Aid and Growth
Steven Radelet, Michael Clemens, and Rikhil Bhavnani
New evidence shows that aid flows aimed at growth have produced results
Controversies about aid effectiveness go back decades. Critics such as Milton Friedman, Peter Bauer, and William Easterly have leveled stinging critiques, charging that aid has enlarged government bureaucracies, perpetuated bad governments, enriched theelite in poor countries, or just been wasted. They cite widespread poverty in Africa and South Asia despite three decades of aid, and point to countries that have received substantial aid yet have had disastrous records—such as the Democratic Republic of the Congo, Haiti, Papua New Guinea, and Somalia. In their eyes, aid programs should be dramatically reformed, substantially curtailed, oreliminated altogether.
Supporters counter that these arguments, while partially correct, are overstated. Jeffrey Sachs, Joseph Stiglitz, Nicholas Stern, and others have argued that, although aid has sometimes failed, it has supported poverty reduction and growth in some countries and prevented worse performance in others. They believe that many of the weaknesses of aid have more to do with donors thanrecipients, especially since much aid is given to political allies rather than to support development. They point to a range of successful countries that have received significant aid such as Botswana, Indonesia, Korea, and, more recently, Tanzania and Mozambique, along with successful initiatives such as the Green Revolution, the campaign against river blindness, and the introduction of oralrehydration therapy. In the 40 years since aid became widespread, they say, poverty indicators have fallen in many countries worldwide, and health and education indicators have risen faster than during any other 40-year period in human history.
Throughout this debate, however, most analysts have missed a critical point by treating all aid as if it were alike in its impact on growth. In a recentCenter for Global Development study, we try to rectify this gap by exploring the impact on growth of aid flows that actually are aimed at growth.
Three prevailing views on aid
Over the past three decades, three broad views have emerged on the relationship between aid and growth:
Aid has no effect on growth, and may actually undermine growth. There are several reasons why aid might not supportgrowth. It can be wasted on frivolous expenses such as limousines or presidential palaces, or it can encourage corruption. It can undermine incentives for private sector production, including by causing the currency to appreciate, which weakens the profitability of tradable goods production (an effect known as « Dutch disease »). Similarly, food aid, if not managed appropriately, can reduce farm pricesand hurt farmer income. Aid flows potentially can undermine incentives for both private and government saving. They can also sustain bad governments in power, helping to perpetuate poor economic policies and postpone reform.
This view has been supported by a range of empirical studies, mostly published from the early 1970s through the mid-1990s. While these studies have been influential, manyare of questionable quality, especially using today’s research standards. For example, most assume only a simple linear relationship between aid and growth in which each new dollar of aid has exactly the same impact on growth as the first (eliminating the possibility of diminishing returns) and ignore possible endogeneity (in which faster growth might attract higher aid, or both might be caused bysomething else), among other issues. A recent paper by Raghuram Rajan and Arvind Subramanian (2005), which also assumes a simple linear relationship for most of its results, stands in sharp contrast to the bulk of recent research on the issue, as discussed below.
Aid has a positive relationship with growth on average (although not in every country), but with diminishing returns. Aid could…