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Foreign Aid

(Concessional financial flows)

Foreign Aid: Concessional loans &

Largest share: ODA, including bilateral and
multilateral soft loans (25%) and grants
Donor countries: most of OECD countries,
some OPEC countries and some Eastern

Multilateral organizations providing ODA:

UN agencies
Single-issue funds (eg: global fund for AIDS)
International Development Association of the
World Bank
Regional development banks
IMF assistance for debt relief

Humanitarian aid
Debt relief
Development assistance:
Financial support to sectors
Financial support for specific projects
Technical assistance (doctors, teachers,

Donor motives
1. Political & strategic motives. Use of aid to
support regimes considered to be friendly
to the interests of the donor governments.
2. Economic motives. Assistance to countries
with strong economic ties, such as Japan,
with aid directed to neighbouring countries
with trade and investment links. Tied aid:
recipients must spent a portion of the
borrowed funds on the purchase of g+s
from the donor country.

3. Humanitarian & moral motives

Short term emergency assistance

Long-term development assistance on debt
relief and poverty alleviation

Political & strategic interests


Arguments in favour of the effectiveness of

aid (Advantages)
1. Aid and poverty cycle. Very poor countries


which are trapped in the poverty cycle face an

investments constraint due to low incomes. To
emerge from a poverty cylce they need
investments in physical, human and natural
capital. However, if the country doesnt have
tax revenues the only way it can achieve this is
through foreign aid.
Aid and provision of basic servcies. In
countries which are not stuck in the poverty
cycle, investments are required in health,
education and infrastructure, which can help

Factors limiting the effectiveness of aid

1. Tied aid. In the context of bilateral aid:

recipients must spend part of the borrowed

funds on g+s from the donor country.

Higher import costs.

Purchase of inappropriate capital intensive
technologies & development and use of skills
inappropriate to local developing country conditions.

2. Conditional aid. Donors impose conditions to

be met by recipients to ensure that funds are

used effectively.

a. Policies towards market orientation.

b. Acceptance of projects decided by donors.
c. Detailed reporting on spending, timetables,

Problems with conditional aid:

1. The preferences of the government or
population group are not considered.
2. Policy prescriptions by donors may be
May not fit in with the governments priorities
May undermine governments authority

3. Aid volatility and unpredictability.

Makes it difficult for recipient governments
to implement policies that depend on aid

4. Uncoordinated donors inefficiencies in

the use of aid resources
5. Aid substitutes rather than complements
domestic resources not enough effort
to increase revenues through taxation.

6. Aid may not reach those most in need.

Aid resources are not allocated on the basis

of the greatest need for poverty alleviation:
Bilateral donors guided by political & strategic

Recipient countrys gov may not be committed to
poverty alleviation or lack expertise to design a
poverty alleviation strategy.

7. Aid associated with corruption.

Misuse of aid funds by recipient countries

Aid vs Trade debate

Three different perspectives:
1. Trade, not aid
2. Trade and aid
3. Aid for trade

Trade, not Aid

Proponents: development should be based
on an expansion of intal trade and
increasing exports of LDCs, while aid
should be curtailed or abandoned.

Failures of foreign aid:

1. Aid is a breeding ground for corruption, as
funds are misappropriated by corrupt
2. Aid substitutes for rather than complements
domestic government revenues.
Governments lose incentive to increase tax
revenues and increase efficiency of tax
system dependency on aid funds.
3. Aid does not reach those most in need.

Countries need international trade:

Success of East Asian countries: intal

trade contributes to growth and
BUT: on the condition that DCs eliminate
their trade barriers and protection of
their agricultures.

Trade and Aid

International trade and an export

orientation are indispensable to growth

and development, but not enough by
themselves in the case of LDCs.
Foreign aid has not failed. Many of its
weaknesses (tied aid, conditional aid, lack
of coordination, volatility) are the
responsibility of donors and there is
pressure to correct these problems.

Foreign aid is necessary...

1. help LDCs to escape the poverty

2. increase provision of basic services.
Aid can make resources available for
investments in health, education and
infrastructure, helping the poor to
improve employment opportunities and
improve their incomes.

3. improve income distribution, by

focusing on the most disadvantaged

4. ...for growth. Aid makes possible
increased investment and consumption
Mozambique, Tanzania, Uganda, which rely
heavily on aid, have achieved high growth

5. ...for the achievement of the MDGs.

6. ...for debt relief purposes. Aid helps

countries reduce their debt burden and

releases resources that can be used for
poverty reduction and economic growth
and development.

Intal trade may be of little use

1. Elimination of agricultural subsidies

would have mixed effects for food

importers (Africa): positive for producers,
negative for consumers.
2. Countries may have little to export:
Limited access to credit
Difficult to move into production of goods
that can be exported.

3. Geographically isolated countries and

communities: no access to markets,

urban centres or to ports unable to
compete in international markets.

Investments in communications and

transportation are necessary to benefit from
trade aid can provide the resources.

Aid for trade

Consensus among development

In order to benefit from from intal trade, LDCs

must have the institutional capacity to
increase their exports.

A portion of aid should be used to support

the development of institutions that
improve a countrys abilities to export.

Institutional constraints:
High transport costs due to poor transport
Limited access to credit
Poor power supplies higher production
High administrative costs (border procedures)
Lack of capacity to meet technical and
sanitary standards

Aid and trade policies should be integrated.

The aid for trade would be in addition to and
not a replacement for ODA.
Efforts to address institutional constraints to
trade should also focus on middle income
developing countries, which do not qualify for
ODA funds.