Evaluate the impact of aid on economic growth.

Evaluate the impact of aid on economic growth.

The relationship between aid and economic growth is increasingly attracting so much literature in recent years. The last three decades witnessed a dramatic growth in aid inflows to Less Developed Countries (LDCs) as advanced economies continue to extend assistance to the world`s poor countries. However, most aid flows are coming from the UK, United States of America Europe, Japan and the Nordic group such as Sweden, Denmark, Norway and Finland countries. It appears as if low income countries heavily depend on foreign aid to finance the level of investments needed to achieve sustainable growth. Many developing countries experience high unemployment, high inflation and balance of payment deficits among others due to inadequate investments in key sectors of their economies. So foreign aid would be needed to finance essential factor endowments like training the country`s workforce, advanced technology, capital investments. Also, most aid receiving nations are prone to external shock because of their dependent on primary commodity exports which can adversely be affected by changes in world demand and weather conditions. As a result, growth rates of most developing countries are not very sustainable as their economies experience higher inflation, fiscal and trade deficit. So it’s a great challenge for developing countries to attain economic growth without some form of external help either in the form of bilateral or multilateral aid. It appears as though foreign aid does provide a foundation for economic growth as it seek to cushion away some of the burden experienced by Less Developed countries (LDCs). Therefore the paper analyse the impact of aid on economic growth of the receiving country.

Furthermore, there are evidence to suggest that foreign aid work in alleviating poverty and promoting economic growth in developing countries. For example, the recent awareness campaign by anti-global poverty activists at the G8 summit in 2005 in Scotland highlight the importance of foreign aid to Less Developed Countries (LDCs. As most developing countries continue to experience mounting debt problem, budget deficits, and high unemployment and worsening poverty, foreign aid can be used to finance development projects aimed at stimulating economic growth or to meet debt repayment. For example, almost 40% of aid inflow in Senegal is used to finance debt obligation (Ekanayake,E and Chatrna.D, 2007)and this may help a country to focus on improving human capital,  technological advancements, and other infrastructures needed to attract private investments such as foreign direct investments . Moreover, by directing aid inflow to meet debt repayment increase a country`s credit rating as a result, funding from lenders would be easily available. Therefore, foreign aid is paramount to the success of recipient countries as it provides extra capital to build necessary tools required for economic growth.

In addition to that, many developing countries continue to experience recurring economic problems ranging from fiscal disparity, trade shocks and poor domestic consumption and all these hardship affect growth as such foreign aid would be necessary tool in encouraging economic growth to Less Developed countries. Pinto and Bayraktar (2008), argues that aid inflow improve budgetary balance and lead to increase in public investment thereby raising the nation`s capital stock thus creating essential conditions for inward foreign direct investments. In other words foreign aid provide desired framework for private investments which are the main drivers of economic growth. Moreover, given that most Less Developed economies largely depend on export earnings from primary goods which are prone to changes in world markets and weather patterns, foreign aid is vital to these emerging economies. Thus, a fall in world demand of primary commodities is likely to cause severe trade deficit of a country whose economy is based on primary commodity exports.  This is echoed by McGillivray (2003), he found that a 40% negative trade shock has a potential of reducing economic growth of country by more than 1%. The availability of foreign aid can mitigate the adverse effects of trade shock and prevent a country from going into recession as such it look like aid has a positive effect on economic growth.

Though aid seem to provide financial assistant to poor countries, countries respond to aid inflow differently as some countries react positively and others respond negatively. For example, Botswana and Republic of Korea in the 1960s and Ghana and Bolivia in the 1980s, and lastly in the 1990s Vietnam and Uganda responded positively to foreign aid, hence achieving economic growth. However, many developing countries that received huge sums of aid performed poorly in terms of attaining economic growth, they include, Zambia, Nepal, Zaire among others. These countries responded negatively to foreign aid and on the other hand, countries that receive little aid inflows such as Costa Rica, Algeria and China performed well to a number of economic indicators (Harrigan, J.and Wang.C, 2011). The reason why countries react differently to foreign is likely to be caused by a number of factors, for instance many developing countries do not have adequate infrastructure to deal with corruption, and ineffectiveness of policy framework of recipient countries. So the intended goals of aid tend to fail if recipient countries do not have enough resources to enforce sustainability use of foreign aid flows. This could provide an explanation as to explain why Zambia and other developing countries reacted negatively to foreign aid in terms of achieving economic growth.

Besides, that almost every year advanced countries give out large sums of money in bilateral aid to developing countries. The United States which is one of the largest foreign donors spent almost $20 billion on development assistance in 2004 and in the 1990s foreign aid claimed on average 0.5% of government budget(Milner,H.V and Tingley,D.H,2010).Donor make extensive use of their aid programs to promote their strategic and political interests (Wagner.D, 2003).For example, USAID is heavily influenced by the country`s interest in the Middle East  and almost one third of bilateral aid is allocated to Egypt and Israel (Minoiu, and Reddy, 2010). This is because American aid is linked to the country`s foreign policy and economic interest, whilst the UK and France seem to direct most of their bilateral aid to former colonies. Therefore, foreign aid will have negative impact on economic growth if donors` aid programs deviate away from economic and social needs of the recipient country. In other words , it appears as though the outcome of aid programs to developing countries is influenced by the donor`s motives and this might provide a clue as to why majority of countries perform poorly in the presence of aid. Moreover, foreign donors are also driven by strategic interests in developing world, and according to Wagner.D, (2003), 50% of bilateral aid in the 1990s was tied or partially tied to exports. Aid that is driven by political and strategic interests of the donor is likely to have a negative impact on economic growth since little or no emphasis on poverty alleviation would be addressed.

