The Roles of Aid in Politics Putting China in Perspective

In this paper we have revisited the debate on whether foreign aid is effective in enhancing economic performance in recipient countries and in particular in spurring growth. Our main hypothesis is that the way aid is allocated is important in determining aid effectiveness. A consistent result of the aid allocation literature is that politics matters and hence it seems natural to question whether politics also matters for aid effectiveness.

Our main finding is that aid extended to non-allies has a strong positive impact on recipient countries’ economic growth, whereas aid to political allies has a negative impact. These results are robust across different samples, model specifications, time horizons, estimators and instrumentation strategies. While there are always caveats that must accompany any empirical analysis of this nature, our results do appear to be striking in terms of both quantitative impact and robustness. In particular, we feel our instruments more adequately explain the pattern of aid than standard donor-recipient time-invariant factors that may explain the pattern of aid between allies but not between non-allies. We remain agnostic regarding the precise mechanism behind our results but consider two likely possibilities supported by additional evidence: i) aid is used to buy political allegiance and hence its effectiveness for growth may be at best a secondary consideration, and ii) aid between allies may be more tied in other dimensions than aid between non-allies.

These results carry strong policy conclusions. They show that foreign aid can be very beneficial to economic development around the world independent of recipient policies. Indeed, the results stress the role played by donors rather than by recipients. This emphasis stands in contrast to much of the recent debate regarding aid effectiveness, which has focused on recipient policies. We suggest here that donors’ allocation policies should be seen as a leading determinant of aid effectiveness.

The aim of this paper was to relate the effectiveness of foreign aid programs to the political regime of recipient countries. I presented a simple analytical framework where poverty is caused or enhanced by distortionary policies introduced by politicians. In my framework, aid does not promote economic development for two reasons: Poverty is not caused by capital shortage, and it is not optimal for politicians to adjust distortionary policies when they receive aid flows. Between 1971 and 1990 most long-term aid was provided on a regular basis with little or no effective conditionality. I found this aid increased consumption but higher consumption did not benefit the poor. The point estimates in my regressions show there was an insignificant impact on investment in countries that received less than 15% of GNP in aid, though standard errors on these estimates were large. I also found that aid had an insignificant impact on improvements in basic measures of human development such as infant mortality and primary schooling ratios. These results suggest that even while particular programs such as immunization and research can be effective, the bulk of long-term aid programs have had little impact on human development and investment between 1971 and 1990.

My empirical results are consistent with a model where politicians maximize welfare of a wealthy elite, and consistent with the pessimistic predictions of Bauer (1971) and Friedman (1958). Past experience has proven it is possible to dramatically improve human development indicators at low cost over a ten to twenty year period. Dreze and Sen (1982) argue that the failure of governments to reduce infant mortality and improve basic human development indicators reflects public choice. The findings in this paper suggest that aid programs have not substantially changed government’s incentives to carry out these programs, nor have aid programs engendered or correlated with the basic ingredients that cause investment and growth.

These findings emphasize the need to better understand the potential role of aid as a tool in changing political incentives. Casella and Eichengreen (1994) examine the potential efficacy of aid in ending harmful wars of attrition between political actors, and Sachs (1994) concludes that short-term aid has in the past played a key role in promoting stabilization and maintaining political stability. In my model aid can be effective when it is conditional on policy and/or political reforms, and it can be effective in narrow cases where aid is non-fungible.

I presented some evidence that political reforms alone can play an important role. In my empirical work I concluded that while at the margin all political systems allocate aid to the elite, liberal political regimes, ceteris paribus, have approximately 30% lower infant mortality than the least free regimes. This may reflect a willingness of liberal regimes to provide more of the basic, though inexpensive services that are needed to prevent famine and improve human development indicators. But it may also reflect other cultural factors or economic conditions that I was unable to control for in these regressions. My coefficient estimates imply that in order to achieve the same reduction in infant mortality through existing long-term aid programs, donors would have to provide annual aid equal to 150% of GNP for ten years to the recipient country.

One plausible implication is that short-term aid programs targeted to support new liberal political regimes, and to encourage greater political and social liberties, may be a more effective means of promoting sustainable development and reducing poverty than current aid programs. If these new regimes stay in power long enough to improve literacy, health care, and education then they may sufficiently empower the poor in the political system so that poverty reduction becomes self sustaining. But alternatively, it may be that the underlying factors that support liberal regimes and poverty reduction are rooted in historical, cultural and institutional factors that are not affected by new governments. In this case, new liberal regimes will not survive, or they may not implement the basic policies needed to reduce poverty and promote development.

