All foreign aid is, in the end, used to pay for imports.
In a few moments we’ll discuss why this is true and why it matters. But let me offer two apologies.
To those for whom this is a statement of the bleedin’ obvious, sorry for wasting your time. Please feel free to skip down to the reasons why this important.
And to those for whom this is a shocking revelation, I am sorry to puncture the bubble. This reality is not the result of a conspiracy between aid agencies and commercial interests but an unavoidable consequence of the fact that aid is provided from abroad.
In what sense is all aid used to pay for imports?
Suppose a rich country gives $100 million in aid to a poor country. The recipient may be a person or organisation, or the government. Sometimes the aid is given as money, sometimes as goods and services (such as food aid, or technical expertise). If the aid arrives as imported goods and services, then the aid has been used, by definition, to pay for imports.
But suppose the aid comes not as goods and services but as foreign currency. The only value of that foreign currency is that it can be used to buy imports from abroad.
Of course the recipient might do something else with the foreign currency, like sell it or save it. But in the end the foreign currency has to be used to pay for imports, or it is worthless.
Suppose you send $100 to an NGO in Nairobi. That NGO might want to use your donation to pay its rent. The NGO has to sell the $100 and get Kenyan shillings to pay its rent. The people who buy the $100 want the dollars at least as much they wanted the equivalent amount of Kenyan shillings. Why? So that they can buy something from abroad, either today or in the future (or sell the dollars on to someone who will). Instead of using their Kenyans shillings to buy something locally, somebody at the end of the chain must be selling their shillings and using the $100 to buy something from overseas. So the impact of your donation on the NGO has been that it can pay the rent (which of course is not an import); and the net impact on Kenya as a whole is that imports have gone up by $100. The additional imports are of value to someone in Kenya, and because you originally gave the claim on those additional resources to an NGO, the NGO was able to use the value of those additional imports pay its rent.
The same argument applies to aid given as budget support to governments. We may expect that the recipient government will use the money to employ teachers and nurses, or to build roads. None of that may be imported. How does giving foreign currency to a government help it to employ teachers? The answer is that we have given them something of value – a claim on imports – which they can trade in the economy to get the money they need to enable them to pay teachers. But since the thing of value we have given them is a claim on imports, the government can only use it if somebody somewhere in that economy wants the imports enough to give up some local currency in return. The aid is in the form of additional imports, even if the ultimate importer is not the original beneficiary of the aid.
It maybe that someone will save the foreign currency – perhaps the Central Bank will use it to increase its reserves, or a firm might keep some dollars in a safe. But these savings have value because the money can be used, by someone somewhere, at some time in the future, to pay for an import.
This should all be uncontroversial – it is, after all, just another way of describing the national accounts identity. Aid is a capital inflow; and an increase in capital inflows must be matched by an equal and opposite current account deficit. So when aid goes up, either imports must increase, or if imports stay the same, exports needed to pay for imports must go down.
Why does it matter that all aid ends up as imports?
Here are some consequences
- Aid to developing countries is a fiscal stimulus for rich countries.
If the cause of the economic crisis was that rich countries were consuming too much relative to how much they were producing, the only possible way out of that is for rich countries to increase production faster than they increase consumption, and that means increasing exports. Increasing aid does that.
- The question of how much aid “ends up” in a developing country is a red herring.
All aid “ends up” as goods and services imported from abroad. The right question is whether they are the most valuable goods and services, and who benefits from them.
- Effective aid must inevitably increase the current account deficit of recipient countries.
Hare-brained schemes to “sterilize” the effect on the balance of payments could only work by preventing the aid from being used. A worsened current account is the accounting counterpart of increased aid. Unless you are a paid-up mercantilist, you’ll know that getting more imports for nothing, or not having to export as much for the same amount of imports, is a good thing. (Of course, if the aid is used for things that increase the country’s productivity, that might increase exports and so improve the current account, but that is a second-round effect which might or might not offset the direct effect.)
- The only significant difference between budget support that some donors give today, and the old balance of payments support they used to give, is the nature of the political dialogue that accompanies it.
In the old days, donors were happy to be told that the money would be used for imports (what else could it be used for?). Today, by calling it budget support, donors feel able to get more engaged in how the government allocates its overall resources. It is weird that auditors seem to think this is a riskier business, when the economics is the same.