Foreign Aid Effectiveness,

Political Rights and Bilateral Distribution

Daniel Ehrenfeld

The effectiveness of aid has recurrently been a subject of much investigation. Though results have been mixed, a consensus that foreign assistance does not generally benefit its recipients sufficiently has emerged. Many in the past have focused the blame for this reality on the donors, insisting that aid-tying practices and conditionality has redirected aid to benefit the North. It has been charged that bilateral aid (aid transferred from one single state to another) is especially culpable for being structured to reap gains for the benefactor and not for humanitarian purposes. Conversely, multilateral aid (aid transferred by alliances of multiple states) was thought to be more geared toward assisting the South through the development process. Yet, research indicates that this effectiveness bias is not in fact the case; in actuality it is bilateral aid that has had a more significant positive effect on development in the South. The following essay will attempt to demonstrate that the presence or absence of political and civil rights in the recipient country has one of the greatest effects on the efficiency with which aid promotes development. It will also link this finding to the aforementioned greater effectiveness of bilateral aid. The essay concludes that while aid may aggregately benefit the North more than the South at this point in time, progress relating to the political rights variable could extensively alter this balance of aid value.

A Brief History of Aid

Foreign aid, or Official Development Assistance (ODA), is a “transfer of resources on concessional terms… [which is] undertaken by official agencies; has the promotion of economic development and welfare as its main objectives [at least outwardly]; and has a ‘grant element’ of 25 per cent or more”. [1] A major basis for the development of today’s aid structure was international actions following the Second World War. Indeed, several institutions have evolved from organizations originally created to contribute to post-war reconstruction. The development work of the UN began with the United Nations Relief and Rehabilitation Agency (UNRRA) founded during the war, and the World Bank, or the International Bank for Reconstruction and Development, which provided loans for recovering Western-European nations, making its first loan to a developing country only in 1950 (to Colombia). The final post-war manifestation of importance was the Marshall Plan, whose success was seen as a model for development elsewhere, and whose approach was reaffirmed in the donor coordinated effort the Colombo Plan for South and South-Eastern Asia. A final feature of the post-war international scene of importance was “the first wave of independence [from colonial rule], creating a constituency for aid. The first meeting of the non-aligned movement in 1955 gave a focus to this voice, as did the various organs of the UN, notably UNCTAD.” [2]

Despite the existence of multilateral programs, bilateral technical assistance to independent countries and even the emergence of the Soviet Aid program in 1956, the 1950s may be described as a decade of US hegemony in aid distribution, as it alone accounted for two-thirds of  total  aid  in  that  decade.  Although the program was subject to continued commercial pressures (especially in the use of food aid), the intensification of the Cold War gave US aid a strongly strategic orientation, which it has retained to this day. Aid was quite consciously used to stop countries ‘going communist’, and development aid and military aid mixed as necessary. In the 1960s, the second wave of independence and the troubled financial state of some already independent countries (notably India) prompted the emergence of greater amounts of bilateral programs. [3]

By 1969, the aid system grew and its channels multiplied and became tangled. There was unnecessary duplication in economic reporting and feasibility studies. [4] Inadequacies of coordination implied a lack of purpose and direction in development assistance. To remedy these deficiencies, the Pearson Commission advocated many changes, among them the strengthening of multilateral agencies. [5] The major multilateral development agencies have grown in number and size over the past fifty years. The first group, the United Nations and the sister institutions created at Bretton Woods, commenced operations after the war; but it was several years before the UN and the World Bank concentrated seriously on development. The IMF was not then – and is not now- a development institution, although its work in many spheres, national and international, has a considerable impact on developing countries. A second group, the regional development banks, began to grow in the late 1950s; from the start, their objectives were developmental. In 1970, UN development agencies accounted for more multilateral ODA than any other channel. By 1977/8, however, they had been overtaken by the World Bank Group, while the regional development banks, such as the African Development Bank, the Asian Development Bank and the Arab Fund for Social and Economic Development, grew exponentially in their import. [6] Today, approximately 25% of aid is multilateral, while the other 75% is bilateral. [7]

