Lindsay on unpredictability

Lindsay Morgan describes the problem of unpredictable aid:

And although more aid, even disbursed on short notice, might seem like a good thing, it’s difficult for governments to spend on useful things when they can’t predict what next year’s aid will amount to. For example, governments can’t hire teachers with a boost in aid this year, when they don’t know if they will have money to pay them next year.

2 thoughts on “Lindsay on unpredictability”

  1. I’m not sure why we seem to think poor countries are not as capable of managing the same challenges that virtually all governments face—i.e. matching uncertain revenue streams with financial needs. In most of the United States virtually every municipal government is facing this problem. Rather than guaranteeing poor governments (which often have poor financial controls and poor systems) uninterupted streams of aid money, we should be improving their ability to manage this challenge– whether it comes from the unpredictability of aid flows or the unpredictability of their own tax base.

    Owen replies: Jeff – Homi Kharas’s estimate of the cost of unpredictability is the cost as seen from Wall Street, not as seen from Lusaka. It uses an option pricing model to estimate the market value of a volatile aid stream. So his estimate does not assume that poor countries are less able to manage the challenges than rich countries – it estimates what the cost to them of doing so would be. (Unpredictability also costs us money in rich countres, which is why people make money in insurance, bond markets and exchange rate hedging).

    But there are some good reasons why volatility is a bigger problem in developing countries than in rich countries. Aid inflows are much more volatile than domestic revenues in developing countries or developed countries, so they are having to deal with bigger swings than we are. Formal economies are less well developed so they have fewer options for diversifying their revenue base. Financial markets are less well developed so it is either more expensive or impossible to hedge risks.

    Most importantly of all, people in developing countries do not have saftey nets of unemployement benefit or welfare systems. If someone loses their job in the US it is a big personal cost to them. But it is unlikely to mean that their children will suffer from malnutrition, or have to be withdrawn from school; farmers are unlikely to have to sell their oxen or their seeds for next year’s planting. If a school teacher cannot be paid in Rwanda, that can affect not only the teacher but an extended family, and the costs can be both devestating and permanent. The welfare costs of financial volatility are much greater in developing countries than in rich countries.

  2. I don’t know about the UK, but the social safety net here in the US is rather shredded these days. Many municipal and state governments are struggling with sudden,unanticipated shortfalls in revenues and believe me, it translates into real pain here. Oddly many of these governments also have limitations on their ability to conduct deficit spending, raise cash in the bond markets, etc. My main point is that developing country governments need to focus on risk management tools to address uneven revenue flows from aid rather than trying to convince donors to make consistent, multi year donations. Such multi year commitments would, in my view, remove what little accountability some governments have for their aid.

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