Can foreign aid help?

In his 2005 book, The Undercover Economist, Tim Harford revealed that fair trade coffee in some London stores cost an extra 25 pence per cup, but that only about a tenth of the markup actually reached the coffee farmer. A fair trade cappuccino might have given the drinker a warm inner glow, but it didn’t do much to reduce world poverty.

Its harshest critics sometimes say the same about overseas aid. They point out that unlike the voters who judge domestic programs, the recipients of foreign aid cannot punish bad policy at the ballot box. Aid’s critics say that with a few exceptions - like disaster assistance - the world would be better off with less aid, not more.

With this year’s budget promising a major increase, Australia’s overseas aid is set to rise from 0.3 per cent to 0.5 per cent of national income by 2015. So the billion-dollar question is: does aid work?

At an aggregate level, it turns out to be depressingly difficult to identify an impact of foreign aid on a country’s level of development. In the 1990s, a series of studies reached ambiguous conclusions. In a famous paper in 2000, Craig Burnside and David Dollar found that that aid did raise growth - so long as the recipient country had good fiscal, monetary and trade policies.

Three years later, William Easterly, Ross Levine, and David Roodman found that these results were fragile, and did not hold up when more years of data were added to the analysis. Subsequent research by Paul Collier contends that even in badly-governed Africa, poverty rates would today be much higher had the continent received no aid.

Most recently, Jeffrey Sachs has argued that much foreign aid in the post-war era was directed towards winning the Cold War rather than helping the poor. According to Sachs, we should not discriminate against countries with bad institutions; instead we should be ruthless about not giving the wrong kind of aid. Good aid, argues Sachs, can make a difference.

This research offers two challenges to Australia. If aid only works when policies and institutions are strong, should we keep giving around one-third of our aid to Papua New Guinea and the Pacific? Ethically, it would be tough to justify withholding charity from some of the world’s neediest people. And given that they are on our doorstep, it is difficult to imagine excluding “fragile states” from the Australian aid program. Yet the research suggests that despite all the hard work that is being done by aid workers in these countries, there is little chance living standards will take off any time soon.

The other challenge for our aid program is to distinguish between good and bad aid. This is a particularly thorny question at a time when the program is being expanded. This year, AusAID’s budget will rise from $3.2 to $3.7 billion. The last thing we want to happen is for the agency to lower its standards in order to get more cash out the door.

Here, the brightest hope for the aid program is that AusAID is taking seriously the question of aid effectiveness. On the last parliamentary sitting day before Easter, Parliamentary Secretary Bob McMullan quietly tabled the first annual report (PDF 547KB) of the Office of Development Effectiveness - an agency established to monitor the overseas aid program.

Carrying out what it called a “health check of the Australian aid program”, the report critiqued aspects of the aid program in surprisingly robust terms. Discussing technical assistance (providing advice, or sending an Australian public servant to fill a role in a developing country bureaucracy), it pointed out that we spend twice as much as other rich donors, and warned that some of our technical assistance programs may undermine the capacity of poor countries to govern themselves. Discussing evaluation, the report emphasised the importance of carrying out more impact evaluations - asking not only whether the program was properly administered, but also whether it helped improve the lives of the poor.

The frankness of AusAID’s Annual Review of Development Effectiveness stands in stark contrast to the self-congratulatory mush of most government reports. Indeed, it is impossible to imagine the health, education, or defence departments putting out such a self-critical report.

This kind of hard-headed approach is particularly valuable given that overseas aid is an area where too many advocates have focused on inputs (aid as a percentage of national income) rather than outputs (poverty reduction). Alongside a multi-billion dollar increase in foreign aid must come more scrutiny of results.

If we care more about making a difference than getting a warm inner glow, distinguishing good aid from bad aid is the only way to go.