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.

34 thoughts on “Could aid slow growth?

  1. This point seems to me obviously true and unbelievably overlooked in the ‘aid’ debates. Even if growth is good for the poor, it is not the only thing that is good for the poor. Improvements in well-being can occur without causing or being caused by growth.

  2. A very interesting topic, Chris. At the basic macroeconomic level the argument often used is Dutch Disease (aid could push up the exchange rate, making imports cheaper and exports more expensive, affecting the competitiveness of industry). But it is extremely complicated, as you say; any much of the effect of aid on growth will be long term.

    It’s quite clear though from the vast growth literature that we have lots of ideas about what causes growth, and a few basic conditions (e.g. investors need to be confident they will be able to appropriate returns) but that the way these are fulfilled in practice are highly country specific. So the effect of aid on growth, I believe, can only really be studied in particular contexts.

  3. I’m writing from a position of almost complete ignorance here, but isn’t Chris’ point a variation on Malthus? My understanding of Malthusian economics is essentially that population growth eats up productivity gains, leaving everyone at a permanently low income level. My understanding is also that Malthus was basically accurate in his description of economic history — right up to the point that productivity took off due to technological developments. All of this seems to fit fairly well within a framework of increased survival rates and flat income, only followed later by a jump in industrialization.

  4. Very interesting point. Not being an economist myself, but being rather sick of some of the shriller versions of the ‘aid debate’ I’d be glad to hear what specialists have to say about this. I also tend to think that measuring all interventions in the economy (aid being just one of them) in terms of their impact on economic growth is really not very constructive. There are, after all, plenty of other dimensions to development.

  5. This is a variant on the Kerala argument, and it’s a sensible one — one really does have to understand that people can live long and satisfying lives on incomes which we as Westerners would consider astonishingly low, if they are fully integrated into a social structure that works for them.

    I guess I can’t help feeling like this is a view that doesn’t do well when one looks at folks who are gay, members of minority groups, or female. It always seems to me that this kind of “getting by” prosperity is built on those folks’ bodies. Wealth creates choices. If you didn’t need the choices because the defaults are good for you, you don’t get near as much out of wealth as someone who does.

  6. I would rather argue that aid cannot be used for development. A commonly cited aid program (the Marshall Plan) is often used, however, this is not the same type of program that is being pushed today as aid. Aid today is essentially trying to develop (industrialize) countries, this is not what the Marshall Plan did. The Marshall Plan as we all know was designed to reconstruct already industrialized countries. Actually, modern aid programs likely hinder industrial development.
    The logic for this goes like this: “Aid programs provide assistance to governments who require it. As a higher proportion of government monies now come from aid it is the aiding power that becomes the aided governments patron versus the people it is meant to benefit. If the aiding entity and the aided people’s interests are coincident then there will not be a problem but this is rarely, if ever the case.” As of late this is the logic put forth by Dambisa Moyo (Dead Aid), but before that the Government of Eritrea has certainly been pushing this idea.
    Aid is not inherently bad, just the wrong tool for the problem.

  7. “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.”

    But what if the failure to industrialise is due, in part, to aid dependency? I would argue that the presence of aid can distort the incentives governments usually face to deliver growth.

  8. Lant explained this before on Aid watch:

    “Being an agency for international development implies more than that the agency provides assistance to improve the well-being of individuals in countries that are not developed, but that the central goal of the organization is to promote development. Promoting economic development, for instance, means supporting actions and policies that create widespread opportunities for people to improve their incomes.”

    http://aidwatchers.com/2009/06/is-usaid-about-aid-or-development/

    development aid and assisstance are 2 different things

  9. Chris,
    A very pertinent question. I can relate to this idea looking at my own experience from my home state in India, one of the poorest regions of the country. Indian and foreign aid reduced just absolutely-avoidable deaths from hunger/starvation, disease and malnutrition, but increased the number of poor in small towns and cities. Then, the next generation of these poor were able to get jobs and the overall economy has prospered. Now, of course there could be many many confounding variables, but it looks like there could be statistical evidence for your idea.