Recipients’ Gains from Aid

Some proponents of foreign aid claim that overseas capital inflow is necessary and sufficient for economic growth in the less developed countries. They argue that it is theoretically justified because it closes the gap between investment and domestic savings, overcoming shortages of capital and low levels of skills, it supplements export earnings to finance imports generally and capital goods more specifically, and helps to close the foreign exchange gap. [8]

These conclusions are confirmed with the experience of individual countries such as Bangladesh and India where foreign aid appears to have played an important role in the development process. For instance, 100 percent of Bangladesh’s development budget depends on aid which has made a significant contribution to the reconstruction of its economy. In India, foreign aid has financed over 8 percent of the domestic investments and about 15 percent of imports. [9]

Some conditions applied to foreign aid can be said to indirectly benefit the recipient country as well. Some states, such as the United States, are increasingly rewarding democratic states with foreign aid, especially since the end of the Cold War, regardless of strategic importance. As an example, former-President Clinton called the promotion of democracy and human rights the “third pillar” of his foreign policy. Foreign aid programs such as the “Support for Eastern European Democracy Act of 1989” and the “Africa Conflict Resolution Act of 1994” are especially geared toward promoting democratization. [10] This may create incentives for reform, which have the potential to drastically increase the standards of living, including the advancement of personal rights and freedoms, for many who would otherwise suffer. Of course, strategic interest should still not underestimated.

In an alternative respect, multilateral agencies such as the IMF and World Bank promote development by focusing on structural adjustment requirements in return for aid packages and loan guarantees. These requirements include the liberalization of foreign exchange and import controls (freer trade), devaluation of the currency (encouraging exports), anti-inflationary programs including the abolition of price controls, and the promotion of foreign investment. [11] These measures are meant to encourage responsible fiscal management in order to sponsor growth and sustainable development.

Donors’ Gains from Aid

For some donors, notably the Nordic countries, developmental and humanitarian motives have figured prominently in the allocation of aid. [12] Even though altruistic behaviour may be part of the motivation in both types of aid, bilateral aid is more likely to be oriented toward the donor’s economic and strategic interests. States are able to take advantage of their direct control of the funds they bestow by requiring, requesting or expecting certain gains (in various forms) in return. For example, “Japan concentrates its aid in the Asian region; Britain and France give much of their aid to former colonies; political and cultural relations are evident in OPEC’s aid allocations; and strategic motives dominate the bilateral aid programs of the United States.” [13] In all these cases, national interest shapes the style of aid in the hopes that it may allow them to strengthen ties with recipients for economic, political, strategic or cultural reasons. [14]

In the economic sphere, the use of tied aid has consistently featured appreciably in foreign aid. Tied aid is the practice of requiring the recipient "to spend a proportion of the aid given on goods and services produced by the donor nation," specifically with reference to bilateral aid, on which the donor has greater control. [15] This strategy is intended to create job opportunities and promote export industry domestically by securing increased sales to the recipient country, and allowing domestic firms to penetrate these new markets. Tied aid also avoids the prospect of subsidizing future competitors in other countries with one's own tax dollars. The United States, Canada and Spain have been the greatest tiers of aid. [16] A total of about 30% of foreign aid is tied. [17]

Political and strategic motivations such as security goals, access to military bases and strategic natural resources, diplomatic ties and prestige have been prominent features of aid policy for the governments of states. They link aid to ‘exchange conditions’, or quid pro quos, either expressly or implicitly. Studies have proven the link between US and Soviet foreign aid and international political support, especially, during the Cold War period, where aid given by the United States and the Soviet Union was meant to solidify their respective alliances and allow them access to territory from which to involve themselves in proxy wars and political currency in order to contain the enemy. [18] Such politically motivated aid can be observed with respect to American aid to its biggest recipients, Israel and Egypt, since 1977 and Soviet assistance to Cuba and Syria. [19]

