Foreign Aid as an Instrument for Poverty Reduction
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Published: Thu, 15 Mar 2018
This essay reviews background literature on economic and political dimensions of foreign aid as an instrument for poverty reduction in Ghana. To fully grasp the causal conditions of aid and its motivations, a political economy perspective is reviewed. This directly feed into how foreign aid has flowed into Ghana, here we explore how the country has absorbed and used foreign aid. In the final section we critically analysis the literature on studies on aid effectiveness linking it with progress made towards the achievement of the Millennium Development goals (MDGs) as adopted in fighting poverty in Ghana. Our conclusion will highlight the relevance of this review to the study of how foreign aid flows reduce poverty.
Political economy perspective of foreign aid
According to Schraeder et al. (1998) the political economy perspective treats aid as a policy action of donors, explained by political and economic goals which are influenced by culture, institutions, power distribution and the dynamics of competing interests. Donors’ goals are varied and include national self-interest, commercial considerations, historical links, political goals and the desire to accelerate economic growth in developing countries but vary over time and among donors (Riddell, 1987). For example as Hopkins (2000) explains economic gains seem important in Japanese aid, political goals in French aid while global welfare improvement are the aim of Nordic aid. As world political conditions change, both the size and purpose of foreign aid change.
Until 1990, cold war concerns provided a core motivation for aid with economic development only a secondary concern (Grant and Nijman 1998). Over time though this changed to focus on international public goods such as political stability, seeking best package of long-term reduction in political crises and better future economic growth among states too risky for private sector funds To achieve these goals however, donors and recipients of foreign aid set terms (conditions) through bargaining (Putnam 1988). The subsequent analysis will explore the interactions of these public goods and how they influence aid conditions.
As Noel and Therien (1995) reiterate the institutionalisation of foreign aid occurred after the Second World War, during which period strategic political considerations were the major force shaping aid allocations especially bilateral aid (Wood 1986 and Ruttan 1996). These objectives changed following the demise of the United States as a hegemonic donor. For example US aid as a percent of GNP, dropped from over 2 per cent in 1950, to about 0.6 per cent in 1960-2, and only 0.08 per cent in 1997(Hopkins, 2000). With the role of the US diminishing, multilateral agencies like the World Bank and UNDP stepped in to facilitate co-ordination in aid administration, while the Development Assistance Committee (DAC) of the Organization for Economic Cooperation and Development (OECD) encouraged more generous giving among its member countries.
With active involvement of multilateral agencies the period between 1960 and 1992 saw an increase in the amount of official development assistance even after accounting for inflation. The important point is that aid during this period centred more on impoverished countries in Africa. Equitable development and economic reform were the main goals of donors. After 1991, though the flow of aid peaked and started to decline (Hopkin, 2000). This decline was due to the end of the cold war, globalisation of trade, budget pressures of donors, donors’ disappointment with the effectiveness of aid. Moreover, donor country special interest coalitions supporting aid unravelled and resurgent neo-liberal philosophies challenged some of the intellectual foundations of aid. For the purposes of this review we focus on how donors’ disappointment with performance caused decline in aid flows.
Otherwise known as ‘aid fatigue’, this reason is understood as lack of satisfaction of donors with the working of aid especially in Africa during the 1980s. This poor performance in Africa has been blamed on donors’ parochial political and commercial interests as well as capture by domestic publics and elites. These failures gave critics of aid credence against the backdrop of massive accumulation of failed aid projects (Burnside and Dollar, 1997). For example, dependency theorists claim that aid was really provided in order to exploit recipient countries, with the effect been slow economic development (Amin 1973 and Seligson and Passe-Smith 1998). In general, flaws in donor motivation, bureaucratic mismanagement and recipient country socio-political distortion of aid objectives were identified as major causes of project failure.
The allocation and absorption of aid according to non-economic factors greatly undermined its desired impact on development. Although Lumsdaine (1993) suggest altruistic motivation during this period, other studies suggest that this was only a secondary motive (Alesina and Dollar 1998, Noel and Therien 1995, White 1974 and Wall 1973). They conclude that most aid was given for political reasons. For example, political motivations as distorting aid effectiveness were a frequent conclusion in several economic analyses (Alesina and Dollar, 1998). Donors resisted broad aid objectives but tied success to adaptive project objectives which invariably limited the prospects of aid for accelerating development. In order to realign objectives for example, Lancaster (1999) propose an amendment of greater country targeting, capacity building and improvement of bureaucratic management for achieving greater aid effectiveness in support of economic performance. The preceding analysis sets a tone for understanding how foreign aid has flowed to Ghana. This is discussed next focusing on the kinds and forms of aid flows.
Foreign aid profile of Ghana
Earlier, we examined the political economy of aid architecture and how this impacted on disbursement and utilisation in the developing world. Our attention now shifts to aid flows in Ghana, showing how geopolitics of aid during the cold war influenced absorption and usage.
