Economic Development - Overseas Aid, Remittances and Debt Relief

Introduction to aid

What role can and what role should overseas aid play in promoting and sustaining economic development?

These are hugely contentious questions in the subject. Estimates vary from those which suggest that overseas development aid has added about 0.5 per annum to growth in recipient countries to those which suggest that it has had no positive, or indeed negative, effect on growth.

Backgrounds statistics on aid

• In 2011, overseas aid payments were $133.5 billion, equivalent to 0.31 per cent of developed countries’ combined national income
• In 2010, global military expenditure = $1630 billion versus $128 billion on development aid
• The value of trade outweighs aid by a large multiple. The export earnings of all developing countries in 2010 were more than 40 times the level of official aid flows.
• Denmark, Luxembourg, the Netherlands, Norway and Sweden exceed the United Nations ODA target of 0.7 per cent of gross national income (GNI)
• The largest aid donors are the United States, Germany, the United Kingdom, France and Japan
• Korea, China and India now also donor nations
• The main destinations of aid from advanced rich nations in 2010 were Sub-Saharan Africa (44%), which also received more aid per head than other regions, followed by South and Central Asia (19.5%) and Middle East and North Africa (10%)
• In 2010, total UK aid amounted to $13.1 billion

Types of Aid

• Bi-lateral aid: Aid on a country-to-country basis e.g. from UK to Kenya or from Brazil to Tanzania
• Multi-lateral aid: Aid channelled through international bodies / aid agencies such as CARE
• Project aid: Direct financing of specific projects for a donor country
• Technical assistance: Funding of expertise of various types
• Humanitarian aid: Emergency disaster relief, food aid, refugee relief and disaster preparedness - Humanitarian aid accounts for less than 10% of global aid flows
• Soft loans: A loan made to a country on a concessionary basis with a lower rate of interest- for example, India has received over $2 billion in low-interest funds from the World Bank for many of its welfare schemes, these soft loans are set to stop as India heads towards middle-income status
• Tied aid: i.e. projects tied to suppliers in the donor country - the UK abandoned tied aid in 1997
• Debt relief – this may take the form of cancellation, rescheduling, refinancing or re-organisation of a country’s external debts

Financial flows into developing countries (also known as foreign savings) can come in different forms:

Although aid is important for many poorer nations, exports from developing countries are now more than 40 times the level of official aid flows. Remittances for migrants are about three times as large as aid flows. Private capital inflows are 10 times aid flows. The latest available data for aid and private capital flows heading to developing countries is shown in the table below.

Aid and Private Capital Flows to Developing Countries 2010
Flows	US$ billions	% of total official and private flows
Total Official Development Flows	128	10.9%
Total Private Flows (including remittances)	1042	89.1%
Foreign direct investment	509	43.5%
Portfolio Investment	128	10.9%
Net private long-term debt	84	7.2%
Remittances	321	27.4%

Priorities for UK overseas aid

Assisting Post Conflict Nations
Examples of aid projects from the UK to help fragile countries and those in post-conflict reconstruction:

• Clearing minefields in Nepal, road building in the Democratic Republic of Congo
• Malaria prevention and treatment programmes in Ethiopia, Training midwives in Pakistan.

Does aid help or hinder economic growth and development?
This is the subject of a fierce debate in the development economics literature

• Aid has a range of economic, social, environmental and political objectives
• Economic development can take place without aid - China and Vietnam have both experienced sustained and rapid growth over nearly two decades without receiving much in the way of international aid payments measured as a share of their GDP
• Well directed and targeted aid can enhance a country's growth potential but the effects may not be seen for many years
• Aid that might help finance the building of a power station contributes directly to aggregate demand and increases supply potential
• Aid that is designed to put more children through school or humanitarian aid to vaccinate kids and prevent them dying will have an impact over a longer time horizon
• Different kinds of aid projects can affect growth at different times and to different degrees

Building the Case for Overseas Aid

Counter arguments – Limits / Disadvantages of Overseas Aid

In the "The Bottom Billion" Professor Paul Collier suggests that, ceteris paribus, overseas aid may have added around 1% per year to the growth rate of the poorest countries of the world during the past 30 years. There are few economists who argue that aid has led to a reduction in economic growth of donor countries. Most of those who are critical of overseas aid focus instead on dependency and corruption. It is possible for countries to grow quickly without aid – but equally there are countries who were initially heavy aid recipients who have grown and developed and are now aid donors themselves for example South Korea.

The ceteris paribus assumption is important. Aid can provide a much needed injection of funds for some of the world's poorest countries and communities - but everything else is not equal. Many external factorsmay reduce or enhance the impact of aid on economic growth, for example the quality of government, the efficiency of financial systems and also the absence of conflict.

