Foreign Aid And Economic Growth In Haiti Economics Essay

Most literatures focused on the determinants of economic growth in developing countries is based on cross- country analysis and thus yield some patterns that hold on average. This paper is engaging; because it focuses mainly on the determinants of growth in Haiti, with emphasis on aid, it states the possibilities of achieving economic growth and stability in the Haitian economy.

By applying the standard neoclassical growth model, using variables: (aid, openness of trade, FDI& Population) similar to that of the model, with a multivariate approach, I estimated using time-series data techniques over a period of 1980-2007. The econometric results support the view that foreign aid has a negative impact on growth.

According to the paper, although the political charged question: “aid relations to growth” in many cases is plausible, in literature it is far from settled, therefore in the long run, without the presence of sound macro-economic policies, excess supply of aid, could lead to moral hazards as a stable macro-economic policy is very essential for the prospects of development in any undeveloped/ developing country e.g. Haiti.

Chapter 1: Introduction

1.1: Background

Foreign aid is usually associated with official development assistance, which in turn is a subset of the official development finance, and normally targeted at the poorest countries (World Bank 1998).

How does foreign aid affect the economic growth of developing countries e.g. Haiti? This question has drawn the attention of many scholars over time. Papanek (1973) found a positive relationship between aid and growth. Fayissa and El-Kaissy (1999) show that aid positively affects economic growth in developing countries. Singh (1985) also finds evidence that foreign aid has positive and strong effects on growth without government intervention. Snyder (1993) also shows a positive relation between aid and growth when taking country size into account. Burnside and Dollar (1997) claim that aid works well in the good-policy environment, which has important policy implications for donors community, multilateral aid agencies and policymakers in recipient countries. Developing countries with sound policies and high-quality public institutions have grown faster than those without them, 2.7% per capita GDP and 0.5% per capita GDP respectively. One percent of GDP in assistance normally translates to a sustained increase in growth of 0.5% per capita. Some countries with sound policies received only small amount of aid yet still achieved 2.2% per capita growth. The good-management, high-aid groups grew much faster, at 3.7% per capita GDP (World Bank, 1998).

By contrast, other scholars have found foreign aid to be negatively correlated with growth. Knack (2000) argues that high level of aid weakens institutional quality, increases corruption and rent seeking, therefore negatively affect growth. Levine, Easterly and Roodman (2003), using a larger sample size to re-examine the works of Burnside and Dollar, find that the results are not as robust as before. Gong and Zhou (2001) shows a negative relationship between aid and growth.

Conclusively, the relationship between aid and economic growth remains inconclusive and has to be studied further. In addition to that, is the trade openness which is found to be influential on economic growth but so far this factor has been neglected in many growth analyses.

Research objective: Does foreign aid encourage or discourage growth in Haiti? The purpose of the research conducted, is to see the correlation of foreign aid and growth in Haiti. By taking an annual data: dependent variable: GDP, . I tested the significance of the relationship between aid and growth by running a multiple regression,

Organisation of the study: Firstly, I introduced my topic in chapter one, in chapter two is my literature review, methodology in chapter three, Model specification and analyses in chapter 4, limitations and conclusion in chapter five.

Chapter 2: Literature Review

Many empirical studies have used econometric analysis to test the relationship between aid and growth at the macro level, complemented by case study evidence at the project levels e.g. (Cassen et al 1986) on micro-based evaluations have indicated that in most cases aid works But on the macro-level, with ambiguous results: it failed to capture the significant growth effect. This conflict is what was described by (Mosley1987) as the micro-macro paradox. His findings states claims that it is impossible to establish any significant correlation between aid and growth rate of GNP in any developing country.

