Free exchange: Aid to the rescue

My first Free exchange column in The Economist is published in this week’s issue. An excerpt:

New research suggests that development aid does foster growth—but at what cost?

Aug 16th 2014 | From the print edition

FIFTY years ago the first United Nations Conference on Trade and Development launched a debate about how much money rich countries should give to poor ones to reduce poverty and bolster growth. In the end, the UN settled on a figure of 0.7% of national income—a target subsequently reaffirmed by endless international powwows. Although few countries have met it, aid spending in real terms has nonetheless increased steadily ever since, to $134.8 billion in 2013 (see left-hand chart). Yet economists are still arguing about how much the aid helps—if it helps at all.

Aid comes in many forms, from food and tents handed out to refugees to cash that plugs holes in poor countries’ budgets. Donors tend to stretch the definition, to make themselves look more generous. But the goal, in most cases, is to lift a poor country’s productive capacity through investment in things like roads, schools and maternal health.

What the UN sees as a potent weapon against poverty, others consider money down a rat hole. Critics reckon aid hurts its recipients by fostering dependency, propping up oppressive or incompetent regimes and pushing up the value of poor countries’ currencies, thereby undermining the competitiveness of their exports. If aid helped, they say, the poorest countries would have been getting steadily richer for decades, which they have not (see right-hand chart). Those who favour giving aid argue that it could indeed lift people out of poverty, but rich countries simply do not give enough. It is like sending fire engines to combat a wildfire: it only works if you send a lot of them.

Assessing the impact of aid on economic growth is complicated by the fact that the causality is not always clear. A positive relationship between the two could simply mean that rich countries reward poor ones for implementing policies that would have helped their economies whether or not they had brought in money. Conversely, a negative relationship may just mean that more aid flows to the countries with the most sluggish growth. In neither instance would aid actually be driving growth.

To get around this problem, economists have long hunted for a factor that affects the amount of aid disbursed but is not otherwise correlated with growth—an “instrumental variable”, in the jargon. Finding one is harder than it seems. Many proposed candidates—such as the size of a poor country’s population or even the colonial empire to which it used to belong—have been found by subsequent studies to have an independent connection to economic performance after all.

Read the rest of my article here.

Simon Hedlin

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