Ghana after independence in 1957 inherited substantial foreign exchange reserves, little debt, and a small public sector. With good economic climate, there was very little need of foreign support until 1961 when the country was hit with balance-of-payments crisis (Killick 1978; Harrigan and Younger 2000; Quartey 2002). In response to this balance-of-payments crisis the country devalued its currency and pursued a prudent fiscal budget at the urging of multilateral aid agencies. These reforms attracted foreign support which came in the form of general budgetary support, sector budget support (mainly health and education), and project aid. Aid inflows, however declined during the first half of the 1970s, picking up only during second half. For example, official development assistance (ODA) as a share of GDP increased from 0.013 per cent in 1974 to 0.023 in 1978. However to put this in perspective, between 1960 and 1983, per capita ODA to Ghana was about $10 which was less than the per capita ODA to the rest of sub-Saharan Africa. However, aid per capita increased from US$9.3 in 1983 to US$ 56.4 in 1991 but then declined to US$33.1 by 2001 and increasing again to US$66.4 by 2009(see figure 2).
Source: World Development indicators & Global Development Finance (World Bank)
Harrigan and Younger (2000), give three reasons for aid increase after 1983. They explain that, the East and Western allies of the developed world were competing for Africa’s loyalty in the post-independence period when most African states began to distance themselves from their colonial powers. Moreover, most donors realized the severity of poverty in Africa relative to other developing countries and responded with more foreign assistance and finally, the development community shifted from the emphasis of growth as a panacea for poverty reduction towards a more interventionist approach.
According to Aryeetey et al. (2005) aid to Ghana remained at less than 5% of GNP until 1985 when aid flow began to climb steadily. They argue that, aid/GNP ratio first peaked in 1989 at about 14% and then again in 1991 at a slightly higher level, the average in SSA (sub-Sahara Africa) which was about 10%. At its peak in 1991, net ODA per capita was about $60, compared to about $40 for sub-Saharan Africa (see figure 1). However, Ghana experienced a dip in aid flow in 1990 (reaching $566 million) and this according to Aryeetey et al. (2005) signalled signs of tension between Ghana and its donors as the country struggled to achieve various benchmarks in policy reforms.
There was a sudden rise in aid in 1991 and this according to Aryeetey et al. (2005) was intended to support economic growth which had stalled in 1990 and also for political reforms which was being actively encouraged by donors who felt obliged to support the institutional changes underway in the country. As explained, Ghana warmed up to aid slowly due to political reasons but by 1980s aid flow to Ghana surpassed the average for most African countries as a share of the economy but then it began to decline as in other parts of the region in the 1990s (see figure 1&2). For example, bilateral aid from Japan during the reform period of the 1980s, grew steadily as a share of gross disbursements however, aid from the US showed a lot of volatility as a share of gross disbursements. By 2009, the top ten donors of gross ODA to Ghana were IDA, United Kingdom, EU Institutions, United States, Netherlands AfDf, Canada, Denmark, Germany and France (OECD, World Bank, 2010) (see figure 3)
Source: World Development indicators & Global Development Finance (World Bank)
To deepen our understanding of the significance of aid in Ghana, we explore its impact on government expenditure, trade and capital formation. The ratio of aid to government expenditure increased from 11.3% to 98.6% in 1989, but has since declined to less than 34% in 2008 (World Development indicators 2010) (see figure 4).
Aid inflows has accounted for significant proportions of Ghana’s imports since 1983. It accounted for 15.6% of imports of goods and services in 1982 increasing to 50.9% in 1989. Although aid as a percentage of imports have declined since then, it still accounts for a significant proportion of imports of goods and services – about 14.15% in 2009 (see figure 5). The proportion of aid in capital formation has also declined in recent years but remains significant. Between 1990 and 1996, aid as a percentage of capital formation averaged 56.7% and over the period 1997-2001 it had declined to 42.0% (see figure 6).
Source: World Development indicators & Global Development Finance (World Bank)
These ratios clearly indicate that external aid formed significant part of government expenditures, particularly on fixed capital formation. In terms of the allocation of bilateral aid, the sector that saw the steadiest rise was social infrastructure. Aryeetey and Cox (1997) indicate that support for economic infrastructure began to grow more rapidly in the mid-1980s and this reflected an increasing significance of Japanese aid channelled to the roads and energy sectors remaining higher than in the rest of sub-Saharan Africa. It began to decline at the end of the 1980s, as bilateral agencies began to rely on multilateral agencies for delivering program assistance. Aryeetey and Cox (1997) argue that total bilateral aid again began to rise faster than multilateral aid after 1991 because of a shift in donor preferences in channelling aid to pursue specific project initiatives with direct observable impacts. By the end of the decade, some 12% of total ODA was in the form of technical cooperation (Aryeetey and Cox 1997).