We have analysed why the aggregate supply of development aid decreased so much in the 1990s, focusing in particular on the impact of the end of the Cold War. In a dynamic panel analysis of 17 donor countries, we found that total aid disbursements were positively correlated with the military expenditures of the former Warsaw Pact countries in the 1970s and 1980s, but not in the 1990s. Hence, the end of the Cold War led to cuts in the aid budgets because one important motivation for aid disbursements altogether disappeared. In an analysis of aid allocation among recipient countries, on the other hand, we found that strategically important countries in the 1970s and 1980s – defined as those receiving US military aid during the period – obtained more development aid than comparable countries not only in the 1970s and 1980s, but also in the 1990s. However, disaggregating the data into donor specific allocation patterns revealed a much more scattered outcome, which probably reflects a combination of different donor patterns and the difficulty of coming up with an appropriate measure of strategic motives for the allocation analysis.

As always, a few words of caution are needed when interpreting econometric results. We have throughout the study done our best to control for other potential explanatory variables (in particular those that can be argued to be correlated with military expenditures in the former Eastern Bloc), but, of course, some of the nuances of the decision making process are impossible to capture. In particular, the influence that different donors have on each other, and the influence on political decisions from shifts in public opinion, are likely to be important factors that we can only partially account for. However, there is no strong reason to believe that these factors are particularly highly correlated with our primary variable of interest, so even if our picture is incomplete, there is no reason to believe that the effect of the military threat is seriously biased. The intuitive sense, and robustness of our results throughout different specifications, at least convinces us that we are measuring something real.

The findings from this paper should be put in the context of the current debate about the future of development aid. The conclusions from this study are that the end of the Cold War triggered a substantial reduction in aggregate aid levels, whereas no clear impact on aid allocation could be established. If the ‘war on terrorism’ has a similar effect as the Cold War, then we should expect an increase in aggregate aid flows whereas the effect on aid allocation should be small. A thorough analysis of whether this has happened is beyond the reach of this paper, but some recent evolutions can put this in perspective. Looking at aggregate aid disbursements, US terrorism-related assistance increased on the order of $3.3 billion in fiscal year 2002 (Weiner, 2002). Also after that, pledged aid commitments have increased in several countries. For instance, 15 members of the European Union agreed to substantially increase their aid budgets up to year 2010 at a meeting in Brussels in May 2005 (despite the continents current economic and political problems), and the world’s richest countries pledged another significant increase in aid commitments at the G8 summit in Gleneagles, Scotland, in July of 2005.

On the allocation of aid, the picture is less clear. The Millennium Challenge Account (MCA) announced by President George W. Bush in March 2002 will allocate funding based on objective selection criteria emphasising good governance and sound economic policies, which seems to preclude the option to target strategically important countries. Furthermore, much of the recent focus has been on increasing aid to Africa, and on debt forgiveness and fighting diseases that are not concentrated in what should be expected to be countries of particular importance in the ‘war on terrorism’. But, on the other hand, there are currently substantial aid flows being directed to Iraq and Afghanistan. Furthermore, the Bush administration’s sudden decision in November 2002 to expand the pool of eligible MCA countries to middle income countries (including now strategically important countries such as Jordan, Egypt and Russia), have been seen as a move to reward countries taking sides with the US in the conflict (Brainard, 2003). Finally, as pointed out in Radelet (2002), countries like Egypt and China qualify for MCA assistance under current conditions, despite their histories of wasted aid inflows and human rights deficiencies.

To conclude, the recent history, from the end of the Cold War to the ‘war on terrorism’, has had a fundamental impact on the determinants of foreign aid. Learning from past experiences can thus be important to better understand what the likely effects of current events are going to be. The finding that the drop in aid levels can be attributed to a large extent to the end of the Cold War, should be contrasted with the more positive findings that total aid budgets have become less strategically motivated in the 1990s.

In spite of the Conservatives’ declared impatience with organized interests, the business lobby continues to operate within the ODA [Overseas Development Agency]. The consultation process, an integral part of the political culture, is still very much alive within the ODA, since ingrained habits and conventions die hard in Whitehall. However, the scope of the discussions has been narrowed considerably owing to the designation of ‘no go’ areas in aid policy. The business lobby has to function within the parameters of limits on public spending and the absence of any significant increases in the aid programme. Therefore the business lobby as a whole and its constituent parts have had to develop a modus vivendi within the ODA.

This has not proved too difficult since the inherent tendency in British government has always been to factorize thorny policy issues into manageable units.³¹ The business lobby has continued to cooperate with the government on certain issues and not on others. Nevertheless, since 1979 the interactions of the business lobby with the government has become more fraught with problems than the former would care to admit. One basic problem of the business community is how to criticize the government that they all support without seeming to undermine it. In theory the commercial interests are in full agreement with it about the need for free trade and unfettered competition in the world market. Yet in practice it continues to look for generous subsidies and other concessions in order to penetrate or retrain a share of developing country markets.

