The destructive effects of foreign aid (1)

Haiti is the 21st-century classic case study of the destructive effects of foreign aid. Following the 2010 earthquake that killed 230, 000 and destroyed infrastructure, humanitarian aid – from governments, and multilateral and private institutions – poured into the country, ostensibly to help Haitians cope with the disaster and rebuild damaged infrastructure. In 10 years, over $13.5 billion was donated to the country, more than the estimated $7.8 billion of critical infrastructure damaged in the quake.

Despite the good intentions, the massive inflow of aid robbed the Haitian government of legitimacy, destroyed the country’s already weak institutions, destroyed local businesses, and distorted the local economy by pushing up wages, rents, and prices. By the time the aid inflow stopped – as they all do – the country had been completely hollowed out and was tethering on the brink of collapse. In 2021, about 50 gunmen walked into the residence of the president, shot him dead, and walked out leisurely without as much as a single shot fired in resistance by the president’s guards.

Haiti is now a completely failed state, dysfunctional, and in absolute chaos. No institution works; no security, no essential services; no sanitation. Haitians are now at the mercy of violent gangs, hunger, and diseases.

Aid and economic growth

Economists, as far back as the 1960s have been engaged in a polarising debate about the effectiveness of aid, with scholars showing contrasting results. However, these studies are always limited by methodological, design, and data issues. Stripped of these limitations and taking a comprehensive view of the data we see that there is a negative relationship between aid and economic growth. More clearly, the highest recipients of foreign aid tend to register the lowest economic growth, as studies by Arvind Subramanian and Raghuram Rajan and William Easterly show. A graph (below) from the study by Subramanian and Rajan summarizes the relationship.

Nowhere is this reality starker than in Africa. As the graph by William Easterly shows, Africa’s growth declined almost in proportion to the rise of foreign aid.

So disastrous were the results that a bipartisan United States House of Representative Foreign Affairs Committee concluded as far back as 1989 that U.S aid “no longer either advance U.S interests abroad or promote economic development.” The same conclusion was reached by a Clinton administration task force in 1992, which conceded that “despite decades of foreign assistance, most of Africa and parts of Latin America, Asia, and the Middle East are economically worse off today than they were 20 years ago.”

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But why is aid not working? A natural experiment

In 1948, shortly after the end of World War II, the US launched the Marshall Plan, which provided about $13.3 billion in foreign aid to Western Europe to spur economic recovery and rebuild damaged infrastructure. It offered the same aid to all of Europe, but the East rejected it and decided to trust its centrally planned economy to rebuild. The aid came with a condition; it went to businesses, which must repay them not to the US but to European local governments, which in turn used those monies for commercial infrastructure – ports, roads, railways – to serve those same businesses.

In many ways, this was a natural experiment. All of Europe was damaged by the war and all European economies were tethering on the precipice by the end of the war. The distinguishing factor was the aid injection in the West and its absence in the East. In 30 years, the result was very clear. Nowhere was this clearer than in Germany, bifurcated by the war into East and West. While the West was rich and prosperous, the East was poor and miserable.

If there were any real beneficiaries of the influx of aid, it was the NGOs and their workers, who were some of the best-paid in the country and had built careers on the backs of poor Africans

 

However, aid to African and Latin American countries, since the 1960s, has gone to governments and not businesses. They are mostly stolen, mismanaged, or used sub-optimally and lack the market and growth-generating potentials that were embedded in the Marshall Plan. What is more, while the Marshall Plan interventions “were short, sharp, and finite,” aid to Africa and Latin America were long, open-ended commitments to governments, which, in the words of Dambisa Moyo, “imbue governments with a sense of entitlement rather than encouraging innovation.”

Read also: China-Africa engagement: Beyond foreign aid

By the 1990s, the US came to recognize aid to governments doesn’t work. They rather strengthen and empower autocrats, weaken and hollow out institutions, and destroy the accountability loop between citizens and government. But instead of channelling them to the private sector, they chose to channel them to Non-Governmental Organizations instead. Thus began the proliferation of NGOs in Africa. Whereas there were only ten registered NGOs in Ghana in 1960, the figure had risen to 350 in 1991, and by 2001, it had ballooned to 1300. The same with Tanzania. In 1992, there were only about 200 registered NGOs. But by 2001, the number had skyrocketed to between 1800 to 8000.

If there were any real beneficiaries of the influx of aid, it was the NGOs and their workers, who were some of the best-paid in the country and had built careers on the backs of poor Africans.

One would even think direct aid and budget support to governments in Africa will taper off. But no; Western countries continue to fund substantial budgets of many countries in Africa, further empowering dictators and sit-tight leaders, damaging institutions and the accountability loop while generating little or no growth in the process. By 2009, foreign aid still accounts for between 50% and 92% of overall government spending of the following countries: Sierra Leone, Liberia, Guinea-Bissau, Rwanda, Gambia, Burundi, Mozambique, Central African Republic, Uganda, Congo DR, Ethiopia, Tanzania and Burkina Faso. Although the flow of foreign aid to governments has since reduced; they are still a significant source of government funding in Africa.

To be continued next week