Leechor (1994) claims that foreign aid has served largely to facilitate policy change in Ghana; for example, he argued that in the absence of foreign aid the structural adjustment program (SAP) initiated in the 1980s would have been far modest. However, Tsikata (2001) has indicated that despite the considerable policy changes that Ghana undertook in the 1980s, the increase in aid did not match the quality and extent of policy reforms. As concurred by Collier and Dollar (2001), aid flows to Africa have not been necessarily tied to sound policies in recipient countries. As revealed by Devarajan et al. (2001), some bad policy countries remained major aid recipients. Here, the issue is how has aid been effective in achieving developmental objectives in Ghana. A review of the literature on aid effectiveness will highlight an inconclusive evidence of aid utilisation especially in achieving the millennium development goals (MDGs) as adopted for fighting poverty in most developing countries.
Studies on Aid Effectiveness
The theoretical arguments of aid were established in the mid to late 1950s when Harrod and Domar introduced the assumption of fixed capital-output ratio to Keynes’ short-run aggregate demand functioninto a long-term dynamic model making it susceptible to policy influence. However, the question of whether aid improves GDP growth is traced to the two-gap model (Chenery and Strout, 1966), which remains the most influential theoretical underpinning of the aid effectiveness literature. In this model, developing countries face constraints on savings and export earnings that hamper investment and economic growth. Aid as argued by Chenery and Strout, relieve bottlenecks inhibiting domestic growth and development thereby increasing the efficiency of domestic resource base under right conditions.
Even though this model has been the target of severe criticism almost since its inception, it has provided the underlying principles for early aid policies (Easterly, 1999). Most early researchers conclude that aid had no significant impact on growth, savings or investment. Aid they conclude, increase unproductive public consumption (Mosley and others, 1992) and fail to promote investment. Boone (1996) and Reichel (1995) for example, found a negative relationship between savings and aid pointing to a substitution effect. However, implicitly, foreign aid where thought to be beneficial in other respects, for example, by improving the lot of the poorer population segments in receiving countries. It is argued that aid may help to alleviate poverty and equalize income distribution, without necessarily having a discernible average growth effect.
For example, Hadjimichael (1995) note that the relationship between aid and domestic savings may be negative in most countries, but positive for good adjusters. Qualifying the above statement, Burnside and Dollar (2000), argue that aid can promote growth in countries with good institutions. However Easterly (2003), Easterly et al. (2004), and Rajan and Subramanian (2008), counter argue that evidence of any effect of aid on growth is spurious, even when institutional quality were high but their results have been challenged as being “extremely data dependent” suffering from a possible endogeneity problem (Dalgaard and Hansen, 2001, Clemens, Radelet and Bhavnani, 2004).
Empirical evidence in the aid effectiveness debate at best remains inconclusive and this has been attributed to misallocation of aid (donors give aid for strategic reasons to the wrong recipients), misuse (recipient governments pursue non-developmental agendas) and the fact that GDP growth may not be the right measure of aid effectiveness. Firstly, while most aid effectiveness papers implicitly define the donors’ objective as promoting development, a parallel strand of literature on aid allocation has shown that most donors often pursue a different underlying agenda and allocate aid on strategic interest (Boone, 1996). If a significant part of aid is allocated for strategic purposes, no positive impact in terms of growth or poverty alleviation can be expected.
Moreover, the assumption that recipient government share the donor’s officially altruistic objective may not be true after all. As argued by Svensson (2000) and Murshed and Sen (1995), a recipient government and a perfectly altruistic donor can have conflicting objectives, as the former represents a variety of stakeholders, including wealthy individuals who might influence aid distribution. If foreign aid is misallocated and misused, then it cannot be expected to have a significant impact on growth. Finally, as suggested by Boone (1996), aid effectiveness should not be measured by its impact on GDP growth. Aid could be increasing consumption rather than investment, which would explain the disappointing results of studies on growth, but still reduce poverty through either “higher consumption of the poor or greater provision of services to the poor.” For example, Boone (1996) found a positive impact of aid on changes in basic indicators of human development such as infant mortality, primary schooling ratios, and life expectancy in the MDGs.
Linking literature to study
Up to this point, our analysis has tried to establish, how foreign aid has evolved over the years with specific reference to developing countries. Depictions of how aid has been absorb and utilized in Ghana was made. In addition a bleak picture of the aid debate has been established to demonstrate the complexities surrounding such studies. To concretise our study of the impact of foreign aid flows to poverty reduction in Ghana, however we focus on two selected human development indicators whose improvement is part of the MDGs which are the infant mortality and adult illiteracy. We choose these indicators for the following reasons: (i) health and education indicators are more concrete measures of poverty as indicated by Boone (1996) and Masud and Yontcheva (2005). They argue that infant mortality indicators respond quickly to improved health services and can therefore be considered as “flash indicators of improvement in the conditions of the poor”.
To identify other variables that could be determinants of infant mortality and illiteracy, we will follow Caldwell (1986) and Dreze and Sen (1989), as well as Gupta et al. (2003), for evidence on improvement of human development indicators and on the success of health and education programs. For infant mortality, besides testing for bilateral and nongovernmental aid, we will control for the level of development represented by per capita GDP, the poverty headcount, the level of rural development, as indicated by per worker agricultural value added, and female illiteracy. We assess the impact of government efforts in reducing infant mortality represented by the per capita health expenditure.
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