Furthermore, in other to compute aid as a growth determinant, it is important that it is included within a robustly specified empirical growth model: the “two gap” approach by Chenery & Strout (1966) model. The gap referred to in the model is the differences between (I) domestic savings and the necessary level of investment to achieve a certain rate of growth, (II) foreign exchange receipts and the level of imports required to reach a certain level of production. Both gaps are the ex ante sense and most be consistent within the target growth rate of output. The essence of the two-gap approach lies within the determinant of the amount of foreign aid essential for the target growth rate of output from the point of view of the welfare implications. However the targeted growth rate needs to be consistent and must be indomitable in a social welfare maximising manner. Furthermore Chenery & strout empirically and theoretically made an extensive study on foreign aid and growth from the two-gap approach point of view incorporating the analysis of absorptive capacity limit. Their results states that most of the developing countries would pass through 3 phases where: (1) the absorptive capacity limit and one of the two gaps are effective (2) the investment saving gap is dominant (3) the import-export gap is dominant.

But recently in a series of papers, Chatterjee et al (2003) and Chatterjee and turnovsky (2007) have developed a general equilibrium endogenous growth framework within which the dynamic effects of aid can be analyzed. This analysis suggests that the positive impact of aid depends crucially on (I) The recipient’s structural conditions, as embodied by the input flexibility of the production sector, access to capital markets, size of the government, and the choice between labour and leisure, (II) The restriction imposed by the donor on how aid must be spent, and (III) the duration of the aid program.

Furthermore into the empirical studies of aid on growth, I revisited this relationship to shed some light on the current policy debate on the management of aid flows. This however came up with a range of answers for the relationship between aid and growth. On the positive side of aid and growth relationship was Singh (1985) whose analysis obtained a positive and significant impact in aid on growth. Also according to the (World Bank, 1990) review, it states that the effectiveness of capital flows and investments will be greater when there is macroeconomic stability and few distortions. Meaning in other for aid to be effective in any failing or failed state, measures for macroeconomic stabilisation is mandatory. Additionally into more recent literatures were: Burnside and dollar (2000), Burnside and Dollar (2004), Collier and Dollar (2002) with findings that aid efficacy is closely related to the macroeconomic, fiscal and trade policies followed by the country in question.

Some recent literatures also entail arguments against the prior claims of aid on growth effectiveness. Example Bonne (1996) with his findings conveying the fact that aid seems to finance consumption rather than boosting growth in the recipient countries. Thus foreign aid is largely ineffective. Furthermore was Lensink and White (1999), Mcpherson (2000), Lu and Ram (2001), Hansen and Tarp (2001), Akhard and Gupta (2002), Dayton-Johnson and Hoddinott (2003), Eaterly et al (2004) and Dalgaard and Hanseen (2005). However their claims on statistical grounds rival the initial claim and thus generate evidence in favour of the hypothesis that aid raises growth regardless of the quality of the policy environment.

Now, looking into the importance of the applied variables, it is important to understand that aid is a very important source of financing for public investment whilst import and export is included to capture the value of trade openness for imported and exported goods in Haiti.

Additionally, by applying similar variables as the neoclassical model, because of its simplicity and flexibility in identifying the core determinants of long-run growth, (Rodrik, 2003b) on the other hand, advocates of endogenous models praise this approach for incorporating policy and institutional factors and for endogenising technological progress.

The endogenous growth theories have helped strengthen the power of the neoclassical model: one of the empirical works that demonstrated the explanatory power of the neoclassical model’ (Barro. 1996:2) with emphasis on investment as a core variable. The endogenous growth theories delegate an important role to investment both in the short and long run: Investment on the other hand was identified as a key determinant by Levine and Renelt (1992) and Sala-i-Martin (1997). But taking into consideration that high investment ratios do not necessarily lead to rapid economic growth; the quality of investment, existence of appropriate policy, productivity, political and social infrastructure are all determinants of the effectiveness of investment (Hall and Jones, 1999; Fafchamps, 2000; Artadi and Sala-i-Martin 2003). Public investments provide necessary infrastructures, while private investment is frequently seen as the engine that drives a country’s economy. These two forms of investment are both related as public investment itself affects growth either directly, via its productivity, or indirectly via its effect on private investment. In other to create positive externalities and to improve private investment, public investment itself in human capital (education and health), law and order, research and development, and social economical and infrastructures is very essential in any economy. Thus one would expect a positive correlation between public investment and economic growth. (Barro, 1991, 1996, 2003; Artadi and sala-i-Martin, 2003).

