Could aid slow growth?

I’ve been thinking idle thoughts about industrialization lately, partly because of the factory visits, and partly because of long discussions with Owen Barder about why aid does or doesn’t “work”.

When people say aid isn’t working, they mean a great many things. But one of more common concerns is that, in cross-country regressions, aid seldom correlates with growth in people’s average income. I don’t really buy into these regressions, but I don’t see any reason to doubt a simple fact: massive amounts of aid have not led to take-offs in growth in poor countries—at least not systematically.

Owen’s writing a smart piece why, even if this is true, we can still regard aid as “working”. I will not steal his many excellent points, but will link to the piece when it’s up.

One thought, however, has been marinating in my brain for the past few months. Since this is a blog post and not a treatise, here is the overly simplified idea.

When we see big growth in per capita incomes, it usually means one of two things: lots of new natural resources are being extracted, or industry is growing. Industry is prime. In a country like Kenya, something like forty percent of GDP is created with four percent of the workforce: those in formal manufacturing. If smallholder farmers are doubling their productivity, then we might see a spurt, but only at very low levels of income. When non-oil producing countries jump from $1000 a head to $10,000 a head, it is mostly coming from the production of goods and services.

Now introduce aid. Aid, if it achieves the UN’s goals, is often saving the lives of the poorest. In this respect, we can say aid has been successful. And it is this very success that could explain why we don’t see any effect on growth. In fact, for the first few decades of aid, it’s conceivable that it would appear to reduce per capita income growth.

If aid saves the lives of millions of poor infants, or mothers in childbirth, at roughly the same rate a country can industrialize, then we’ll see an increase in the number of poor people at about the same rate that we increase GDP per person. Unless aid is also spurring faster industrial growth, the growth figures essentially won’t change. The things that aid does well–increasing primary education, saving lives, and leading to a demographic transition (essentially lower population growth–may reasonably take a generation or two to impact industry.

So if aid has been good at saving lives now, but not (in the short term) at spurring industry, then we shouldn’t be surprised that we don’t see take-offs. Rather, in most countries aid might actually lower the short term, measured number.

But by almost any measure, though, aid would still be a huge success. Maybe the “failure of aid” is really a failure to industrialize, disguised.

I’d be interested in impressions. I am, as readers of the blog know, no macroeconomist. So feel free to pull my house of cards down. This strikes me as mainly an empirical question, one I haven’t seen answered so far.