The business lobby has been able to capitalize upon the government’s 1980 aim of reorienting aid policy by giving more weight in the allocation process to commercial and industrial considerations. However, this has not granted the business lobby unfettered access to the aid budget, for several reasons. Incrementalism in government, which allows competing viewpoints to be accommodated, persists. Pledges and forward commitments inherited by the Conservatives have also acted as a brake on the plans of the business lobby. In their first term the Conservatives tried to involve the private sector more fully in the overseas aid programme through joint ODA-CBI [Confederation of British Industry] seminars, but these efforts were gently deflected by the business lobby. British business interests have always considered overseas aid as primarily a governmental activity, preferring to concentrate on lobby specific issues such as an increase in the ATP [Aid and Trade Provision] and better gearing costs for firms.

It is the author’s contention that the relative success enjoyed by business interests in winning concessions from the government owes as much to the reorientation of aid policy since 1980 as to the skill and influence of the lobby itself. The fact that commercial and industrial considerations were made explicit criteria for aid giving allowed the DTI [Department of Trade and Industry] – a powerful backer of the business lobby – more of a voice in the allocation process. In fact the ODA’s departmental ethos, which has always shown a strong bias towards money-moving through large capital-intensive projects, has been legitimized even further under the Conservatives.

This rare convergence of interests between politicians, the civil service and the business lobby has allowed business interests to make gains where they can, but still within the limits imposed by government policy.

Bressand, Albert (1982), “Rich Country Interests and Third World Development: France,” in Cassen, Robert, Jolly, Richard, Sewell, John, and Wood, Robert (eds.) Rich Country Interests and Third World Development, pp. 307-332, London: Croom Helm.

An analysis of French objectives and performance in relations with the Third World can therefore contribute, at least in the view of the author, to explaining the paradox of France’s actual or would-be distinctiveness.

It is clear that, when analyzed in World Bank English, French policies are only marginally different, in either their strengths or their weaknesses, from those of other countries. As the point is made below even when it comes to geographical emphasis, French trade policy is no longer characterized by the ‘chasses gardées’ mentality of the colonial period. The French Franc zone is no longer a special and major trading partner. Whatever yardstick is chosen to measure it (i.e. including or excluding some or all overseas provinces), the French aid effort is at most slightly above OECD averages and at best ten per cent short of the internationally agreed target of 0.7 per cent of GNP, neither disreputable nor an exceptional achievement. French positions on the standard NIEO [New International Economic Order] issues, as expressed in UN Resolutions, have been on the whole marginally more forthcoming than those of other major Western countries, even if on some particular issues, other countries take a more ‘progressive’ position when they have the will and the financial means to do so, as was the case for Germany on the debt cancellations.

French distinctiveness lies elsewhere, and can only be understood if one broadens the analytical framework. It is to be found in the deeper emotional reactions, which Third World causes have evoked, under varying forms, among the French intelligentsia and political class. It is to be found in the more explicit recognition of the political and security dimensions of North-South relations. And it is to be found also in the way in which the ‘standard’ development co-operation and economic relations are managed (notably in terms of bilateral/multilateral and geographic emphasis) to take into account this broader context as well as the increasingly crucial issues related to the dialogue on energy.

Is this overall policy posture likely to be adapted to the needs of the 1980s? Contrary to the reluctance with which many specialists in the pure science of economics tend to view political factors, the present author believes that this association is likely to be more and more called for by the international environment. To view countries such as Saudi Arabia, Brazil, Mexico, Algeria, not to mention China or Cuba, only as economic actors or even more narrowly, only as outlets for manufactured goods, is to ignore the nature of international relations. The special circumstances which prevailed after the Second World War and the fact that some of the most successful ‘developing nations’ of the time (Japan and, later, Korea) had little political room for maneuver have made it possible for economists to take the political and security framework for granted and therefore to think in terms of what appeared as ‘depoliticized’ economic relations. But in an increasingly multipolar world, a country like France needs to perceive developing countries as political actors as well and to accept the consequences of that perception. Mexican or Brazilian trade barriers, the new role of investment as a precondition or even substitute for direct exports, are political as well as economic facts understandable only as the expression of global national development objectives.

It so happens that the French attitude towards the developing world, although it evolved in part as a way to cope with the decolonization problem and in the context of East-West rather than North-South diplomacy is able to encompass a global approach more easily than purely economic approaches.

This is certainly not to say that, in its concrete expression, this approach is necessarily well adapted to the present context. On the contrary, French policies have tended to display rigidities which suggest that a regular process of reassessment will be needed.

