Is budget support less fungible than project aid?

Something about which I am not particularly bothered is the possibility that, if we give aid to a country to contribute to its school system or health clinics, the effect may be that the government chooses to spend less of its own money on these services, and instead to spend more of its money on something else which did not catch our eye, such as infrastructure or even defence. (This is a concern usually known in development circles as fungibility of aid – though see the pedantic footnote.)

One reason that ‘fungibility’ doesn’t bother me much is that I think that it is a good thing for a government to be able to choose (and to be accountable for) its own spending priorities. To govern is to choose, so if we want to encourage the emergence of capable, accountable and responsive states we should think twice before trying to limit the ability of a government to make choices over its spending priorities. I also think there is a reasonable chance that they are better informed about their priorities than we are.

But suppose you don’t agree with me, and you think that donors should try to ensure that when they give aid, the overall effect is to increase spending on the thing for which they have given the aid.

You have broadly two choices.

Option 1: you can give your aid as a project. You use your own procurement system, pay the contractor directly and check that the clinic has been built, or that the teacher has been trained. So you know that your money has built the school. (Right?)

Option 2: you can give your aid through the government, either through the finance ministry or through the relevant line ministry. They pay for the work to be done, and you can still check that a clinic has been built.

It may look at first like a no-brainer: the project seems to give you more certainty that your money has been used as you intended. But that superficial view is pretty much exactly wrong. There may be good reasons for preferring project aid in particular circumstances, but the ‘fungibility’ of budget support is not among them.

Under option 1 the government is still able to make its own budget allocations. So if you build a clinic the government can, if it wishes, reduce health spending to offset your project spending dollar for dollar. Now it can spend that money on defence, or the President’s palace, or any number of other things. When you ask for assurances from the finance ministry that it will not spend the budget on line items of which you disapprove, it will probably point out that none of your money is involved and that you should mind your own business. There is no way to compare actual health spending with what it might have been without your project, so you can never determine what impact you have had on the government’s budget allocations.

Under option 2, by contrast, the government budget is at least partly your business. You might employ staff to understand the budget allocations and to discuss them with the finance ministry and with line ministries. Before making your grant you seek assurances about the future trajectory of spending you think is important. You might obtain assurances that spending on social services will continue to rise from one year to the next, if that is what you think should happen. If the government decides to spend money in ways you think unwise, or worse, you have some standing to have a conversation with the finance ministry and to ask it to reconsider, or even to make your aid conditional on the overall budget allocations (for example, donors attempted to constrain the growth of Uganda’s military spending in this way).

Here is an example of how our normal assumptions about fungibility can mislead us. A USAID assessment of Mozambique alleges that, “more than $100 million of donor funds were used in 2001 to bail out the failed privatization of the Commercial Bank of Mozambique (BCM)”. Let’s think about what this means. In what sense were ‘donor funds’ used to bail out BCM, rather than the government’s own revenues?

This assertion seems to require us to speculate that if the donors had not given aid to the government, the government would not have bailed out BCM. But is there any reason for thinking that if there had been no aid at all, the government would have felt obliged to spend its own resources on health and education first, instead of the bank bail out? Or would it have bailed out the bank just the same and provided fewer schools and clinics? And if all the donors had run health and education projects themselves, instead of giving aid to the government, what would the government have done with its budget savings in these areas? Would it not have used the money for the bank bail out?

The (explicit) claim that donor money was used for the bail out, and the (implicit) claim that this could happen because the aid was provided through the government budget rather than as stand alone projects, both seem doubtful. The bank bail out would probably have happened anyway: in which case the effect of aid was that there was more provision of health and education services than there would otherwise have been. If so, then in ordinary language we would say that donor funds were used for heath and education (not for the bail out) because that’s the difference the aid made.

Furthermore, in this particular case, the fact that the donors were mainly giving budget support almost certainly resulted in higher spending on social services than if they had been giving only project aid. The donors giving budget support had robust discussion with the government of Mozambique about its plans to bail out the banks, and thereby perhaps limited the resources used for the bail out. If the donors had been giving all their aid through projects, they probably would have not been able to have that conversation at all. If budget support gives the government less room to reallocate its spending because donors have more influence, this suggests that aid provided through the budget is less ‘fungible’ than aid provided as projects.