  10. Putting into a standard Solow formulation, Chris’ model seems to make population growth, capital accumulation, and productivity all a function of aid (among other things). With the relative impact of aid higher on population growth (as least in the short-run), an exogenous increase in aid raises the population growth rate more than capital accumualtion rate or TFP growth. Thus, the steady-state level of per capita income goes down (or, assuming exogenous TFP growth, per capita output growth rates would be lower in the transition dynamic before recovering to their steady-state level).

    My memory is that Barro’s growth regression work found a negative relationship between population growth and growth. Barro’s cross-country regression work is controversial and I’m not sure if there is more specific empirical work on this. I also recal that some endogenous growth models are based a postive relationship between population growth (or maybe it’s level?) and output growth. The idea is that increased populations spurs innovation and TFP growth.

  11. Couldn’t we look at assistance as a necessary condition for maintaining the possibility of future industrialization? From what little I know of growth models, the costs of developing human capital seem to directly subtract from the allocation for technological progress and capital accumulation. If technological progress is expected to occur endogenously, then as a precondition there are really, really going to have to be major allocations directed towards the wellbeing and creation of human capital.

    It seems to me that, at least in theory, any economy receiving aid in the form of schools and hospitals etc. would be more able to allocate its resources to industrialization and more efficient production, if there is not a big war going on or anything. I am sure this would take a long time to impact a large population, but it seems logical that aid could lead to lower costs for the creation and support of human capital, and over time, economic growth.

  12. There is good empircal evidence that humanitarian aid saves lives in places like Darfur (where the mortality rates in the camps are now lower than in other poor parts of Sudan), but if your thesis is right you would have to show that there is a positive correlation between aid recipient countries and population growth over time. We know that high birth rates and poverty correlate and that the purpose of giving aid is to tackle poverty – so this means that aid is going to countries with high birth rates. However, if it is being effective in reducing poverty this should presumably reduce birth rates over time. Can you show that aid is actually leading to population growth in particular countries?

  13. Another aspect of Aid might be the following: while industrialization happens in the city, aid has long had as an explicit goal to keep people on the land. Setting a poverty trap for them.

  14. At the risk of sounding evil, I remember reading about a few people (their names escape me) back in the 60s who warned that Western interventions in developing countries to improve the lives of the desperately poor might be dangerous precisely because of their success. Even Aid skeptics accept that Western interventions (Green Revolution/ improvements in basic sanitation and water supply) have been hugely successful at keeping people alive. But now what? For 30 odd years now in many developing countries living conditions have remained stagnantly low for the rapidly growing poor population which the West has put on life support, but no more.
    Almost every successfully developing country has experienced sharp drops in their population growth rates since the 60s. Yet most of the countries who fail to develop have steady, or only weakly declining population growth rates, and again we bear some (a lot of) responsibility for propping up these rates.
    I agree with you that AID could have slowed growth in these countries because of this, but I am less willing to call such interventions “successes.” It is dangerous to meddle with that which we do not understand and as Easterly frequently points out, We do NOT understand economic growth.

  15. Chris,

    How is this line of thinking any different than the arguments put forth by Jeff Sachs in “The End of Poverty”? There he offers plenty of arguments that aid will not lead to immediate growth, and that insufficient aid can be wasted aid, in the sense of not being enough to enhance productivity. But I think your line of thinking is complementary to Sachs’: perhaps aid, if in large enough quantities and used wisely enough will eventually facilitate a demographic transition that supports the establishment of industry.

  16. I think it depends on what you mean by aid. My understanding is that official development assistance, the variable that many would use to measure aid, is primarily spent on roads, energy or irrigation infrastructure, etc. (projects with direct industrial sector benefits, as well as poverty reduction benefits) not on saving babies (which I would indeed expect would have a delayed, more indirect impact via domestic income/demand)

  17. Chris, I think you’ll find that a generation of Marxian and post-Marxist economists (particularly macroeconomists) have been suggesting something like this for a long time. Actually they don’t even really mention the aid because it’s an irrelevance for economic growth except insofar as it hampers it. Both parts of this argument:

    1) The fundamental problem of development for growth is that most developing countries are primarily pre-capitalist. They do not have the relations of production necessary for dynamic capitalism to occur throughout the economy. What this means is that vast swathes of the economy (particularly agriculture, where the two forms of organisation tend to be peasant agriculture and plantation agriculture which looks a bit like bonded labour. I did an analysis of the Sri Lankan tea industry which looked at this in a roundabout way). Such economic forms are not dynamic and do not stimulate rapid economic growth.

