A recent entry over at Unrestricted Domain raises an interesting and important point which is often ignored in the discussion of the relationship between aid and growth.
Unrestricted Domain says:
To be honest, I’d find it extremely odd if several hundred billion dollars failed to yield any benefit whatsoever.
This is absolutely right. And it highlights that not everyone realises that the various aid-growth studies are an attempt to measure the medium term growth benefit to the economy over and above the direct benefit of the transfer of the aid.
Say, for example, that the UK gives $1 million in aid to Uganda. Even if this aid had no long term growth benefits, the direct effect is to reduce consumption in the UK by $1m, and increase consumption in Uganda by the same amount (assuming that it all arrives – which on the whole it does). If Ugandans get more benefit from the money than we do (economists call this diminishing marginal utility) then the Ugandan gain in welfare from the extra $1m will be bigger than the British loss of welfare, and the world as a whole will be better off. Transferring money from someone who will barely notice the difference to someone who goes to bed hungry is, in itself, a good thing. To my mind, that would be justification enough for aid, even if it did not increase growth but simply shifted consumption from the relatively rich to the relatively poor.
But the aid-growth regressions are a more demanding test of aid effectiveness. The question they ask is: what is the effect of these transfers on the growth of the economy, over and above the direct benefit of the transfer? Clearly, if aid is invested in transport infrastructure, commercialisation of state utilities, or in improving agricultural productivity, it might be expected to have long term benefits above the simple increase in consumption that it permits.
The most recent, careful study finds that aid does have a considerable positive impact on growth. On average, aid worth one percent of national income increases annual growth in the recipient country over the medium term by about a quarter of a percentage point a year. Or, viewed as an investment in the growth of developing countries, the average rate of return from aid is at least 13% – which is higher than many other uses of public funds. These rates of return are additional to the direct benefit of the aid transfer.
In other words, aid would be justified even if there was no long term impact on growth, as it would still increase incomes of people who need the money most, at only a modest cost to those who pay. The fact that a whole raft of studies find that, on top of this, there are long term benefits for the recipient economy strengthens the case, but the case for aid does not depend on this finding.