 Also in such countries as Japan, Italy and Britain governments have devised aid and trade packages specifically in response to domestic pressures such as political lobbying by local business and commercial interests, and public opinion. [20] Public outcry could result more generally in cases of humanitarian disasters, [21] and more specifically by ethnic groups who are asymmetrically altruistic to specific recipient countries. The government accepts contributions from the lobbyists and the level of contribution depends on the policy that the government pursues. For example, the African lobbies in France, the Indian lobby in the United Kingdom and the Turkish lobby in Germany are well known for their activities in these multi-cultural donor countries. [22]

Another aspect of the political motivations for aid donation has been the provision of assistance for democratic political reform, institution building, and better governance. There are self-regarding causes for the disbursement of foreign aid and conditionality, including the ‘Pacific thesis,’ which argues for the impossibility of the existence of warring democracies, where a world populated by democracies would enhance the potential for national security. A second theory considers the effects on national security as civil unrest may create a refugee crisis that destabilizes immigrant-accepting countries. Another cynically considers whether aid conditionality may simply provide the donor with another way of exercising its power for its own sake. [23]

General Findings of Effectiveness

Measures of development and growth in the majority of the following studies, as most of them have been conducted by traditional conservative economists, have by and large centered on GDP statistics. While it is understood that this characterization is quite limiting and reductionist, a more progressive conception will be applied below.

While some research has shown that aid has a positive effect on economic growth, [24] the majority of studies have found that foreign aid has had no relationship with investment and growth in developing countries. [25] Some even assert that it has had a negative effect on domestic savings and economic growth in some states. [26] Clearly, although a negative effect on growth tends to be the consensus, the results do vary, most likely depending on the pools of subjects selected and periods observed. What is also evident is that much of the literature concerning the effectiveness of foreign assistance using growth models are too broad in scope, failing to isolate variables that may shed more light on the complexity and nuances involved in aid effectiveness. [27] An important model specification, concerning civil liberties in beneficiary countries, will be addressed below.

The Traditional Shortcomings of Bilateral Aid

In evaluating the potential negative effects on aid effectiveness (for recipient country development) that donor restrictions and specifications could produce, we may focus our attention on each form of conditionality in turn.

Tied aid, to begin with, has a tendency to reduce aid effectiveness, value for money, and sustainable development in developing countries. By forcing aid money to be spent on the donors' goods, competition in the market for the provided goods is eliminated, allowing firms to charge noncompetitive prices, resulting in excess costs of between 15-30%. [28] The recipient countries are thus receiving a lesser value for their aid money. The funds, at the same time, are funneled away from firms in the recipient country that are not provided with the capital to develop, for the country to become self-sufficient. The developing country, in the process, is also denied any decision making on resource allocation, inhibiting the enhancement of administrative skills. Tied aid also encourages dependency and wasteful spending. [29] Goals of poverty reduction and sustainable development are in these ways hampered.

Tied aid also distorts trade. By subsidizing domestic producers or uncompetitive firms in declining industrial sectors, tied aid acts as a mercantilist device that deepens international protection and retards economic restructuring at home. [30] As for donors' choice of recipient, the donor country may favour higher-income countries or élite groups in low-income countries, as there is incentive to initiate a relationship with a country that will more easily become a stable consumer of the donor's exported goods. [31] It also results in capital-intensive infrastructural projects being chosen over labour-intensive ones. [32]

Aid given to developing nations for strategic and/or political purposes can also have detrimental consequences. As the well-being of the recipients is not of premium concern, the interests of the LDCs become secondary to those of the benefactors. When desperation for funds is acute, some states may find themselves in precarious positions for accepting the explicit or implicit terms of agreement. Vietnam, for example, was converted into the fighting ground for a major war as the superpowers became intrinsically involved in their internal affairs. [33]

Multilateral agencies have several advantages for development effectiveness, besides the obvious element of better coordination of donor states. They are built to be largely apolitical; their bidding procedures for procurement are relatively transparent; the pooling of resources widens the range of feasible activities; and the multilaterals’ size gives them the competence to handle large projects and the experienced personnel to conduct the missions. [34] The recipients also tend to stock more trust in multilateral institutions as opposed to bilateral ones which they see as manipulative. As Douglas Dillon once stated, “In the delicate area of fiscal and monetary policy, governments find it much easier to accept the counsel of an objective, impartial, and highly competent international organization rather than the advice of other governments, no matter how good or well-intentioned.” [35] Savvy of the motives of individual states, developing nations expect multilateral arrangements to prohibit unfair tied aid practices (to which country’s industry would the aid be tied?) and political exploitation.