Key point: The contribution aid makes to growth differs sharply in countries at peace and countries in conflict

Aid Graduates – Countries whose overseas aid as a share of GDP has declined over the years
Country	Maximum aid as % of GDP	Year	Minimum aid as % of GDP	Year	Growth of GDP per capita p.a. 1990–2010
Bangladesh	8.2%	1977	1.3%	2009	5.8%
Botswana	31.6%	1966	0.5%	2005	7.1%
China	0.7%	1992	0.01%	2008	11.6%
Ghana	16.3%	2004	4.1%	2008	4.0%
India	4.1%	1964	0.1%	2009	7.0%
Kenya	16.8%	1993	6.1%	2008	3.1%
Malaysia	1.2%	1987	0.07%	2009	6.1%
Vietnam	5.9%	1992	2.9%	2008	7.4%
Source: World Bank, Global Development Finance

Critics of much of the aid that has gone to Africa in recent decades argue that a high proportion of aid has gone to low-income countries with poor institutional regimes. The UK Coalition government has a target of allocating 0.7% of GDP to overseas development assistance (ODA) - this target came into being in 1970 and has never been revised! But is it right to stick rigidly to such a target independent of what else is happening in both the domestic and the global economy? 0.7% of UK GDP is forecast to equate to around £15 billion in 2015. In November 2012 the UK announced it would end aid to India in 2015, to focus on trade links. It has suspended aid support to Rwanda over its alleged funding of rebels in the Democratic Republic of the Congo, and to Uganda over alleged corruption

In a world of increasing resource scarcity, aid can also help achieve three important aims

• Helping to overcome skills shortages
• Funding to relieve infrastructure shortages
• Aid funded projects to help the poorest countries become more resilient to climate change

Smart Aid

• There is increasing interest in the use of "smart aid" - aid programmes that use experimentation and focus on bottom-up projects in order to increase the effectiveness of each £ or $ given in aid.
• The work of Esther DuFlo, the author of the award-winning "Poor Economics" and professor of development economics at the Massachusetts Institute of Technology, has been influential in shaping ideas about smart aid and the importance of randomized trials to improve the effectiveness of aid.
• Oral rehydration therapy, vaccines and the spread of bed nets to reduce malaria in Africa are examples of where randomised testing has had an effect to give aid projects more impact.

Remittances

Remittances

• Remittances are transfers of money across national boundaries by migrant workers.
• Despite a dip because of the recent global recession, total remittance flows have grown in the world economy over the longer-term as the scale of migration between countries has grown
• For many developing countries, money coming in from remittances is an importance source of income.

Advantages of remittances

Officially recorded remittance flows to developing countries are estimated to reach $406 billion in 2012, a growth of 6.5% over the previous year. The top recipients of migrant remittances in 2012 are India ($70 billion), China ($66 billion), the Philippines ($24 billion), Mexico ($24 billion), and Nigeria ($21 billion).

The size of remittance flows to developing countries is now more than three times that of official development assistance.

Limitations of remittances

Debt Cancellation and Debt Relief

Many of the world’s poorest countries are saddled with high levels of external debt owed to other governments, institutions such as the IMF and foreign companies and individuals.

• The current near $5tn of external debts owed by developing countries costs them more than $1.5bn a day in repayments – and much of that comes from the poorest countries
• Most of the world’s poorest countries have limited access to international capital markets – their sovereign debt does not have an official credit rating.
• Without conditional loans from the IMF, World Bank and others, they would have to pay interest rates many times higher on private sector loans.
• Some developing countries have chosen to borrow from other emerging economies such as China or Brazil as a way of avoiding conditional loans from international institutions
• Countries with persistent trade deficits end up accumulating large external debts, so too a government where spending greatly exceeds annual tax revenue leading to high fiscal deficits

External debts can act as a severe constraint on growth and development – often times, the interest on existing debt takes up a large percentage of a nation’s export revenues or annual tax revenues. These debt repayments have an opportunity cost, they might be better used in supporting development policies.

To what extent should richer nations be prepared to write-off external debts of poor countries? The Jubilee Debt Campaign pushes for debt cancellation and debt relief avoiding where possible conditions built into debt reduction agreements that create further problems for vulnerable countries.

One option is to reschedule debt payments and change the nature of the interest rate paid on these loans. In July 2012 a United Nations report made the case for introduced indexed loan repayments where the interest rate is tied to a country’s rates of economic and/or export growth. This would help balance the risk of loans more equally between lender and borrower. In good years when growth of GDP is strong, the borrower country would repay more of their debts. During hard times (i.e. a recession caused by a fall in export revenues), the rate of interest on debt would fall.

Heavily Indebted Poor Countries Initiative (HIPCI)

This is an initiative to provide debt relief to heavily indebted low income countries. Under the Initiative, the International Monetary Fund (“the IMF”) and World Bank calculate the proportionate reduction required in the country’s external debts in order to return them to 150% of the country’s annual exports, which is considered to be a sustainable level. All creditors – multilateral, bilateral and commercial – are expected to provide the proportionate reduction that will achieve this. The Ivory Coast has benefited from HIPCI – it has been granted external debt relief of $7.7bn. As a result the stock of public debt decreased from 69% of GDP in 2011 to 40% of GDP in 2012.