    The vast majority of the economics profession takes capitalism for granted, or associates it with free markets or with entrepreneurship, neither of which are the same thing. As a result the vast majority of economic policy is concerned with making it easier for people to do business, but not with transforming the economic structure within which they function; thus, we make marginal improvements without transforming the economy into one capable of sustained high-growth capital and innovation- driven development.

    2) Aid is at best an irrelevance to this argument. We are talking here about socio-economic relations of production. Aid does not seek to transform these. However, this is the best case scenario. However, there is also the real possibility that aid actually hampers capitalism’s emergence. This happens in two ways.
    Firstly it entrenches pre-capitalist forms of organisation, primarily in agriculture but also in towns, by making unsustainable activities or marginal activities sustainable in the short term and giving them artificial stability. The creation of a wage-labour force is therefore hugely slowed down and it traps people into being part of either a peasant economy or an unstructured piecework (still pre-capitalist, but closer to capitalist) economy.

    Secondly, as Matt points out in the comments above, Aid also completely alters the incentives that all actors face in developing countries. For example, most people who want to earn and build up savings etc. are faced with either trying to create a capitalist enterprise in an essentially pre-capitalist economy or to get a job as an aid worker or NGO manager or project manager or something like that. Easy choice for most. Many of the best, most dynamic minds I’ve met in developing countries are engaged in aid work. Compare this to a place like Hong Kong, where all of the most dynamic minds turn immediately to business.

  18. For those following the argument that I make above through – it does end up in a place similar to Justin’s comment above. ‘Success’ in saving lives lived in the margin can hamper any possibility of long term escape from poverty.

    As a macroeconomist this isn’t a surprising outcome, but it raises ethical difficulties related to aid.

  19. I think a closely related idea is tested in D. Acemoglu and S. Johnson’s 2007 JPE article. They use global health campaigns (“eradication of X disease”) as exogenous shocks to health and look at the effects on growth. They also argue that factors that make people more healthy may not have positive macroeconomic effects precisely b/c the economy may not utilize the healthier workforce.

    The punchline is “there is no evidence that the large increase in life expectancy increased income per capita”.

  20. Ranil,

    I have to compliment you on the sharpness of your comments (both here and on your blog). I am 100% in agreement, but always have a hard time myself expressing relations like this in such an astute and concise manner. Kudos!

    This is exactly the kind of perspecitve that is missing so dearly in (development) economics. (Leaning myself a bit out of the window here, but am I correct in sensing SOAS-grown thought here?)

    Cheers!

  21. Ranil,

    I have to compliment you on the sharpness of your comments (both here and on your blog). I am 100% in agreement, but always have a hard time myself expressing relations like this in such an astute and concise manner. Kudos!

    This is exactly the kind of perspecitve that is missing so dearly in (development) economics. (Leaning myself a bit out of the window here, but am I correct in sensing SOAS-grown thought here?)

    Cheers!

  22. is it that obvious?! yes, I did an MSc in SOAS, but my undergrad was in the more conventional framework in oxford, in history and economics, which proved a nice balance.

    I read your comments here, too and was really interested as well.

    I like your name, btw!

  23. It is not surprised many people doubt if aid is working or not especially when it fail to produce much tangible result like economic growth. I think “grow” should not be the major indictor to evaluate aid. Aid can be regard as success if it can save many people’s lives, and provide daily necessities in some poor regions. As for economic growth, I think it’s the responsibility of governments, not aid. Poor governance needs the intervention from international community, rather than in the form of aid.

  24. The point that no country ever developed without industrialization has been always stressed by (non-orthodox) economists – see writings of Ha-Joon Chang (Cambridge) or Dani Rodrik, whom you know well. The rest of your idea is just a corollary of this argument.

  25. Not exactly. Kenny’s argument is that if we look at other indicators of development apart from gdp per capita growth, a region like sub-Saharan Africa has seen a lot of success over the past couple of decades. I don’t think he necessarily argues that this is due to aid. I’d say that (and I don’t think Kenny would disagree) aid plays a big part in the observed improvements in health and education, for example.

  26. If aid saves the lives of infants and mothers, then how does aid lead to lower population growth? And how can it possibly do both in the same paragraph?