Whether or not you agree with these judgments about what might have happened in Mozambique, the example shows that our talk about ‘fungibility’ is somewhere between meaningless and irrelevant. We ought to be concerned about whether the clinics or schools got built. We can observe these outputs equally well whether we give project aid or budget support. We get into a mess when we start to speculate about what would have happened in an alternative universe in which we did not give aid, or in which we gave aid in some other way, which is what concerns about ‘fungibility’ invite us to do. We can’t predict whether those outputs would have been built without us, irrespective of whether we give project aid or budget support. Nor can we predict what would have happened to the rest of government spending whichever way we choose to give our aid.

Any statement about ‘fungibility’ requires us to compare the real world with some hypothetical world in which we did not give aid or in which we gave aid in some other way. Whatever we do to improve public financial management in the real world does not solve the problem that we can’t audit the hypothetical world. Even if we had perfect information about the real world – which is what we try to approximate by running our own projects – that wouldn’t tell us more about the alternative world, so it wouldn’t reduce the uncertainty about ‘fungibility’. If you are concerned about fungibility, greater use of stand alone projects is not a rational response.

If we are concerned about how the rest of government spending is allocated, the best way to have some influence is to give some of our aid through the government. Then at least donors can have a conversation with the government. (This isn’t merely a theoretical point. It actually happens. The US tends to be less influential over government budgets and public financial management in developing countries than other donors because it normally provides project aid.)

There are countries in which public financial management systems are incomplete and weak. In those environments we are inclined to be especially careful that the aid we give is used for the purposes we intend. It is common to assume that providing aid as a project makes it less fungible, and so less susceptible to being used to finance spending which is not consistent with our priorities. But this is nonsense. Governments can use the fiscal space created by aid equally well whether you give aid as a project or through government systems; when you give project aid you shut your eyes to the problem, but it doesn’t go away.

Pedants’ corner

Though this issue is usually known as fungibility of aid, to be pedantic the correct label is liquidity of aid since the concern is that aid may substitute for a different asset – namely domestic revenues – rather than another unit of the same asset.

17 thoughts on “Is budget support less fungible than project aid?”

    1. @Lee – Oh indeed, there is also an issue about the possibility of theft. (On that, I suspect there is more theft in NGO projects than most of us want to acknowledge.) But in this post my limited ambition is to tackle the argument of so-called fungibility, which is that the claim that we can show that project aid is used for a particular purpose in a way that we cannot demonstrate for budget support. Once we’ve disposed of ‘fungibility’ we can have a serious debate about the other stuff (efficiency, risk of theft etc).

  1. In face of the dilemma, and from an institution-building approach to development, I think government aid is more likely to help build the institutions and public policies for a context-based development. It will not be straightforward and produce immediate results (and of course all the issues around efficiency and accountability -although these issues also apply to project aid) but development is a long term and iterative process. I think some project aid is still looking for immediate results, too caught up in the limits of ‘log-frame development’ and too western-centred. Then, of course, all depends on the context and the answer to the dilemma might vary depending on the circumstances of each country and its institutions (whether the country is a conflict state, fragile state, a stable and fast growing country, etc.)

    Thanks for the post!

  2. One of my concerns about this debate is that we drift into an either / or debate when actually what might be preferable is a nuanced balance of both, (i have recently worked on several ‘projects’ designed to get PFM systems to a place where ‘budget support’ can be utilized. Unfortunately, the other less talked about driver of DBS, that it is preferable when the donor is rapidly scaling back their own human resources, such as your former employer, it tends to rob of the people who are in a position to make nuanced judgments!
    I also worry that there is a killer assumption at the heart of budget support which is that the recipient Governments want to be accountable, responsive…

    1. @Matt – I’m all for a nuanced discussion of the pros and cons of both (who wouldn’t be?) but let’s do so on the basis of considerations that make sense. One such consideration is fungibility. It is often assumed that budget support is more fungible than projects, but I think that assumption is false. I just wanted to get that particular red herring off the table.

  3. Re: the necessity of government being able to choose, ie manage its budget priorities, look no further in the developed world than the State of California and the economic mess it is in partly due to the fact that the plebiscite based system has partially disenfranchised its legislators from doing their jobs. There are aid programmes, though constituted differently, that have the same such effect on governments in the developing world.

    Option 3: governments continue to set their priorities and budgets and any aid allocations and disbursements are done on a matching or quasi-matching basis. In other words: ‘if they don’t spend, you don’t spend’. This is by and large, though the formulas can get quite complex, how transfer payments work in federal systems. Option 3 therefore, looks upon aid as an international rather than federal transfer payment.

    The main reason such transfers in federal systems have limited resource trap effects is based upon Oliver Williamson’s work in contracts and transaction costs: since the receiving government has its own equity invested, it has reason to make the necessary investments to protect that equity alongside the received funds.