Moreover, the other area of consideration when examining the impact of aid on economic growth, it could worth pointing out that most aid programs received in developing countries have conditions attached to them. So most these conditionality aid programs focuses on demand restraint policies, usually implemented by large reductions in government expenditure through measures such as removal of subsidies, public sector employment cuts, privatization and tax reforms as well as liberalism of domestic economy. Although such conditionality on aid might have desired goals of encouraging efficiency economic practice in developing countries, there is growing evidence that majority of countries which implemented structural reforms performed badly. For example, structural reforms in Latin America between 1980s-1990 failed to resort economic growth in the region possibly because some policies prescribed by bilateral and multilateral aid donors were irrelevant to the region`s own growth strategy. Also the real wages rates dropped sharply in Latin American economy than the previous three decades of post war period (Woller, G.M and Hart, D.K, 1995) as the region experienced high inflation driven by economic restructuring of that 1980s-1990s.Huchison and Noy,(2003) concluded that  macroeconomic stabilization programs in Latin America were unsuccessful because IMF sponsored structural reforms did not have provide a platform that would put a stop the cycles of instability in the Latin American region. Therefore, in the presence of conditionality, foreign aid is likely to negatively affect economic growth of the receiving country.

In addition to that, the conditionality attached to aid often embodies element of strategic, economic and political motivations of donors which may diverge from the recipients on development goals (Wagner.D, 2003). Hence aid that is driven by self-interest of donors could distort the aid transfer process and may negatively impact on economic growth. For instance countries that give bilateral aid to gain export market of their capital goods to developing countries such aid is likely to respond positively to donor country that to the recipient. The argument presented by Milner,H.V and Tingley,D.H,2010) and (Wagner.D, 2003) that foreign aid which is aimed at promoting donors’ interests will only respond positively to donors’ objectives than promoting economic growth. The case for US aid which appear to focus on promoting America`s foreign policy and to enlarge its export market base somehow challenge the contention that aid work for developing countries. However, empirical evidence shows that bilateral aid from Nordic countries does appear to have positive effects of economic growth. The success of aid from Sweden, Denmark, Norway and Finland is more development oriented as it focus on strengthening economic infrastructure of the receiving countries such as poverty alleviation and social services programs. It would fair to say most Scandinavian donors have no special interest in the recipient country and as such aid programs are centred on promoting economic development. Given that most developing countries lack adequate infrastructure to attract private capital inflow, aid that is orientated towards build the necessary framework for national competency will have positive impact on economic growth of the recipient countries.

The intended objective of foreign aid is to create a platform for economic growth such as job creation, better education facilities, increased in taxable bases, and improve in health provisions of country or region.  In contrast the number of foreign aid recipient countries which appear to benefit from aid inflows are narrowing suggesting that aid could be detrimental to economic growth than it is perceived of. The outcome of foreign aid on economic growth is affected by a number of factors such as the manner, in which donors allocate their aid. So donors who allocate aid to promote their own interest rather than the recipients’ goal will yield negative on growth. Similarly many growing empirical studies shows the adverse effects of conditionality attached to foreign aid, particularly those that require recipient countries to liberalise their economies. In my view such donor policies are damaging growth potential recipient countries because liberalism expose the country to numerous risks such as in inflation, risk associated with trade and capital outflows. For example capital flight was a major problem in Latin America when the region relaxed exchange controls at a time of economic instability. So donors’ policies which seek to promote capitalism in developing countries in exchange for aid do in a way worsen economic growth in developing. Therefore, for aid to have positive impact on economic growth, it has to address economic and social needs of the recipient and be geared towards development.

Conclusion

The relationship between aid and economic growth has attracting large volume of literature in recent years and practitioners seem to disagree if aid does promote economic growth. Given the motive of some major donors it is highly unlikely if aid is going to have a positive impact on economic growth of recipient countries. For this reason aid that is driven by donors` economic, political and strategic interest will have negative effects on economic growth. The worsening economic crisis in most developing countries like those in Sub-Saharan Africa is alarming given the extent of foreign aid flows to these countries. However one major reason to this could be cause by conditionality attached to foreign they receive, many of these countries have implemented liberal economic policies with little success as a result incidence of extreme poverty, and unemployment and shrinking real GDP are common. This raises serious questions regarding the impact of aid on growth, is it that foreign aid fail to encourage growth orientated projects or failure is caused by corruption in recipient countries. I would therefore conclude that aid is very important to poor countries if it provide the foundations of economic growth of the recipient and is free from donors` strategic and economic interests.