Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa (11 page)

Even in an environment where the domestic currency is not freely floating, but rather its exchange rate remains fixed, the Dutch disease phenomenon can occur. In this case, the increased availability of aid money expands domestic demand, which again can lead to inflation. Aid flows spent on domestic goods would push up the price of other resources that are in limited supply domestically – such as skilled workers – making industries (mainly the export sector) that face international competition and depend on that resource more uncompetitive, and almost inevitably they close.

The IMF has stated that developing countries that rely on foreign capital are more prone to their currencies strengthening. Accordingly, aid inflows would strengthen the local currency and hurt manufacturing exports, which in turn reduces long-run growth. IMF economists have argued that the contribution of aid flows to a country’s rising exchange rate was one reason why aid has failed to improve growth, and that aid may very well have contributed to poor productivity in poor economies by depressing exports.

In other work, their research finds strong evidence consistent with aid undermining the competitiveness of the labour-intensive or exporting sectors (for example, agriculture such as coffee farms). In particular, in countries that receive more aid, export sectors grow more slowly relative to capital-intensive and non-exportable sectors.

Aid inflows have adverse effects on overall competitiveness, wages, export sector employment (usually in the form of a decline in the share of those in the manufacturing sector) and ultimately growth. Given the fact that manufacturing exports are an essential
vehicle for poor countries to start growing (and achieving sustained growth), any adverse effects on exports should
prima facie
be a cause for concern.

Moreover, because the traded-goods sector can be the main source of productivity improvements and positive spillovers associated with learning by doing that filter through to the rest of the economy, the adverse impact of aid on its competitiveness retards not just the export sector, but also the growth of the entire economy.

In the most odd turn of events, the fact that aid reduces competitiveness, and thus the traded sector’s ability to generate foreign-exchange earnings, makes countries even more dependent on future aid, leaving them exposed to all the adverse consequences of aid-dependency. What is more, policymakers know that private-to-private flows like remittances do not seem to create these adverse aid-induced (Dutch disease) effects, but they largely choose to ignore these private capital sources.

As a final point, in order to mitigate the Dutch disease effects (and depending on their economic environments), policymakers in poor countries generally have two choices. They can (in a fixed exchange rate regime) either raise interest rates to combat inflation to the inevitable detriment of the economy, or they can ‘sterilize’ the aid inflows.

Sterilization implies that the government issues bonds or IOUs to people in the economy, and in return they get the cash in the economy. Through this process the government can mop up the excess cash that aid brings in. But, as discussed later, even sterilization has its costs.

Very often, poor countries cannot actually use the aid flows granted by rich governments. At early stages of development (when countries have relatively underdeveloped financial and institutional structures) there is simply not enough skilled manpower, or there are not enough sizeable investment opportunities, to put the vast
aid windfalls effectively to work. Economic researchers have found that countries with low financial development do not have the absorptive capacity for foreign aid. In countries with weak financial systems, additional foreign resources do not translate into stronger growth of financially dependent industries.

What happens to this aid money that can’t be used? In the most honest of outcomes, if the government did nothing with the aid inflow, the country would still have to pay interest on it. But given the policy challenges of large inflows discussed earlier (for example, inflationary pressure, Dutch disease effects), policymakers in the poor country must do something. Since they cannot put all the aid flows to good use (even if they wanted to), it is more likely than not that the aid monies will be consumed rather than invested (as before, thereby raising the risk of higher inflation).

To avert this sharp shock to the economy, African policymakers have to mop up the excess cash; but this costs Africans money. In addition to having to pay the interest on the aid the country has borrowed, the process of sterilizing the aid flows (again, issuing local-country debt in order to soak up the excess aid flows in the economy) can impose a substantial hit to the government’s bottom line. Uganda offers a telling example of this. In 2005, the Ugandan central bank issued such aid-related bonds to the tune of US$700 million; the interest payments alone on this cost the Ugandan taxpayer US$110 million annually.

Naturally, the process of managing aid inflows is particularly painful when the interest costs of the debt the government pays out are greater than the interest it earns from holding all the mopped-up aid money.

Corruption, inflation, the erosion of social capital, the weakening of institutions and the reduction of much-needed domestic investment: with official aid to the continent at 10 per cent of public expenditure, and at least 13 per cent of GDP for the average
country, Africa’s continual aid-dependency throws up a host of other problems.

Aid engenders laziness on the part of the African policymakers. This may in part explain why, among many African leaders, there prevails a kind of insouciance, a lack of urgency, in remedying Africa’s critical woes. Because aid flows are viewed (rightly so) as permanent income, policymakers have no incentive to look for other, better ways of financing their country’s longer-term development. As detailed later in this book, these options, like foreign direct investment and accessing the debt markets, offer more-diversified and greater prospects for sustainable development.

Relatedly, in a world of aid-dependency, poor countries’ governments lose the need to pursue tax revenues. Less taxation might sound good, but the absence of taxation leads to a breakdown in natural checks and balances between the government and its people. Put differently, a person who is levied will almost certainly ensure that they are getting something for their taxes – the Boston tea party’s ‘No taxation without representation’.

Besides, any rational government should be thinking about different forms of taxation as a way of running their affairs. In today’s culture of aid-dependency, were aid to disappear (as unlikely as it seems), a country’s tax-raising mechanisms would have atrophied to a point of incapacity.

Large sums of aid, and a culture of aid-dependency, also encourage governments to support large, unwieldy and often unproductive public sectors – just another way to reward their cronies. In his research, Boone (1996) finds that aid does increase the size of the government.

