Parth
J Shah & Ali Mehdi: Foreign aid or economic freedom?
Parth J Shah & Ali Mehdi / New Delhi September 08,
2006
Aid leads to larger government while economic freedom eventually
results in higher FDI and growth.
Amongst the developing countries, India has been the largest
recipient of foreign aid. During 1951-2005, India has received
Rs 2,260 billion as loan and Rs 242 billion as grants (about
10 per cent of total aid). It has managed to pay back Rs 1,669
billion as principal and Rs 768 billion as interest. Multilateral
aid — 90 per cent of which has been provided by the
World Bank — accounts for about 60 per cent of India’s
total aid. Amongst bilateral donors, Japan has been the most
generous, giving India 23 per cent of the total bilateral
aid used by India.
Has being the largest aid recipient helped India achieve economic
growth more than economic freedom has? It is a fact that India’s
development and economic growth have been far more impressive
since the liberalisation of the Indian economy. Supporters
of foreign aid claim that while arguments against aid effectiveness
are partially true, they are over-emphasised. Jeffrey Sachs
and Joseph Stiglitz, both previously associated with the World
Bank in different capacities, are two famous names in this
context. Sachs, the director of Columbia University’s
Earth Institute, talks about “the poverty trap”
in poor nations, requiring a “Big Push” from foreign
aid, in his book, The End of Poverty. He says that the poor
“are too poor to save for the future and thereby accumulate
the capital that could pull them out of their current misery.”
Rich nations should increase official development assistance
(ODA) from 0.3 per cent to 0.7 per cent of their GNP, as pledged
by them in Monterrey Financing for Development Conference
in 2002.
However, William Easterly, professor of Economics at New York
University and the author of The White Man’s Burden:
How The West’s Efforts To Aid The Rest Have Done So
Much Ill And So Little Good, argues that foreign aid does
not have any measurable impact on growth, and that it has
miserably failed to reduce poverty, primarily because of it
being tied to centralised, state planning (Economic Freedom
of the World: 2006 Annual Report). According to him, “initially
poor countries grow faster than rich ones, once you control
for economic freedom.”
In general, foreign aid has led to the burgeoning of government
bureaucracies, with increasing state interference, inefficiency,
lack of accountability, corruption, and so on. At the utilisation
level, it has more often been used for consumption rather
than investment, to serve political purposes rather than achieve
development. Evaluation mechanisms have been weak, and so
have been the feedback and improvement systems. On the other
hand, “economic freedom gives markets, which are great
feedback mechanisms for learning what is succeeding and what
is failing,” explains Easterly.
Already, in most South Asian countries, the flow of private
capital is much higher than that of foreign aid. Between 2000
and 2004, India received $ 6 billion in foreign aid, $ 25
billion in FDI, and $ 86 billion as workers’ remittances,
the largest in the world. Governments in the region should
therefore ease the restrictions placed on the flow of private
capital, instead of seeking more aid. They should learn from
the example of south-east Asian countries, where FDI has been
a significant source of availing capital and technology for
exports as well as economic growth. FDI and remittances have
the potential to offset aid as important engines of growth
and development in South Asia, and these countries need to
develop conditions that bring in more FDI. At a macro level,
to ensure aid effectiveness, South Asia in general, India
in particular, needs to bring in good governance and sound
macroeconomic policies, which not only make aid effective,
but are also able to use aid for building infrastructure and
other avenues which help in attracting FDI.
Nevertheless, until aid flows continue, it might be more effective
to have direct transfers of cash or vouchers in targeting
the affected population, and in achieving the targets set
for development programmes. Mexico’s PROGRESA scheme
gives parents cash for sending their children to school and
getting regular health check-ups. The Mexican government’s
programme has been extremely successful in enhancing enrollment
as well as the quality of education for the poor. The Bangladesh
Female Secondary School Stipend Programme paid school fees
and transferred an incentive money directly into girls’
bank accounts on condition of at least 85 per cent school
attendance, staying unmarried until 18 years of age, and passing
examinations. This has increased enrollment rates by 12 per
cent a year in rural areas. India has announced a pilot program
of food stamps, though it is yet to come into effect. Ideally,
the issue of aid should be decided by individuals, communities
and voluntary associations — by civil society. Government-to-government
aid should end.
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