The traditional belief concerning the potential effectiveness of aid is thus that bilateral aid should be less effective than multilateral aid due to the biases associated with it. Since bilateral aid is often used as a tool of a given country’s foreign policy to secure political, military or economic interests, that aid is expected to benefit less, if not impair, growth capabilities in the recipient country, as compared with multilateral aid that is presumed to have diluted donor control and neutralized ulterior motives.

Data collected by Burnside and Dollar (2000) and analyzed by Ram, however, have shown that one percentage point increase in bilateral-aid raises the growth rate by one-third to three-fourth of a percentage point. On the other hand, one percentage point increase in the multilateral-aid variable lowers the growth rate by one-half to one percentage point. [36] These results beg the question of how aid that so often is guided without the interest of the recipient in mind has a much more positive effect on the development of developing countries than assistance from a supposedly impartial agency that has growth and development as its goal. The following will attempt to resolve this seeming discrepancy.

Bilateral aid has many advantages. Countries often are peculiarly well placed to assist others with which they have long-standing relationships. They have specific technical skills often developed in, or because of association with, the countries concerned. They often times, as is the case with imperialist/colony relationships or other historical ties, have linguistic and personal affinities which may facilitate the ability to render appropriate technical assistance. Their institutional structures are often derived one from the other, as well. [37]

Moreover, some factors neutralize bilateral aid’s negative points. Tied aid, for example, can be seen as a tool to increase effectiveness in a way, as it is contractible. That is, contrary to many international agreements where there are no third party or institution that can enforce contracts, tied project aid is contractible within the donor country. Furthermore, such a contract is credible not only because of the use of legal institutions within the donor country, but because the third party involved, i.e., private firms within the donor country, is likely to enforce the contract for profit-maximizing reasons. By introducing a third party into the game between the donor and the recipients, a conflict of interest between the beneficiaries of aid is created. This in turn constrains the donor’s ex post incentives, thereby providing the necessary incentives for the recipient governments to induce effort. [38]

Concurrently, multilateral flows, particularly in the case of the World Bank, have come under severe criticism. One main argument is that these institutions are influenced unduly by the North or even by one country; the United States. It has been noted by former-US Treasury Secretary Nicholas Brady that “for every dollar provided to these [multilateral] banks, the U.S. economy gets back $9 in U.S. procurements.” [39] Some critics of aid have thus contended that there actually has been little distinction between bilateral and multilateral aid decision making, as the Bretton Woods institutions include weighted voting tied to subscriptions and contributions. These institutions then impose conditions that allow for easier and cheaper access by trade and investment of developed nations. [40] Even within the United Nations Development Program (UNDP) and other UN programs, where there is no such weighted voting, formal and informal arrangements and pressures put the United States in a position to play an important role. [41]

The World Bank also has been accused of undertaking too many environmentally, socially and economically detrimental projects at the expense of the poorest nations. [42] It can also be hypothesized that the stringent conditions placed on aid by multilateral agencies do harm, at least in the short term, relative to the growth prospects of the recipient countries. [43] Egypt, for example, acquiesced to IMF directives to reduce subsidies and government spending in 1977, which resulted in civil unrest, riots, and destabilized the government’s authority. [44]

Aid and Political Rights and Freedoms

While all the aforementioned claims are very much relevant, one finding appears to deserve focused attention. Analysis by Jakob Svensson shows that long-run growth impact of aid is conditional on the degree of political and civil liberties, as aid has a positive impact on growth in countries with an institutionalized check on government power. Democratic institutions – political parties, elected representatives, free speech, rights to organize, and the like – provide a recurrent and institutionalized check on government power. Since the immediate impact of foreign aid is to relax the recipient government’s budget constraint, thereby giving the recipient increased opportunities to promote long-term development and growth but also increased opportunities to explore non-development activities, the degree of political accountability will (partly) determine to what extent these additional resources will be utilized for productive purposes. [45]

