The effectiveness of aid agencies

There are people who think that there should not be a significant expansion of aid to developing countries; of these, some believe that all aid harms the recipient, while others believe that aid is generally effective, but that there are diminishing marginal returns which mean that expanding aid significantly beyond current levels would not be effective. 

One concern about increasing aid is that there might be adverse macroeconomic effects from large aid inflows, broadly comparable to the Dutch Disease effects associated with export earnings from natural resources.  These resource inflows lead to an appreciation of the exchange rate, which can make domestic industries internationally uncompetitive.  Recently, some literature has focused on the negative impact that large external resource flows might have on governance and accountability. If there are small benefits from additional aid, then it is possible that these negative effects might outweigh the benefit of marginal extra aid dollars.

In a very interesting new paper, Is Aid Oil?, Paul Collier compares the impact on African countries of aid inflows with the impact of revenues from natural resources.  Collier finds that the way in which aid is given makes it vastly better than resource rents as a source of finance.

Aid evidently has very different effects from resource rents. Indeed, when aid is introduced alongside resource rents in the Collier-Hoeffler growth regressions described above, the hypothesis that they have the same effect can be decisively rejected. This suggests that the superior average results of aid are not simply due to better allocation among countries: within a given county aid and resource rents have distinctive effects. In turn, this tells us that the in-country modalities of aid have made an important difference. 

Aid agencies are adding value to the transfers that they administer, and indeed doing so to a very considerable degree. The evidence of oil implies that aid agencies face an intrinsic problem: the baseline effect of resource transfers is negative and the agencies have to offset this by purposive allocation and complementary inputs. Nevertheless, such an activity need not be forlorn: an analogy with the effects of hospitals might help to clarify the point. The baseline for hospital activity is also significantly negative. By bringing patients with a variety of illnesses together in a single building, a hospital transmits disease. Even in well-run hospitals, many people contract illnesses from others while there, and spread these illnesses when they leave. Nevertheless, societies rightly see hospitals as vital: the value-added of a well-run hospital far offsets this negative baseline effect. This seems to be the story with aid agencies. The radical critics of aid are correct in the sense that the effects they point to are adverse and important, as demonstrated by oil. But their overall assessment is as wrong as would be a proposal to close hospitals. Indeed, their critique would be far more usefully directed to reforming the governance of oil revenues: the task of making oil work more like aid is far more promising than thetask of making aid work better.

Full disclosure: the author is an official of the UK Department for International Development, currently on unpaid leave to work at the Center for Global Development.

1 thought on “The effectiveness of aid agencies”

  1. I like the look of that Collier paper – looks like a very clever way of reconciling some superficially opposing arguments on aid.

Leave a Reply

Your email address will not be published. Required fields are marked *