Wisdom Ejebugha and Gilbert Mbara Can foreign Aid Buy Growth and The Big Push Déjà Vu: A Review of Jeffery Sachs’s The End of Poverty: Economic Possibilities of Our Time BY William Easterly Presented by: Wisdom Ejebugha and Gilbert Mbara MADE, Dev_Workshop 2007 26th November 2007

Outline The Big Push Déjà Vu Can Foreign Aid Buy Growth Conclusions Introduction Critique Can Foreign Aid Buy Growth Conclusions

The Big Push Déjà Vu 1.1 Introduction 1/3 “The End of Poverty”by Jeffery Sachs proposes: Doubling foreign Aid to about 100 Billion USD per year. Foreign Aid will fill the ‘financing gap’ – the difference between what a country needs and what it can afford on its own. Comprehensive package of interventions covering all the needs of the poor. Package to be implemented by Aid Agencies, the UN and National Governments. The principle element in the Big Push would be a doubling of foreign aid. Foreign aid would fill a “financing gap” between what a country needs and what it can afford on its own, making it possible for each of the poorest countries “to break out of the poverty trap and begin growing on its own” Comprehensive package of interventions covering virtually all of the needs of poor people

The Big Push Déjà Vu 1.1 Introduction 2/3 1/3 Easterly’s critique: No big solution to a big problem. Aid and Poverty Trap. Poverty Traps versus Bad Government. 1. The promise of a big solution to a very big problem is an outlier in the practice of economics, where usually economists study marginal changes to existing systems or policies to generate marginal improvements. Theory of second best: we cannot know whether a partial movement towards a free market equilibrium will be beneficial. 2. Sachs proposes investments to make say roads attain a certain threshold quality, to spur self sustaining growth – Easterly notes that styled facts do not support the prediction that aid has growth effects. Controlling for initial poverty and bad government, bad government explains the slower growth.

The Big Push Déjà Vu 1.1 Introduction 3/3 1/3 Easterly’s critique cont.: Development as a technical problem. The Piecemeal Approach. The Dangers of Hubris. This portrayal of poverty as a technical problem is at odds with the rich literature and political science that stresses the social causes of poverty—bad institutions, bad politics, misguided policies, trading networks that exclude the poor, high transaction costs in markets, and ineffectual aid donors. Administrative problems: a) how to design principal-agent contracts to give good incentives as plan are decreed at the top but implemented at the bottom. b) access to poor information about the realities at the bottom to design the right interventions at the right place and time. No feedback from the voiceless poor. c) Multiple goals and agents according to the Principal-agent theory weakens incentives to deliver on goals 2. Aid should be targeted at only successful programs.

The Big Push Déjà Vu 1.2 Our Critique 1/1 1/3 Big Solutions: The Marshal Plan is an example of one a Big Push Idea that worked. Aid has been increasing while growth is falling – but this in not the whole story. Some development problems are technical. Piecemeal approach. Economists usually study marginal changes to existing problems to generate marginal improvements. Theory of second best: we cannot know whether a partial movement towards a free market equilibrium will be beneficial. Sachs proposes investments to make say roads attain a certain threshold quality, to spur self sustaining growth – Easterly notes that styled facts do not support the prediction that aid has growth effects. Controlling for initial poverty and bad government, bad government explains the slower growth. At odds with economic and social sciences literature that stresses the social causes of poverty

Can Aid Buy Growth 2.1 Introduction 1/4 2/3 Empirical evidence on the links between aid and growth Boone (1996) – Aid finance consumption rather than investment. Burnside and Dollar (2000) – Aid positively affects growth under sound policies. Easterly, Levine and Roodman (2003) – No relationship between Aid and Growth. Financing the consumption of a few poor people is not bad. But aid proponents expect a society wide transformation from aid financing investment and growth. Aid has a positive impact on growth in developing countries with good fiscal, monetary and trade policies but has little effect in the presence of poor policies. Same specification as Burnside and Dollar but with more data points. The coefficient for the aid*policy interaction term is insignificant.

Can Aid Buy Growth 2.1 Introduction 2/4 2/3 The Theory of Aid and Economic Growth Chenery and Strout (1966) – “Two-Gap” model. Assumptions: Linear relation between investment and growth. Aid financing investment and not consumption. Easterly (2001) – tests financing gap model. No empirical support the model. Model still used to estimated aid requirements. The first gap is between the amount of investment necessary to attain a certain rate of growth and the available domestic saving, while the second gap is the one between import requirements for a given level of production and foreign exchange earnings. At any moment in time, one gap is binding and foreign aid fills that gap. Assumptions: First, it assumes the stable linear relationship between investment and growth over the short to medium run – but economists generally have avoided this Leontief production functions with fixed requirements of labour per unit of capital. A second key assumption of the model in which aid fills a financing gap and allows greater investment is that aid will actually finance investment rather than consumption. This assumption will only hold if investment is liquidity constrained and there are favorable incentives to invest. Tests financing gap model in which aid improves investments which in turn improve growth. TS data.

Can Aid Buy Growth 2.1 Introduction 3/4 2/3 Aid Institutions: Moving the Money Disbursements as output measures. "Disbursements (of loans and grants) were easily calculated and tended to become a critical output measure for development institutions. Agencies saw themselves as being primarily in the business of dishing out money.“ World Bank (2002). High-income country governments may have many different objectives for their aid besides poverty reduction, such as rewarding allies, promoting donor country exports or fighting drug trafficking.

Can Aid Buy Growth 2.1 Introduction 4/4 2/3 Selectivity in Foreign Aid Conditionality Evaluation Countries that have performed well on a series of indicators in the past should receive aid (money). Aid should be directed to where it can do good. Countries receive aid only if they behave well, implementing policy changes, embracing macroeconomic stability (low-budget deficits and inflation), noninterference with market pricing, privatization of state-owned enterprises and openness to international trade. Aid agencies typically give low priority to evaluating projects after completion.

Can Aid Buy Growth 2.2 Our Critique 1/1 2/3 Increasing aid while growth is decreasing. Lack of robustness of Burnside and Dollar (2000). Lack of differentiation between the different types of aid. (Lack of dis- aggregation of aid). Overstatement: Aid does not drive growth. Aid may have been responding to poor growth outcomes. Also, majority of aid is disbursed when countries are experiencing financial difficulties and this aid usually goes to finance government recurrent expenditure rather than investments, hence one should not really expect growth outcomes. The lack of robustness of the Burnside and Dollar results is not an Some type of aids such as short term aid do not have an impact on economic growth while other aids used for infrastructure and investments will result in a positive economic growth. With the use of aid, some achievements have been recorded contributing to some levels of growth.

Conclusion Contradictions in Easterly’s arguments: ‘Big Push’ can overcome the lack of evaluation capacity. In spite of negative results, there are a lot of positive effects of aid. There is no counter factual to determine the true effect of aid on growth. “AID IS AS OLD AS THE AGES, AID SHOULD CONTINUE” Ability of poor countries and donors to evaluate aid effectiveness can be enhanced if there are massive investments to improve data collection abilities, improve poor countries’ technical abilities, improve roads to access the poor. Aid still plays an important role in improving the welfare of the poorest of the poor. To determine the true effects of aid on growth, we would need poor countries that began on an equal footing, e.g. initial income, education, health, etc and compare the growth outcomes of the group that received aid against the group that didn’t.

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