  4. Essentially I agree with Owen, though I think the terminology ” budget support” and “project support” seem to be used in the wrong sense.

    In this context we are only talking about support to a government, which is for the moment the preferred aid modality.

    When we support a government priority, such as building one clinic , and do so through the systems of the government, namely one budget line in the budget, using the government tender procedures, warts and all, it is, in your context budget support, while it is very much a project, or do I understand it wrong?

    In my experience, when donors add some technical assistance to improve the government processes in such an approach, the results can be very positive, and deliver a lot of the added value that are normally associated with projects, while strengthening the programmatic capacity of the government like the wider budget support normally does.

    The whole matching funds proposal seems to me a very strong incentive for creative accounting, while the aid liquidity issue does not diminish in any sense.

  5. The point seems very well made and taken. Perhaps the worry about the recipient government using aid funds (whether project or budget aid) to release matching funds and use them for quite different purposes is greatest when the recipient country is receiving very substantial overseas aid, so that the counterpart funds thus released can be used for all sorts of marginal or objectionable purposes (such as buying a luxury jet for the President, or sophisticated arms that will make possible an attack on a neighbour) which would simply not have been possible in the absence of substantial aid receipts (i.e. unlike your example of the bank bail-out which would have happened even if there had been no foreign aid).

    When I was involved in UK budget aid for Nigeria, a very long time ago, I seem to remember that we tried hard to maintain some control over how the counterpart local currency released by the foreign exchange funds we were supplying would be used, and to do what we could to ensure that those funds would be both developmentally useful and also additional to what the Nigerian federal government would have done if they had not been available. Of course we could never be 100% sure of achieving either purpose, but at least we tried. This may have entailed a degree of intervention in Nigeria’s fiscal and development policies that would not be acceptable nowadays, but we would have sought to justify it, if challenged, on the grounds that the level of corruption and sheer thievery in Nigeria was so high that UK taxpayers would have been outraged if we had seemed simply to give the Nigerians a cheque and hope that they would spend the money wisely.

    Incidentally, in discussing these issues at the time we often referred to the obvious fact that money is ‘fungible’, but I don’t recall anyone calling aid fungible. Perhaps more of us had read classics in those days.

  6. Owen– As usual your clear reasoning displays the flaws in conventional notions about aid. Project aid is just as fungible as direct support. However, I don’t think you can dismiss the issue of outright theft as a completely separate issue from the problem of fungibility. Indeed, I would say the fungibility issue is really a red herring for what donors are most concerned about– government theft. Many donors prefer to give to contractors because they can audit contractors, hold them responsible for theft in ways that it cannot hold a foreign government responsible– particularly when the principal-agent relationship is mixed up with a bilateral diplomatic relationship. I agree that the idea that one can put a fence around aid that is a liquid commodity is an illusion. But it is an illusion which serves an important purpose– it reassures taxpayers and constituents that somehow what they are supporting in a country which is badly governed and possibly run by thieves can be separated.

    If you take this illusion (red herring) off the table, then donor governments have a much tougher decision about providing aid to rotten governments. It won’t be in a parallel universe, but in our world that governments will have to decide that no form of aid should go to a country that is run by people who are more interested in lining their pockets than helping their own people. While it may be more coherent, it could also be to the detriment of the people of Cameroon, Chad, Zimbabwe, and so on.

  7. Jonathan Glennie

    Very good post and v convincing about lack of counter factual, which is a reality that affects all aid assesments, not just budget support vs project. The issue you don’t mention which many recipient govts are raising re budget support is that this influence you mention is sometimes considered obtrusive ie even more intervention in sovereign govt processes than previous forms of conditionality. Clearly that is not what this post is about, but it would seem to be one of the major problems with general budget support, if less so for sector budget support. J

  8. I note that other responders have also talked about an option ‘3’ and I wonder if I could add in an additional option that being that no money for clinic or school be provided either by budget support or by project aid. This may seem somewhat radical but in a simplistic theorectical world such an option in my mind would lead to one of two outcomes. Firstly the government in question would have to use its own resources to build said school or clinic and as Owen alludes to the assumption of this course of action would be that as the government has limited resources it would have less funds to spend on the alternative – in this case defence. The second outcome is that the government simply spends what money it has on defence i.e. not bothering with the school or clinic at all. This doesn’t necessarily appeal to our Western mindset but as a recent WB report stated there is no point ‘doing development’ until one has security so it could be argued to be a constructive use of resources. Also this outcome could be seen to be acceptable to Owen if we use his reasoning about it being a good thing to ‘give government the choice over its own spending priorities’.