It has long been confirmed that rent-seeking is a serious problem in developing countries, to the extent that an increase in government revenue lowers the provision of public goods, while the mere expectation of aid may suffice to increase rent dissipation and reduce productive public spending. [46] A study conducted by Boone, using data for ninety-six developing countries for the period between 1971–1990 observed that a sizeable portion of the aid was used for government consumption. [47] Bauer has also argued that official aid is liable not go to poor people, but rather to their rulers whose spending policies are determined by their own personal political interest with low priority for long-term development. [48] Some African dictators, for example have been known to divert large sums, including foreign aid, to their tribe members or clients. [49] There is evidence that aid also especially increases the size of government. Government consumption tends to rise by approximately three quarters of total aid receipts in those less developed countries, in which the poorest 60% of the population earn 26% of the national income. [50]

It can be assumed that these problems associated with the use of foreign aid are far more likely to occur in countries with few, if any, political liberties. In these cases, aid can be manipulated to gain allows domestic support by reducing taxes (or increasing subsidies) and distributing patronage to elites to secure government control. Of course, such use of assistance can substantially reduce economic efficiency. [51]

There is additional robust evidence that aid inflows’ beneficial effects on LDCs are conditional on a stable macroeconomic policy environment. Burnside and Dollar, for example, have found an aid/GDP ratio to be a significant determinant of growth only in combination (multiplicatively) with an index of good macroeconomic policy/stability. [52] While not expressly cited, it may be hypothesized that such stability may be rooted in a more politically liberal framework.

In connection to this finding, political/civil rights seem to play a significant role in determining bilateral aid, as a one unit increase of civil “integrity” rights, as Neumayer terms them, leads to the receipt of about 32% more aid by that country. [53] However, neither human rights nor their change over time seem to influence the allocation of multilateral aid. Results seem to hold during the Cold War period, as sampled between 1984-89, as well as in the post-Cold War era, as observed from 1990-95. [54] The results are based upon respect for personal integrity rights as measured by a codification of country information from Amnesty International’s annual human rights and US Department of State’s Country Reports on Human Rights Practices. [55]

In support of this research, Alesina and Dollar in a panel of five-year averages from 1970 to 1994 also find that if all bilateral aid is summed up, political rights exert a positive impact upon the allocation of aid; and Cingranelli, Pasquarello and Poe have all found that human rights considerations are important determinants of the level of US aid allocation as well. [56] Why is this so?

With respect to democratic considerations, studies show that security-driven goals have become less critical and ideological goals more important with the passing of the Cold War, prompting the United States to increasingly reward democratic states with foreign aid. US policy makers are likely to believe that the more the nation can do to promote democracy, human rights and development, the more stable and peaceful the world will become, which ultimately benefits the donors, as mentioned above. [57]

In contrast, multilateral conditionalities threaten to undermine democratic prospects for developing nations. In so far as they are responsible for social discontent that produce divisions in society, the consolidation of stable democratic government is made more difficult. [58] The example of Egypt again seems pertinent here, as the 1977 riots following required economic restructuring led to strict suppression by the military and the assigning of greater authority to then-president Sadat’s supporters in the managerial elite. [59] For a more contemporary illustration, one can point to India, which is actually rejecting bilateral aid, though is less discriminating with regards to multilateral aid, since bilateral assistance had often been accompanied by “sermons about human rights, corruption and good governance” [60] , which the state preferred to avoid.

In addition, countries with low gross domestic product (GDP) per capita (and low scores on such indicators as life expectancy, infant mortality and literacy) tend to be more in need of foreign aid, but are also less likely to satisfy economic and social rights. [61] It is those same states, however, that tend to garner much of the multilateral assistance, not unreasonably to a great degree, because of their precarious positions. Authoritarian regimes are well aware that disbursements of foreign aid are guided in part by the needs of the poor.  Anticipating this, recipients have little incentive to improve the welfare of the poor, especially when dealing with multilateral organizations that have greater aversion to persistent poverty, such as UN agencies, than more self-interested individual state aid, which is tied often to private business, profit-seeking stakeholders.