The issue against the prior claim of investment and growth is explained by the three gaps model which identifies the constraints to growth. The gaps explained by the model are: I) Savings gap, II) Trade balance gap and III) Fiscal gap. These gaps have to be filled by foreign aid to enable growth. Now looking at the poorest countries with Haiti on the first thought, they have inadequate level of savings and foreign aid acts as a supplement to domestic savings, which is needed to finance investment. However, in the prior paragraph, the claim would assume that all foreign aid will have to be allocated for investment purposes. This in reality is not case for a poor country like Haiti as aid is also given for: (1) humanitarian purposes, 2) supplement for export earning to import capital goods and 3) finally as a revenue raising assistance to cover the desired level of public investment. However despite the objectives of aid being identified in theoretical based models, recent studies especially on poor countries with Haiti on the league have been unable to provide an appropriate answer to whether aid promotes growth.

Furthermore, in other to address the issues behind aid on growth effectiveness in the Haitian economy, I started by understanding the nature of its economy.

History of the Haitian economic status and aid effectiveness

The Island Haiti with a population of 8million people in an extreme case has received billions in foreign assistance yet remains dysfunctional and impoverished. As a result, it has been considered as one of the poorest countries with an insignificant growth rate in decades. Indicators convey this as due to its violent, corrupt, lack of transparency and instability nature. Furthermore, in other to understand why foreign aid to Haiti has failed and to make any structural adjustments, we should understand the economic, societal and environment degradation problems faced by the Haitians.

According to the UN human development index (HDI), Haiti is ranked as the 153rd least developed out of 177 countries. An estimated three-fourth of its population live on less than $2 a day causing half of the population lack of access to even portable water. It was also estimated that only 10% of the population have electrical services of which in any country’s prospects to development, electrical supply is very essential in attracting investments. Additionally, an estimated 95% of employment in Haiti is underground denoting that there is 95% of invaded employment tax. Also with an estimated 80% of businesses operating in the urban areas are off the books and about 66% of the country’s wealth is owned and controlled by only 4% of the population, with unemployment rate has reaching its high at about 70%.

The critical environmental state in Haiti resulted to its ranking by Yale University’s Environmental Sustainability index as the 141st out of 155.This has been because of its high level of deforestation caused by excessive wood harvesting by private companies for energy. The deforestation irony in Haiti has made it prone to chronic disasters. In 2004 tropical storm Jeanne caused property damages at 3.5% GDP.

On the verge of trying to understand the failure of foreign aid in Haiti, we should also analyse the corruption rate, transparency & accountability, Government size, judiciary power, lack of long term investments and Maintenance:

Corruption: In 2009 Ti ranked Haiti as the 158 out of 180 most corrupt countries. This reputation of a highly corrupt nation erodes the trust from donors therefore causing a draw back on the level of aid required for measures necessary for economic growth.

Transparency and accountability: The lack of transparency and accountability in Haiti ironically is considered as part of the reasons to why foreign aid has failed. As a result of corruption in every level of the Haitian government and institutions, transparency in several contracts on projects from donors is lacking thus causing a daunting prospect of foreign aid leading to prosperity in Haiti. In other for Haitians to solve the problem of transparency and accountability, according to the transparency international on Haiti, empowerment of organisations e.g. La Fondation pour Héritage Haïti that protect the interest of the country and the people is very essential in other the improve transparency and accountability.

