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Beyond the Numbers: using aid to combat the crisis in poor countries requires more than just cash

The forthcoming G20 summit in London will focus on plans to address the global financial crisis, and perhaps even strike a ‘grand bargain’ to ensure that a crisis of this magnitude cannot happen again. Although no low income countries are members of the G20, the crisis will have severe and real consequences for them, with net private capital flows to emerging markets forecast to fall from $929bn in 2007 to $165bn in 2009. Any grand bargain should include the world’s poor.

Much of the debate about how rich countries can help has centred on building the political coalition for vast and rapid additional resource flows to countries that have insufficient fiscal space to protect the poor and stimulate the economy. This has been accompanied by numerous back of the envelope calculations about what appropriate volumes might be, with the rhetoric invoking the post-war Marshall Plan and setting out a new role for aid.

The loudest call has come from President of the World Bank, Bob Zoellick. He has proposed that 0.7% of each developed country stimulus package should be pledged to a vulnerability fund to assist the poorest developing countries. For the US this would mean providing US$6 billion of its US$825 billion stimulus package. Nancy Birdsall, President of the Center for Global Development, argues that in order to help emerging market economies as well as poor countries $1 trillion will be required. World Bank Chief Economist Justin Lin has even suggested that twice that figure may be necessary. From a situation where many donors were quietly reneging on their aid commitments, we suddenly have a potential aid bonanza.

Less attention has been paid to how such additional resources should best be deployed in developing countries, and what this means for the channel and type of the support provided. It is important not to forget the hard learned lessons of how to deliver aid effectively and what it can realistically achieve in a short time frame. Aid that does not have an effect on economic and social activity within the next 18 months will surely lose any counter-cyclical value, while bringing forward aid spending planned for 18-24 months from now (through bringing forward the pipeline) will help but at the possible cost of longer-term funding commitments.

Some key principles are needed to guide any additional aid spending during the crisis:

Rationalise and coordinate rather than fragment: Creating new funds and initiatives imposes a negative externality by adding to the complexity and fragmentation of the aid non-system. We should guard ourselves against the ‘innovation-itis’ that assumes each new problem needs multiple new initiatives: for example, at a conservative estimate, 18 different global climate funds for developing countries have already been set up. This may even provide an opportunity for some rationalisation of the multiple climate change funds if there is to be a green tinge to a fiscal stimulus for developing countries.

Less ambitiously, we need a better coordinated response. Lessons from previous multilateral responses to crises suggest that a lack of coordination between the IMF, World Bank and the regional banks hampered the efficacy of the response.

Take country context into account: The World Bank has suggested countries should be classified according to their exposure to the crisis and how far they are able to cope with it. In the most exposed countries, the binding constraint is often a lack of institutional capacity to deal with additional spending. The Bank suggests briefly that ‘tax measures’ may be a way that such states can respond to the crisis. However, temporary tax exemptions risk weakening already fragile domestic accountability between tax payers and the state. Ultimately, the capacity to spend large amounts at very short notice is severely limited in these countries.

The efficacy of aid depends on how the recipient uses it: As research has shown, in many countries not all aid is converted into local currency by the central bank. In such cases some proportion of aid money is accumulated as foreign reserves. This would limit its contribution to a fiscal stimulus. To address this aid needs to be provided in the context of more explicit agreement as to how the foreign exchange will be absorbed as well as how the budget resources will be spent.

To avoid waste and delay, the emphasis should be placed on the accelerated completion of ongoing or planned investment projects rather than new initiatives which may either take too long to or be wastefully hurried. The same goes for expenditures aimed at providing social safety nets. One of the key lessons from the Asian financial crisis was to expand established safety net programmes rather than create new ones.

Don’t forget aid quality: Principles of aid effectiveness are as important in a crisis as at any other time and can even help point to less distortionary ways of channelling additional aid. Hard won commitments to untie aid should remain in place, especially given the imperative for rapid disbursement. The availability of additional crisis resources should not let donors off the hook from honouring their existing aid commitments. Tackling volatility is also critical. Sudden and unpredictable surges in aid inflows can have severe costs for recipient countries, just as sudden reductions can.

One improvement to aid quality donors could introduce at the stroke of a pen would be to drop their insistence on tax exemptions for projects that they finance (as the World Bank has done). This would provide an instant boost to government revenues. The default position should be payment of taxes, with clearly defined and commonly agreed criteria for opting out.

While a pragmatic and flexible approach that responds to country specific needs seems sensible, part of that approach should allow for the use of budget support (such as that provided to Brazil in response to a previous crisis). This would seem the most consistent means of delivering substantial additional resources while maintaining aid effectiveness commitments.