Among the numerous issues which would have to be addressed, three seem to be of paramount importance:

(1) the human aspects of relations, both in terms of the presence of French expatriates in the Third World and of the presence of migrant workers in France;

(2) the geographical emphasis of the various aspects of French policy; and

(3) the concrete translation into practical policies of the slogans of industrial restructuring (‘redéploiement industriel’) and ‘organized trade expansion’ which so far have provided little more than a conceptual framework for the French search for a new role in the world economic order.

(Not addressed here because it would deserve a separate essay in a global European perspective, European co-operation must have a major impact on French policy formulation, notably on the last two of these issues.)

Although there are about 1.5 million French people living in foreign countries, including 400,000 whom French consulates are aware of as living permanently or temporarily in the Third World, French companies find it extremely difficult to recruit enough personnel to develop their presence overseas. The reluctance to expatriate oneself seems decidedly greater in France than in other Western countries. Hence the very high (and even, in the light of growing Indian and Korean competition, extravagant) price tag of French expertise. The creation, within the Foreign Ministry of a ‘Direction de Français de l’Etranger’ illustrated the growing realization of the importance of this problem. But much more would be needed as part of a global employment policy. One should note in particular that while there are more than 40,000 French people living in Ivory Coast, there are only 24,000 in the whole of Asia and 47,000 in Latin America.

At the same time the presence in France of 1.8 million migrant workers (two-thirds of whom come from the Third World) and of a total migrant population of 4 million has become a domestic political issue. The new socialist government will have to find a war to remain faithful to its commitment to put an end to the policies of the previous government (which combined financial incentives for departing migrants with a heavy-handed policy on illegal immigration) while pursuing its goal of reducing domestic unemployment.

(b) The geographical emphasis of relations with the Third World will also present French decision-makers with difficult choices. Many foreign observers have described these relations as organized around three circles:

(1) the inner circle of black African countries which participate in the annual ‘Conference Franco-Africaine’, recently set up as a small-scale replica of Commonwealth meeting, and which receive the bulk of the development co-operation efforts;

(2) a second circle consisting of the other African countries as well as Caribbean, Pacific and Mediterranean countries to which the EEC Lomé Convention and ‘global Mediterranean policy’ address themselves; and

(3) a third circle defined negatively as the ‘non-associate’ LDCs which have no preferential agreement links to France either directly or through the EEC.

This view is of course not deprived of factual bases and can even be considered as a rough approximation of the institutional setting for the French development cooperation policy. Similarly after more than one century of colonial involvement, French political relations with the Third World cannot be but influenced by historical factors. Yet it would be a mistake to extrapolate to the economic level this political fact-of-life and to conclude hastily that French economic relations with the Third World are organized around the preservation of protected markets (‘chasses gardées’). This would ignore a major reorientation which has brought the share of the French Franc Zone in total French exports from about one-third per cent in the early 1960s to five per cent in 1978. Similarly the importance of the Zone in terms of French currency holdings has almost vanished although the Zone continues to represent an element of stability and solvency for the African member countries. An economic explanation of French security concerns in Africa would likewise overlook the relative independence of political and economic factors in French policy. France had indeed very little economic interest to protect in Shaba where its investments are 40 times smaller than those of Belgium and ten times smaller than those of America. Even its imports of cobalt come from Morocco and not Zaire.

Nevertheless, a clear weakness is the insufficiency of the French presence in the more advanced countries. Steps have been taken to correct this situation such as the funding of 300 fellowships a year for students of a dozen rapidly industrializing countries, the signing of a significant oil deal with Mexico and numerous presidential and ministerial official trips to such countries. Yet American financial flows towards the seven most advanced LDCs were 35 times higher in 1975 than similar flows of French origin while they were 12 times lower in the case of French-speaking Africa. Germany, with financial flows to the seven most advanced LDCs six times higher than France, has also clearly taken a lead of major economic significance. Obviously, France cannot allow, without risk, its ‘portfolio’ of interests in the Third World to remain so much out of balance with the intrinsic importance of the countries considered.

Objective and subjective reasons therefore explain why the French government, even at the time when the emphasis was put on adjusting to free market forces, has been more sensitive to the need to keep the pace of the adjustment process within socially and politically acceptable limits. Hence its emphasis on the need to ‘organize’ the expansion of trade, a concern to which the new government will probably give a more systematic expression.

Understandable as it can be in the French context, this policy does however raise considerable implementation problems. The translation into German and English of the slogan ‘libéralisme ogranisé’ under which it has (imprudently) first been presented has an Orwellian ‘double-think’ flavor which has aroused little sympathy. Aside from the Multi-fibre Agreement, few concrete expression of this policy have justified so far the political cost of a conceptual attitude which other Western countries have often quietly put in practice while reasserting very loudly their commitment to liberalism.

On this issue as on many other ones, France is therefore confronted with the difficult search for a synthesis between the distinctiveness that results from the French way of looking at the world and the need to take increasingly into account the common constraints of interdependence.