Government size: The political instability and power struggle between political parties generate lack of cooperation which in turn leads to riots and rallies that could result in the destruction of government infrastructures and increase crime rate in Haiti. This therefore could be identified as a reason to the failure of foreign aid to Haiti. In other for the Haitians to succeed in achieving a decent level of growth, the electoral sector should initiate a fair and unbiased election process where candidates from any political party are voted for and elected on the basis of their level of accountability to the people and the country and not otherwise.

Judiciary independence: The judicial system of any country on a verge for progress and openness has to be an independent body of its own, away from been controlled, manipulated and financed directly by the government. This ironically in Haiti the opposite is the case as legislative power is vested in both the government and the two chambers of national assembly in Haiti. Also with the lack of power, modern facilities and standard judicial institutions, offenders cannot be held and brought to justice for breaking the law. This therefore poses a threat to donor confidence in a Haiti. Conclusively, judiciary independence and empowerment in Haiti will decrease the level of crime and criminals in the government thus increasing donor and investor confidence in Haiti.

Lack of long term investment: It is very important for Haiti to invest every financial aid from donors wisely in other to secure a safe and sound investment in the long and not just the short term.

Maintenance: The lack of maintenance on donor financed projects in Haiti could be stated as an underlying reason to the failure in foreign aid. The lack of incentives to maintain and invest as future poverty and destruction will call forth future aid which is a classic “Samaritan’s dilemma”:

Finally Haiti also suffers from brain-drain by day as the situation gets worse. Estimates shows that four-fifth of the college educated Haitians live outside the country. Causing the large hopeless uneducated population to emigrate to different countries in search of a better life. The prior features in conjunction with poor governance, failure from donors caused by the complexity of aid administration and lack of supervisions on projects has caused foreign aid to fail in Haiti.

The implication of foreign aid failing in Haiti has a detrimental effect on the growth prospects of the Haitian economy as mentioned earlier, Haiti is very much dependant on foreign aid for sustenance. As a result of the motive to aid failures in Haiti as mentioned in the paragraphs prior to this, the Haitian government is obliged to address the issues in its weak institutions amicably so as to use aid to channel the economy to a state of self sustenance.

HAITI AND HOPE AFTER NATURAL DISASTER:

Haiti in the past has suffered from series of natural disasters which has caused a disturbing disruption in the growth of the Haitian economy and the effectiveness of foreign aid in Haiti. Example: the 2004 flooding affecting over 200,000 people with a recorded 600 deaths. This horrifying tragedy cost a Haitians a whopping 3% of their GDP causing further threats increase in the level of poverty thus calling forth more future aid. Moving on to a more recent event was the case of the devastating 7.0 magnitude earthquake in January 2010 putting the Haitian capital port-au-prince in shamble with a record of over 250,000 deaths and over a million people displaced this event is second only to the shaanxi earthquake in china (1556) with over 800,000 people perished.

Haiti in the past has faced several natural disturbing tragedies but compared to the recent disaster in January 2010, Haiti has been left with an enormous challenge of rebuilding its nation as the earthquake ravaged the capital city causing a break of violence and upheavals as many are displaced with no access to basic amenities and medications to the wounded. This disturbing incident brought Haiti to the spotlight of a country desperately in need of foreign assistance.

The situation in Haiti has raised concerns of what could become of the nation after the devastating earthquake. With many homes, individuals and institutions destroyed the threat raised as a result of lack of resources can be thoroughly analysed using the Malthusian catastrophe. According to the traditional Malthusian theory, if a country’s population exceeds its resource limits, the nation will fall into a poverty trap, referred to as to Malthusian catastrophe, since it can no longer sustain itself.

Population growth is assumed to be exponentially growing whilst resources are assumed to grow in arithmetic progression yielding both a non linear and linear model respectively.

Furthermore, the model predicts that if populations goes unchecked for a prolonged period of time and holds a growth rate greater than 1.0, the exponential growth of the population will surpass the linear growth of resources leading to the Malthusian catastrophe, hence, poverty remains. Thus there will still be need for aid from donors in the future.

