The Hindu Business Line : Economic rationale of foreign aid

The debate on foreign aid and growth is back: Does it really help the recipient country or is it an instrument to spread the donor's influence? The agenda of multilateral institutions and nations is complex. But for the sake of posterity and for enhancing the space for globalisation, carefully planned aid is worth global support, says A. Vasudevan.

INTEREST HAS picked up in recent moths on the link between foreign aid and economic growth. The G-8 summit in early July gave a further boost to it. Almost coinciding with the meeting, the International Monetary Fund (IMF) came out with two working papers on the subject. The IMF studies came to no definitive conclusion on the link between aid and growth. One needs to examine as to whether the ambivalent conclusions are due to the methodology of using panel data or due to the absence of appropriate institutions.

The impressions on the subject in India have, however, been somewhat definitive. If you are a Gandhian, you would oppose foreign aid of any sort — self-reliance and self-sufficiency being the main motto. If you are a developmental economist, as most Indian economists are, you would tend to favour foreign aid as an instrument that could be used for fostering economic growth.

It is not that Indian economists are a special breed. When Lenin shaped the New Economic Policy (NEP) in the 1920s, much under the influence of Nikolai Bukharin, he did envisage foreign aid in the form of foreign investments for promoting economic development in the Soviet Union. It must be appreciated that no distinction was made then between foreign investment and assistance. This was so almost till the 1960s. The NEP, however, fell through with Lenin's death.

Indian Marxists, with perhaps the exception of the early M. N. Roy, did not, on the other hand, explicitly oppose foreign aid even while espousing the cause of self-reliance. They did not object to the Soviet financial support to the Bhilai Steel Project. Nor did they object to the Soviet support to the Indian Institute of Technology, Bombay. They opposed foreign investments in the private sector, whether all by itself or in partnership with Indian ventures. The followers of Jawaharlal Nehru, Nehruites to be simple, favoured both foreign investment and aid in terms of finance or goods in order to close the gap between the investment needs and the domestic savings.

The economic rationale of foreign aid (as well as of foreign direct investment) has never been in doubt. For purposes of discussion here, let us not consider foreign investments, direct or of the portfolio variety. By bridging the gap between the planned or targeted investments and actual domestic savings, aid would enhance the prospects of growth, given the productivity of investment. It is implicitly assumed that there would be no problems of governance in the transformation of the inflows of foreign savings into investment. The need for appropriate institutions to ensure effective use of aid was not an issue till the early 1990s. Nor was foreign aid considered an appropriate vehicle to resolve problems of unemployment and poverty.

The economic logic of aid would in the real world hold good if it is put to good use by recipient countries. Donor countries have a good case for considering the criticality of effectiveness of aid. Besides, they would before deciding on aid disbursement or increasing the quantum of aid be largely guided by certain considerations — the fiscal space for giving aid, to whom it should be provided, and for what purpose.

But, then, many observers of Indian economic history have other concerns as well. For example, the American official viewpoint on aid right from the 1950s through the 1980s was largely dominated by the powerful writings of Prof Hans Morgenthau who contended that as nations crave for power and are led by what they perceive as their national interests, foreign aid should be treated not merely as a humanitarian issue but as one to promote the US interests. In other words, aid should be used as a tool of foreign policy and thus has to be selective.

This approach has had a disastrous consequence. Aid has been empirically found to be not conducive to domestic resource mobilisation efforts of the recipient countries. In some recipient countries, aid had helped the rulers and the elite to enrich themselves.

The official aid of the US and most other developed countries has over time declined in relation to their respective GNP for a variety of reasons including the fiscal imbalances, and averaged about 0.4 per cent of GNP in recent years. As a result, the UN target that development assistance from developed countries should be 0.7 per cent of GNP agreed to on October 24, 1970 has remained a distant dream.

The donor countries' assistance needs to be seen in the context of the financing of economic adjustment and projects by the IMF and the World Bank since about the mid-1970s. The conditionality associated with multilateral institutional support has been found by most developed countries to be more useful than bilateral aid for wielding influence over the policies (and at times politics) of developing countries. This aspect is best reflected in the deliberations of the Group of 24 Finance Ministers and in the writings of the Commonwealth Secretariat.

Irrespective of the perspectives on aid, a number of countries have since the early 1980s adopted economic adjustment programmes with considerable amount of structural or institutional reform content in them. The countries that have been left behind in such endeavours are mostly in Africa which remained poor and heavily indebted to external creditors, both governments and multilateral institutions.

Against this background, it is believed that the recent initiatives to provide large aid to some of the heavily indebted poor countries, mostly of Africa, would help eliminate poverty and raise growth rates if certain preconditions are met. Among the major preconditions that recipient countries have to fulfil, the ones cited most often are the need for creating sound and appropriate institutions including the rule of law and property rights, improving administrative capabilities and governance mechanisms and eliminating corruption.

The preconditions, however, cannot be met overnight. It is possible that once the countries in question take up in earnestness the issues relating to the preconditions there could be the realisation of the Millennium Development Goals (MDGs) over the long term. In the immediate future, however, aid is needed not so much to achieving the MDGs as to triggering and sustaining growth impulses.

Right now, the African growth pattern has been variable, with growth rates being unsustainably low in most years. To overcome the growth variability and to enable aid to move towards realising the MDGs, multilateral institutions have to play the critical role of bringing the donor and recipient countries together. They should, for instance, ensure that aid-givers free their trading and labour policies so that the countries benefit. But in their order of priorities, this is given a relatively low score. Multilateral institutions are perceived as spending more energy to see that recipient countries undertake reform policies. But for effective use of the financial support that countries receive, the multilateral institutions would need to work concert with civil societies and reputed non-governmental organisations.

The agenda of the multilateral institutions is large and complex. But they have to live up to their tasks. And for the sake of posterity and for enhancing the space for globalisation, carefully planned aid is worth global support.

(The author, a former Executive Director of the Reserve Bank of India, can be accessed on asurivasudevan@hotmail.com)

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