    In some ways I agree with Owen’s approach i.e. that all this talk of fungibility is a bit of red herring. The question for me is less about the question of fungibility but more about whether budget support is in fact more effective than project aid per se – it may be that I don’t have enough knowledge of this area but I haven’t yet seen any definitive evidence to show that it is – Owen/others perhaps you could point me to appropriate reports indicating that budget support is the more effective mechanism? In addition having read the post and subsequent comments I keep wondering where in all our theorectical pondering does the question of sustainability come in? When I use the S word I think I’m talking about the ability of a country to fund services for its people over a longer and more permanent timeframe utilising its own resources. It doesn’t matter whether these services are related to defence, trade, health or education the problem is surely whether they’re able to do any of this in a way in which they don’t become completely dependant on bilateral donors. I haven’t read much more of your blog yet Owen but would be interested to hear your thoughts on this question of sustainability aka Billy Easterly.

    Lastly I would note that the idea of budget support supposedly giving us more of a say in what a country does didn’t seem to work out very well in Malawi but then neither did giving lots of money in project aid either – when the President wants a new jet the president gets a new jet.

    Finally finally I’d note that following on from my comments about sustainability and by allusion percentage of aid to GDP ratios I found reading the ODI’s recent case study reports on development quite interesting especially when you compare what they said about economic progress in Vietnam (successful and likely to be sustainable) and economic progress in Malawi (also a success but reading between the lines not likely to be sustainable perhaps because all the money for the import substituion policies came from donors).

  9. @ HK – “by allusion percentage of aid to GDP ratios”

    “The various adverse repercussions, on the other hand, are brought about by amounts of aid which, while small as a percentage of gross domestic product of recipient countries, are often a significant part of government revenues and of foreign exchange earnings. …

    For India [all 1980 figures], aid was 1.6 per cent of recorded GNP, 16.8 per cent of tax receipts and 31.2 per cent of export earnings. For Tanzania, the corresponding figures were 18.1 per cent, 106.8 percent and 152.8 per cent.”

    P.T. Bauer. Reality and Rhetoric. p. 47.

    I briefly presented an option 3, not just along the bases of Williamson’s arguments that investing equity is the best long-run defence against sub-goal pursuits, but that the matching argument will not distort Bauer’s triptych to the point that aid becomes a disincentive to government making the necessary public goods investments for economic growth. As to where lies the tipping point to aid overwhelming a capital deficient economy and producing resource trap effects – I have absolutely no idea.

  10. Giving money to accountable governments is a no-brainer. The real challenge is figuring out how to give money to governments that are not accountable. Such governments may know their citizens’ priorities (as you suggest), but in too many cases they choose not to spend on these.

    You ask: “is there any reason for thinking that if there had been no aid at all, the government would have felt obliged to spend its own resources on health and education first, instead of the bank bail out?” I think the answer is ‘yes’. Doesn’t the fiscal space created by aid make it even easier for governments to spend on their pet projects rather than on real priorities?

    So the impulse to exert control on unaccountable government is understandable, even if its expression in the form of project aid has proved to be misguided. The fact that project based aid does not work, does not mean that no control is possible, but rather that we need to look for more sophisticated forms of control.

    It is probably time to stop beating up on project aid and to talk more seriously about what less misguided control looks like. The good news is that a growing number of donors are thinking harder about how to build the domestic accountability that should eventually make their efforts to control superfluous.

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  12. ‘Doesn’t the fiscal space created by aid make it even easier for governments to spend on their pet projects rather than on real priorities?’

    Of course. It also makes it easier for governments to collect less tax than they should.

    Billions are being pumped into Tanzania’s systemically corrupt government via budget support. Huge grand corruption cases are being ignored by Mr Barder’s former employer, DFID, as they attempt to pump even more into budget support Thankfully, other donors are beginning to see the light:

    Most of the money is being stolen or eaten up by ‘quiet corruption’ and the government’s record on the collection of tax, licence and excise duties is abysmal – why bother collecting direct and indirect taxation when you can pocket bribes from those who should have paid instead?

    Yes of course it’s just as likely that money spent on projects will be stolen. Ditto aid given to NGOs. Meanwhile….

    However, donors put hitting their .7% GDP targets before worrying about how where the money actually goes so this is all pretty academic, isn’t it? Fungibility is a complete red herring.

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