    Maybe aid is ineffective because the chief proponents of aid suffer from large cognitive dissonance.

  27. Chris, you might want to read JK Galbraith’s “The Nature of Mass Poverty”, which makes some similar points, but with more sarcasm.

  28. I agree that the meassure of success of aid should not be tied to economic growth unless that is what the aid was specifically meant for. I think that the majority of aid is aimed at helping the poorest with health, education and welfare.

    With this in mind it seams to follow to me that aid could slow growth for a time as mortality rates decline. I too, think that this would be a temporary situation, especially if education is one of the benefits of the aid.

    I also agree that aid should be aimed at helping the poor and growth should be a government responsibility. We can see how good planning has helped several nations achieve very high levels of success with economic growth. Aid and economic growth can accur in conjuction with one another, but it would take good economic planning and a bit of luck.

  29. When people griped that aid doesn’t work using cross-country regressions, they failed to explained the following (1) that most of the aid to Africa, especially Cold-War era aid was given to propped up corrupt “strong men” allies with any accountability whatsoever; (2) most of the aid went to finance the consumption of the elite because of (1), and a lot of it found its way back in secret ban accounts in the West – limiting the intended trickle-down impacts on the poor; (3) that the amounts were spread across so many countries and so many sectors that they failed to have deep impact on particular sectors/industries and (4) aid was usually given for “feel-good” reasons instead of result-oriented reasons, and so there was no competition among donors with regards to outcomes of the money they gave.
    Africa, in particular need more aid not less. But the aid should be targeted – on 2 to 3 sectors: agriculture, education and health – with limited achievable and measurable goals. Also let donors compete among themselves as to whose aid bring about greater positive effects on the targeted sectors – this is an idea I’m exploring in as a research paper.

  30. Max, I think your points are well put. However, there is certainly some aid that has been targeted and sufficient to make some kind of measurable impact, no?

  31. Chris,

    If your argument is correct, then we may not see any growth in GDP per capita due to aid. However, you should observe increases in life expectancy or educational attainment. Aid could also improve governance or the rule of law.

    However, how much evidence is there for aid contributing to health, education, or governance?

  32. I think what’s missing from this discussion is the political reality of the implementing agencies and donor organisations.

    Why is ODA funded? Partly for political reasons. In Australia (as one example) aid is generally used as a foreign policy football in election campaigns. Describing foreign policy to regular voters is difficult; aid programs are quantifiable and provide a ‘feel good’ factor to what is a dull area in public policy. (Compare the potential popularity of spending US$50 million on aid programs or spending US$20 million on multilateral trade agreements with developing countries; the latter will probably have the better economic result, but the former will win hands-down with voters). This presents two clear problems.

    First, as usual, good politics can result in bad policy. Aid spending has shifted remarkably over the past 20 years. Spending on ODA that directly supports economic growth (economic infrastructure and services) has fallen from a 28% share of all ODA to 12% from 1997-2007. Aid for environmental prograns and governance outstrips spending on economic programs. The simple fact is that poverty is not as fashionable as it once was. The dominant international issue is climate change. Unsurprisingly, resources that were once oriented towards increased trade, infrastructure, etc., are now being put into more politically palatable areas. Consider the political backlas if an aid agency implemented a program that improved forest management and timber harvesting and manufacturing processes in a developing country – despite the fact that it might increase levels of employment, environmental management, exports, etc.

    Second, the political nature of ODA does not require strict monitoring and evaluation. Even when it is closely monitored and evaluated, voters do not care. In these cases aid programs may do no harm, but they may not do much good either. In other words, no result is better than a bad result. Consequently aid programs can become blunt tools that aim for very little.

    I would highly recommend the work of Michaela Wrong (“It’s Our Turn to Eat: The Story of a Kenyan Whistle-Blower”), who has highlighted the entrenchment of aid agencies within their host countries and all their failings. She highlights the story of the World Bank and the UK’s DFID in Kenya. I personally have seen the same thing happen with foreign aid in Papua New Guinea and Indonesia.

    I would also recommend the following report by World Growth, a free-market NGO. http://www.worldgrowth.org/assets/files/WG_Aid_Paper_final.pdf. It was written be colleagues of mine. They track the spending of aid by OECD countries and in which areas the money is spend. There has been a big change since 1997.