We can look at the example of Pre-Kibaki Kenya, in which a repeating set of events, a sort of ‘aid tango’, demonstrate the potential futility of aid: First, Kenya wins its yearly pledges of foreign aid, then the government begins to misbehave, backtracking on economic reform and flexing its authoritarian muscle. Sharp rebukes follow, following which Kenya placates its benefactors and the aid is pledged anew. [62] Another example is that of Jordan, where political reforms gearing towards democratization were reversed upon the receipt of great amounts of foreign aid following its peace agreement with the State of Israel and formerly-regular elections have been continually postponed since 1997. [63]

Denis Goulet argues that the drive for ‘development’ that foreign aid has the potential to generate needs to encompass more than simply an increase in annual GDPs. He proposes that its definition, as offered by the Marga Institute, include the creation of equitably distributed wealth; increased well-being (health, education, employment…); the respect of human rights and political freedoms; the retention of cultural identity; and the ever-elusive life purpose and meaning. [64] Leaving aside the last two less-measurable and subjective variables, Goulet’s understanding of development corresponds to those findings listed above in several ways. It is clear from this definition that political rights and liberties are a crucial element of development in and of themselves. In terms of equitably distributed aid and well-being indicators, the existence of civil rights and freedoms also correlate with less corruption, patronage and elite procurement of aid funds. The aid is thus more evenly allocated, creating a greater opportunity for the society as a whole to benefit from the goods and services it is used to acquire.

What may be most interesting, however, is that the calculations for development and growth referenced above almost exclusively consider a purely GDP/aggregate macroeconomic conception of development. That is, they do not contemplate the fairness of distribution, and yet their results still show a positive correlation between political rights and effectiveness of aid. This contributes an added layer of legitimacy to the results, even for traditional liberal economists.

Who Benefits?

It is clear, however, that even though the level of civil and political rights seem to play an important role in explaining cross-country differences in the long-run growth impact of foreign aid, the donor community has not, as of yet, systematically allocated aid to more democratic countries during the 1990s. [65] As such, it seems that, in general, aid’s effectiveness in assisting its beneficiaries is quite minimal. Especially when considering the developing population as a whole, foreign aid’s worth is questionable, since the many authoritarian regimes that make up the bulk of aid recipients tend to funnel those funds to elite supporters. As mentioned above, the allocation of aid to freer and more egalitarian societies can substantially change this reality.

In contrast, the North (aid donors) appears to benefit in the majority of instances. It is of course difficult to objectively and systematically measure whether the cost of aid in dollar figures is worth the political, strategic and economic returns, since such yields are impossible to quantify in broad and context-free terms. A study that would attempt such a feat is unlikely for those logistical reasons. For the purposes of this paper, though, it may be concluded that while humanitarian concerns do play a part in assistance distribution, self-serving objectives exist, and much of aid would only be conferred if the expected benefits outweighed the costs. Hence even though the benefits of aid (North or South) are not necessarily a zero-sum proposition, they do, within the current system, favour the North.

The question of aid effectiveness is a complex one, the answer to which is contingent on a number of variables. One of these variables that appears to explain success in development (by a more traditional or progressive definition) to a significant extent is that of political and civil freedoms, where those countries that allow a greater degree of such liberties are able use aid more effectively. Since bilateral assistance has tended to be granted to countries with higher standards of political rights, as compared to multilateral aid, it is the bilateral form that statistically has had a more positive influence on LDC growth and development. However the majority of less-developed countries still do not have such rights, and thus in aggregate terms, aid is prone not to benefit recipients appreciably. Conversely, because of the explicit or implicit conditionality of aid for strategic, political or economic ends by the donors, the North most likely does profit from its own aid donations. One can only assume that this pattern will continue as long as LDCs insist on restricting political freedoms to their citizens and the North (especially multilateral institutions) continue to sponsor them without making respect for civil rights a more prominent consideration in its selection process for beneficiaries.

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