Conclusively, for Haiti to recover from natural catastrophe to economic stability several recovery measures have to be taken. Thus causing a research boom by researcher “Paul Collier” on the realistic attainment of economic security strategies:

I: A realistic strategy for rapid attainment of economic security.

Collier “2009” argues that attainment of Economic security cannot be based on long term grand goals since the status quo exhibits high levels of civil unrest; the Haitian government must create policies that attain instant payoffs on basic services, jobs, food security and environmental sustainability. The visible involvements and creation of basic amenities will give dignity and structure to the lives of a typical Haitian and will seize the threat of emigration of the Haitian workforce which manifestly is destructive and poses limitations on the prospects of growth in Haiti.

The provision of basic services, thus, avoiding child mortality and likelihood of children reaching adulthood without schooling will show a good level of state responsiveness towards citizens’. Thus command more state-citizens cooperation and economic prosperity.

II: Policies for basic services

As argued by Collier, in order for the Haitian government to improve its welfare sector and provide basic services to raise the confidence of citizens, the government has to initiate cooperative ideas with NGOs and Private services providers.

Also by the involvement of the large Haitian Diaspora, it might be ideal to give representation to the Diaspora organisations in other to attract funding.

Another possible model for polices that provide basic service is that of the Independent Service Authorities (ISA). The ISA is a public agency outside the civil service which implement government policy but does not set policy. By adopting the variants of the ISA, the quasi-independent public agency will coordinate and co-fund NGOs and private sectors in the providing support to lacking sectors and ministries in Haiti.

By adopting the ISA model, it will improve the situation of the Haitian Economy by taking funds from foreign donors, governments and other potential sources, thus channelling these funds into a wide range of NGOs and private service providers by entering into contracts with them and finally monitoring the performance of the service providers to make sure contracts with the least satisfactory service providers are not renewed. This approach therefore may well turn out to be a more appropriate institutional redesign for Haiti than that of the largely unsuccessful approaches taking in the past.

III: Policies for environmental sustainability

IV: Policies for food security..

V: Policies for jobs:

A: Reconstruction

Without the reconstruction of the Haitian fundamental infrastructure and increases in export zones the creation of mass productive jobs, as argued by collier, is feasibly thin.

The geographical location of Haiti is prone to series of natural disasters in the past half decade; prior to the hurricanes, in 2008, Haiti has been in massive need of a sustainable infrastructural system that entails the construction of roads, transport links, health care and educational institutions; without placing the prior into top prioritization help from international entities, for foreign aid, will be futile if these infrastructural issues are not addressed properly.

Consequently, the primary reason for the failure of foreign aid consists from the lack of maintenance in current infrastructures. This as explained in the prior section, is a very necessary downturn to economic growth in Haiti. This can be monitored and controlled by setting up a steering and monitoring committee that will oversee and maintain all projects to avoid the case of having to rebuild same infrastructure twice. This will not only be good for the indigenous people living in Haiti but also for the donor and Haitian economy as it will reduce their expenditure on things that has already in the past been settled

Similarly, the secondary reason, for the current and past failures of foreign aid, endorses the lack of strategic infrastructural provision on breaking bottleneck in the economy. Haiti’s geographical location with past and recent natural devastations is prone to unwanted natural disasters. In other to tackle the problem of infrastructures collapsing, strategic measures should be taking when building infrastructures in Haiti so it can resist the common natural disturbances bringing them down and having to get to rebuild them over again.

In the past, Haiti has been highly dependent on aid from foreign donors and this, debatably, delinks the capital budget from the recurrent budget, as the same donors or another donor will rebuild any infrastructure fallen apart as a result of lack of maintenance, consequentially, decreasing government incentives to maintain infrastructures.

VI: Exports

Another argument raised by Collier, to improve the Haitian economy, is to enhance the garment export industries. The Haitian economy is heavily dependent on agricultural produce with a comparative advantage in the garment industry.

