Chapter Summary

Learning Objectives

After reading this chapter, students will be able to:

  • identify, define and classify different kinds of foreign aid
  • describe the different eras of foreign aid since 1945
  • summarize arguments claiming that aid furthers underdevelopment and arguments defending foreign aid
  • describe, criticize and defend the role of the IMF and World Bank

Chapter Summary

Some analysts believe foreign aid is one of the keys to reducing underdevelopment. There are several kinds of foreign aid. A grant is money or services that are given without the expectation of repayment. Soft loans are loan that are given but at less than market conditions related to interest or other terms. Debt relief is forgiveness of some past debt. Aid can also be classified by its sources: one such classification is bilateral aid (from one country to one country) compared to multilateral aid (given by an intergovernmental organization or NGO as examples).

Bilateral aid is frequently tied to some goals of the donor country. These goals can be geopolitical, commercial or some other goal. Intergovernmental aid organizations gather money from member governments and distribute aid, often in the form of loans, based on the agreed upon goals of the organization. NGOs are private organizations that raise money to provide services or give aid.

The chapter divides the modern history of foreign aid into four phases. The first phase from 1945-1970, was dominated by the US’s concern for stopping the spread of communism, initially in Europe through programs like the Truman doctrine and the Marshall Plan. By the 1950s aid programs in support of anticommunism were expanded to other parts of the world. While there were certainly altruistic programs, like the Peace Corps, the dominant goal was anticommunism. From 1970 to 1989, as Cold War tensions subsided initially in the era of détente, there were increases in foreign aid that was directed more at needy countries rather than just strategic allies. The amounts of aid increased as well. Additionally, more multilateral organizations, both IGOs and NGOs were established and active. More and more aid was used to influence changes in government policies as well. The period from 1990-1999 witnessed an increase in donor fatigue. Aid flows declined and also went to new sources such as the former communist countries. In addition, the issue of systematic debt relief climbed higher on the agenda and the World Bank launched the Highly Indebted Poor Country initiative. After the year 2000, the Millennium Development Goals to create measurable targets for s few specific areas of development. There was also a revitalization of geopolitical aid, now to be used to stop the spread of terrorism.

Critics of aid question its effectiveness. Given that donor countries may have motives other than the elimination of poverty, donors may continue to give aid they know is not effective at eliminating poverty if it achieves their geopolitical goals. Aid to Zaire is an example where donors knew aid was being taken by a corrupt government, yet continue to fund programs because geopolitical goals overrode development goals. Commercial goals may also limit effectiveness. Some aid is tied to purchasing services or supplies from donor countries, even though they could be purchased more cheaply elsewhere. One study suggested this increased costs by 20 percent.

William Easterly, a leading critic of aid, contends that donors tend to have a “planner mentality” resulting in experts telling local people what they need. The result is a “one size fits all” approach to development that ignores local realities and devalues local expertize. This results in continual failures, but according to Easterly, aid agencies have little incentive to change because their success is measured by how much they lend not how much they better the lives of the local population.

Another criticism of aid is that when there are multiple donors, aid may not be properly coordinated. Projects may overlap or be in conflict with each other. Further, aid flows are volatile, so it is difficult for governments to plan.

Additionally, recipient states have limited absorptive capacity. Buying machinery or building hospitals does not work in the long term without having trained local staff and a way of paying this staff when grants or loans run out. This is compounded by the problem of poor governance. If governments are undemocratic and unresponsive to the needs of the people, and poorly designed projects provide aid to the people, there is little incentive for governments to develop indigenous programs to meet these needs.

Aid can also cause economic problems. Influxes of aid can cause inflation and can increase consumption. It tends not to increase investment. In addition, governments can switch money from programs receiving aid (like education and healthcare) and use it for other less productive purposes like military spending.

Supporters of aid have several responses to these criticisms. Economist Jeffrey Sachs contends that underdevelopment prevents governments from making needed capital investments; properly designed aid can help break this poverty trap by providing enough investment to help extremely poor people become taxpayers and investors, starting the promotion of growth.

Aid has also had some successes. Health outcomes have generally improved in many LDCs thanks to aid projects. Introduction of more advanced agricultural techniques has often increased production, making famines rarer than in the past.

In addition, aid supporters contend that there simply is not enough aid since donor countries have never met their stated goals regarding their amount of aid. Increased aid, they would argue, accompanied by improved aid strategies would make a difference. These new aid strategies, verified by randomized trials, are an example of the aid community learning from past errors. Likewise, current aid projects have been coupled with methods to support improved governance in LDCs.

The chapter analyzes the significant developmental institutions, the International Monetary Fund and the World Bank. These institutions are sometimes referred to as the Bretton Woods institutions because they were founded after World War II at an international meeting in Bretton Woods, New Hampshire.

Both of these institutions provide concessional loans to countries. They have slightly different responsibilities, but share some overlapping goals. After the Second World War, western countries wanted to avoid a new depression. The IMF was created to deal with balance of payments crises by making loans to countries facing these situations. Additionally, since much of Europe was destroyed in the war, the International Bank for Reconstruction and Development was established (which became popularly known as the World Bank) to fund specific development projects like bridges, dams, etc. Since the end of colonial rule, both organizations have shifted much of their focus to LDCs rather than Europe. Both expanded the kinds of loans and projects they were willing to finance.

By the 1980s, these organizations started introducing stricter conditionalities to their loans. These conditions often required LDCs to privatize state industries, open economies to international trade, eliminate or reduce prices subsidies and other unpopular measures. These conditions reflected neoclassical assumptions about development which seeks to reduce the state role in the economy.

By the 2000s, these institutions responded to criticism of conditionality by trying to mitigate some of the human impact of the conditions: it often now requires gender equity and good governance checks on projects. Fewer loans have the stricter economic conditions than before.

The criticisms of the IMF (and World Bank) can be divided between those linked to the conditionality of loans and other criticisms. Related to conditionality, critics contended that the conditions imposed often worsened the immediate situation of the poorest part of society by removing things like food subsidies and demanding closure of inefficient parastatal business. Opening business and capital markets also meant that LDC economies were subject to the volatility of international trade impacts which would be felt most sharply by the poor. All of this policy conditionality was seen as a violation of the sovereign right to have governments decide their own policies.

Other criticisms of these organizations include their undemocratic nature: voting within the organizations is based on how much each state pays as dues (which ids calculated by the size of the member’s economy). In addition, by making loans rather than grants, these institutions serve to increase the debt of LDCs. By forcing governments to pay back these loans, even with concessional interest rates, diverts money from government budgets that could have been used on things such as education and health. Further, because these organizations want to collect repayment, they sometimes offer loans to service these debts, increasing debt and interest payments in the future and offering no tangible benefit to the country at present (other than not defaulting).

Defenders of the IMF and World Bank respond that these institutions are making loans because the countries have requested them to. They come to these organizations because other private lenders will not make loans. The IMF makes conditions on its loan to protect its investment and if countries do not like the conditions they can decide to not accept the loans. In reality, there is little the IMF and World Bank can do to actually enforce these conditions, and frequently countries do not follow through on these conditions. The conditions that are implemented tend to be ones that government leaders wanted to implement anyway.

Additionally, the IMF and World Bank contend that the conditions are often requiring the end to policies that were unsustainable anyway and that the conditions are to promote long term economic growth. And, the defenders assert, there are many examples of LDCs having good economic growth after having followed this advice and implementing market economic policies.

The case study at the end of the chapter focuses upon Pakistan, a major recipient of foreign aid since its independence. It examines failed aid projects, political instability and limited state capacity and obstacles to development from the fact that much of Pakistan lacks water for agriculture and human consumption.