The net result of aid-dependency is that instead of having a functioning Africa, managed by Africans, for Africans, what is left is one where outsiders attempt to map its destiny and call the shots. Given the state of affairs, it is hardly surprising that, though ostensibly high on the global agenda, the Africa discourse has been usurped by pop stars and Western politicians. Rarely, if ever, are the Africans elected by their own people heard from on the global stage. And even though, as discussed earlier, the balance of power
may have shifted supposedly in favour of the African policymakers, it is still the donors who are in the policymaking driving seat (which might help explain why, over the last five decades, independent African policymaking and national economic management have diminished considerably). So aid-dependency only further undermines the ability of Africans, whatever their station, to determine their own best economic and political policies. Such is the all-pervasive culture of aid-dependency that there is little or no real debate on an exit strategy from the aid quagmire.

Dead Aid
is not the first critique to be levelled against aid as a development tool. One of the earliest critics of aid was a Hungarian-born London School of Economics economist, Peter Bauer. At a time when the pro-aid model enjoyed wide support, Bauer was a lone dissenting voice, many of his writings drawing on his personal experience as a colonial officer studying the rubber industry in Malaysia and Nigeria. He saw what should have been flourishing industries wrecked by huge aid subsidies that rarely reached the indigent in the recipient country.

Aid, Bauer argued, interfered with development as the money always ended up in the hands of a small chosen few, making aid a ‘form of taxing the poor in the west to enrich the new elites in former colonies’. Bauer argued most strongly that aid-based theories and policies were wholly inconsistent with sound economic reasoning and, indeed, with reality. Although he was a favourite of the British Prime Minister, Margaret Thatcher (she gave him a peerage
¹⁰
), at the time of his death in 1992 Peter Bauer was an outcast from the state-led socialist development agenda and his critique of the aid-based development strategy remained largely ignored.

More recently, the author and former World Bank economist Bill Easterly has provided numerous case studies on the failures of aid policies across the developing world. In
The Bottom Billion
,
Paul Collier criticizes the blanket one-size-fits-all aid approach as paying no heed to the unique circumstances of individual countries, and thus proposes a more nuanced approach to aid-driven proposals, and only where they are needed.

Perhaps where all this literature falls down somewhat is that it does not explicitly offer Africa a menu of alternatives to aid. But, more importantly, the people who actually and actively implement the aid agenda are yet to be convinced. These are the people who are so wedded to aid that they are unable to see Africa as anything but helpless without aid intervention.

What follows is a discussion of other, better ways for Africa to finance its economic development; ways that have been tried and tested in places as far-flung as India, Russia and Chile, and even, closer to home, in South Africa.

Population: 30 million. Average life expectancy: forty years (down from sixty-five in the past twenty years, mainly because of the HIV–AIDS epidemic; in its cities, one in three adults have the disease). Annual per capita income: US$300, with 70 per cent of its population living on below US$1 a day. Average growth rate in the past twenty years was 1 per cent and 5 per cent in the last five years: has benefited from a recent copper price surge. Chief exports: copper, gold, cotton and sugar. Political system: adopted a nominal democracy ten years ago, having spent twenty years as a one-party state led by the same political party, and the same president.

This is the Republic of Dongo. While fictitious, the Republic of Dongo is not far off the reality of many African countries. Freed from European colonial rule in the 1960s, the country’s background and evolution are pretty characteristic of the average African country. A socialist economy in the 1970s, it underwent privatization in the mid-1980s, moved to a democratic regime after
Glasnost
and
Perestroika
,
¹
and is ranked 3 out of a possible 10 on the Transparency International Corruption Perceptions Index (where 0 is the least transparent). In the 1980s the country had accrued as much as US$3 billion of debt – twice as much as the country’s annual GDP, and more than three times its combined education and health budgets. Dongo benefited from debt relief in the early part of the 2000s, which left minimal debt. Yet the country remains the beneficiary of millions of dollars of aid each year. Aid share of GDP: 10 per cent. Aid as a percentage of government revenues: 75 per cent.

Like Nigeria and Malawi, Dongo was granted its independence in the 1960s. Like Uganda and Botswana, it is struggling under the weight of HIV–AIDS. Like Zambia, Mali, Benin and the
Democratic Republic of Congo, Dongo relies on commodities (mineral and agricultural) as a primary source of export revenue (by comparison, 60 per cent of Zambia’s export revenues come from copper, and over 95 per cent of Nigeria’s export earnings are from oil and gas). Although not as extreme as the Gambia or Ethiopia, where 97 per cent of the government budget is attributed to foreign aid, Dongo’s fiscal revenue is mainly aid-dependent. Like Kenya, it has in place a fragile democracy, which under the confluence of exogenous factors is susceptible to political destabilization. And like the majority of African (and indeed most developing) countries, its population is skewed towards the young: 50 per cent of its citizens are below the age of fifteen. Faced with few obvious prospects, Dongo, like so many of its neighbours, is intensely vulnerable: a breeding ground for disaffection, unrest and civil war.

Where will its young men and women be in twenty years’ time? If a country can’t produce the next generation of well-educated civil servants, politicians, economists and intellectuals, then how can it not regress? Will Dongo have changed, or will it still be locked in a cycle of disappointment and despair?

This book is not about specific development policy. It is not a book about whether one way of tackling the HIV–AIDS problem is better than another, or if one education strategy yields better results than another. It is about how to
finance
the development agenda so that, whatever the development policy, economic prosperity might be realized. Dongo will only change if its fundamental model of aid-dependency is abandoned and the
Dead Aid
proposal of this book adopted wholesale, in its entirety.

The choice of development finance is at least as important as the policies a government adopts. You can have the best development policy in the world, but without the right financial tools to implement it, the agenda is rendered impotent. Put differently, it matters little whether Dongo is capitalist or socialist in development orientation – of paramount importance is how Dongo finances its economic development. Indeed, neither a capitalist nor a socialist economic agenda can be truly achieved in the longer term without a financing strategy based on free-market tools.