The global garment industry is huge relative to the Haitian economy; like many other industries, global production is organised into clusters of firms to reduce individual cost. By introducing a pool of experienced labour and creating a sufficiently large market to support specialist suppliers in the garment industry thus lowering individual costs. However the global market enters a virtuous circle that increases competitiveness. In order for Haiti to improve its garment industry and crate job opportunities, it must lower its cost to the global status thus breaking the threshold of competiveness created by the virtuous circle, according to study, the forthcoming UNIDO Industrial report 2009

The Haitian garment industry only has two locations in Port-au-prince and Quanaminthe. The mobilization support passed by the American congress “HOPEII” for duty and quota free access to the American market has lead to the cluster in the prior two locations, although, Haiti still faces a threat of dissipating the support provided as necessary fuelling factors for the improvement of this industries and export in general is lacking i.e. Electricity and infrastructure.

Section 3: Methodology

Now, in other to analyse the coefficient of the variables: GDP.

Where: GDP = Gross domestic production as the dependent variable.

Constant

Source of data: I extracted my time series data from the World Bank indicators (WBI) via the ESDS link.

I analysed my data by applying the multiple regression analysis to test the relationship between all the independent variables and the dependent variable (GDP). Also I included the error term, so as to capture any important variable that could be added to the analysis as the aid and growth question is far from settled and there is more room for important an important explanatory variable.

Chapter 4: Regression results and explanations:

Also while conducting the test I had to multiply the aid & FDI variable by 100 to express the values in the log term.

In other to test the correlation between foreign aid and economic growth, I employed a time-series data from the World Bank indicators link via ESDS and conducted a multi-regression analysis with a sample size of 29 (n=29), to see the significance of aids impact on growth. The gross domestic production (GDP) is conveyed here as the dependent variable and aid, population, export, import, and FDI as the explanatory variables.

C: The variable c stands as the constant term with a coefficient of 28.76999.

GDP: The GDP being the dependent variable which conveys the growth rate in Haiti, it will be used as a bench line for any % change in the explanatory variables above and how they affect growth.

Imports and Exports: The coefficient of the imports and exports as a % of the GDP conveys the trade openness in Haiti and its relationship on the growth in the Haitian economy. Thus with a coefficient of -0.01820, it states a negative correlation with the growth in the GDP. This however shows that there has not been any significant change in the GDP as a result of trade openness in the Haitian economy.

Aid: The aid coefficient signifies the correlation of aid received from foreign donors in the past years and its relationship on the growth in the Haitian economy. Thus with a coefficient of -0.008122Ã-100 = -8122 to make it a natural log (LN), the value of the coefficient however is still negatively correlated with the growth in the GDP in the Haitian economy meaning the level of aid received has not made any positive change in the level of GDP in the Haitian economy.

FDI: The FDI coefficient signifies the correlation of foreign direct investments into the Haitian economy and its significance on the growth rate. However, with a coefficient of 8.36E-10 (0.000000000836Ã-100) =0.0000000836. This however has conveyed a positive correlation on the GDP stating that the presence of foreign direct investments in Haiti has positively had an impact on the GDP.

Population: The population variable coefficient explains the correlation of the population growth on the GDP, with a coefficient of -0.417473, It has a negative correlation on the growth rate, therefore there is no significant relationship between population growth and GDP.

: The R-squared value shows the % of how much the data is explained by the regression, putting in mind the higher the R-squared, the higher the variables are explained. However with the % of the r-squared being 0.828807 0r 83%, it conveys that there is 83% correlation between the GDP and the other variables.

Adjusted: The adjusted R-squared, is similar to the R-squared apart from the fact that it has room for more variable, in the case of my research, the adjusted R-squared is better to use because there are no definite variables for testing the relationship of aid on growth therefore there is more room to other explanatory variables.

Furthermore, i went on to test if there was any sign of auto correlation. So i conducted a white test.

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