeconomics of Scaling Up Aid

Date
Time (GMT +00) 13:00 14:30

Speaker:

Tony Killick, Senior Research Associate, ODI

Discussant:

John Burton, Deputy Chief Economist and Head of Profession, Economics, DFID

Chair:

Karin Christiansen, Research Fellow, ODI

Tony Killick

Tony Killick explained that his presentation was based on a project he ran at ODI, work the IMF had done, and on a DFID-IMF conference. Country case studies covered in the presentation included Mauritania, Mozambique, Sierra Leone, Tanzania, Ethiopia, Ghana and Uganda.

He began stating that even if the promises made at the Gleneagles G8 summit in 2005 are not kept in full, many donors are increasing their aid and many African countries are receiving much higher volumes of aid. Ghana, for example, has seen its aid inflows more than double between 2002 and 2006.

He gave 2 reasons why increasing aid volumes are problematic:

1. More aid can lead to increased liquidity. If not properly managed (i.e. spent on increased imports, not domestic goods or labour), inflation may rise.

2. High pre-existing aid dependency. Aid is a high proportion of GNI, Gross Capital Formation and imports in the countries studied.

These two factors mean that a doubling of aid will have serious ramifications.

He turned to macro management issues and the distinction between 'absorption' and 'spending'. 'Absorb and spend' is the textbook solution. Thinking of aid in terms of achieving higher imports and increasing government spending, he explored the consequences of inducing an economy to import more. He pointed out the risk to private producers of tradeables. An appreciating exchange rate means exporters earnings are worth less. The alternative, allowing the government to sterilise by raising interest rates, creates a squeeze on credit. He argued exports are vital to the long term development of Africa so the pressures on the private sector are a crucial issue.

He pointed out that no country in the study had fully absorbed and fully spent the aid received. Ghana, for example neither spent nor absorbed aid. They built up international reserves and paid off government domestic debt. He said there are substantial constraints on the absorption of aid. He said aid flows are highly unreliable and highly unstable. Countries do not assume short term gains in aid will continue. Ghana made a responsible choice.

He went on to discuss neutralising the problems from the supply side. To induce a positive supply side response aid could be used to improve infrastructure (reducing the costs of private sector), invest in human capital to raise productivity and to reduce the perceived risks of investment.

However, there are limitations, which include:

  • an absence of strong evidence on aid and growth
  • a mixed past record on aid for infrastructure (which led the World Bank and DFID to move away from that type of aid)
  • a danger that doubling aid is likely to result in diminishing returns
  • a risk that aid can undermine institutional development
  • a risk that spending will be poor quality
  • a risk that problems will be aggravated by changes in the end-uses of aid. Aid has the potential to improve productivity and profitability of private sector but this is not automatic

He outlined some policy implications for recipients:

  • Be careful, depending on initial situation
  • Much hangs on nature of political system
  • Need for conscious, joined-up management policy, including for tradeables
  • Need for a long-term planning horizon

And for donors:

  • Predictable gradual increases easier to manage than large discontinuous jumps
  • Work with recipients on management & spending plans. Don't rely on conditionality
  • Re-examine balance between social and directly productive applications
  • Improve predictability of aid flows

He concluded by comparing a big increase in aid to winning the lottery - it comes with pros and cons.

John Burton

John Burton responded by returning to the reasons why doubling aid what seen as a good idea in the first place: the MDGs are off target.

On scaling up, he said that it is not necessary to double aid to every country in order to double aid globally. Therefore not every country would face the absorption problems Tony Killick outlined. He talked of 'scaling up smartly' by giving more aid to countries currently underaided. This could include countries in Asia and countries emerging from conflict.

On the relationship between aid and growth, he said that although aid may not be a driving factor of growth it does help countries where growth is at very low levels and sectors which are growth-related. He acknowledged promoting growth is an important issue.

On good uses of aid he mentioned building reserves, importing HIV/AIDS drugs and liberalising trade to bring in more imports.

He said that the evidence from case study countries shows countries have not suffered Dutch disease effects yet.

He disagreed that countries should start saying no to aid, but does recognise that aid does need to be good quality.

He concluded that Tony Killick's argument does not lead to the conclusion that aid should not be doubled, only that it must be well managed.

Discussion

The discussion covered the following points:

  • The political case and the implications of doubling aid
  • Rural and urban disparities and income distribution
  • The increase in private demand as a knock-on effect of aid spending
  • The impact of increased spending on the productive sectors
  • The effects of importing producer goods
  • Increasing demand via cash transfers in rural areas
  • A comparison of Dutch disease effects from aid and from commodity booms
  • The importance of institutions
  • Pro-poor recipient country policies towards receiving aid
  • The importance of managing the exchange rate for long term growth
  • The IMF's approach to inflation
  • Investment in infrastructure
  • Under-aid countries
  • Budget support and aid for operation and maintenance

Description

With most African countries already highly reliant on aid, large-scale increases in assistance would unavoidably create challenges for macroeconomic management. To set against the benefits, it is now recognised that such ‘scaling-up’ could create disincentives for exporters and other local producers. There need to be strong supply-side responses to offset these. Enlarged aid inflows could be a powerful stimulus to raising productivities and investment but experience suggests that such outcomes should not be taken for granted. The case for larger aid quantities cannot be divorced from measures to raise aid qualities and results are likely to vary across countries.

These issues, and their policy implications, were explored in this meeting, building on ODI-led country research.