1. Foreign Aid Political Economy of the Global South Prof. Tyson Roberts

2. Review of the “Resource Curse” Negative effects of natural resource endowments – Reduced economic growth – Inferior institutional quality such as property rights, rule of law, democracy, … Mechanisms – “Dutch Disease” – Revenue volatility – Political/institutional deterioration

3. However, these negative effects are not deterministic How can “Dutch Disease” be avoided? – Invest (in the future) rather than consume (in the present) – Indonesia and Malaysia invested in agricultural production and industry – increases competitiveness – Mexico mainly promoted its state oil company – fell behind in competitiveness

4. However, these negative effects are not deterministic How can revenue volatility be addressed? – Stabilization funds – For example, Chile’s Copper Stabilization fund

5. However, these negative effects are not deterministic How can “political deterioration” be avoided? – Natural resource revenues stabilize regimes (including democracies), they do not necessarily lead to transition to dictatorship – Resource rents lead to more corruption in low- quality institutional environments (e.g., dictatorships), but not in high quality – Botswana had (fairly) good institutions before diamond revenues came on stream – Sequence matters

6. How to address the resource curse? Two strategies: – Take resources away from government or bypass government (e.g., give revenues directly to citizens) – Keep revenues in hands of government but change government policies (e.g., natural resource funds)

7. Foreign Aid

8. Competing Views of Foreign Aid “Big Push” vs. Dependency “Big Push” – Poor economies are trapped in poverty (finance gap) – Need major aid inflows to push out of trap Dependency – Aid flows make poor economies dependent; undermine incentives to improve – Aid => rentier state

11. Answers to the dilemma? Empirically-supported aid Conditional aid Selective aid

12. “Big Push” Harrod-Domar Model: – y=f(k) – Constant returns to capital – Growth determined by savings rate

13. Poverty Trap – Finance Gap However, poor countries cannot afford sufficient savings – Low income => low savings => insufficient investment => low income If rich countries transfer savings to poor countries, poor countries will grow until they can afford to self finance => “takeoff” – High income => high savings => high investment => high income

14. Poverty Trap

15. Is X money? If so, sending money should push aid recipients out of poverty trap

16. Other determinants of growth Solow Model (based on Cobb-Douglas) – y = Ak α l β ; α + β = 1 – Diminishing returns to capital & labor – Growth determined by exogenous technology Improve labor (aid for education, health)

17. Increase in education often has no effect on growth Source: Pritchett 2001

18. Why might education not lead to growth? Piracy: Educational capital goes into privately profitable but socially unproductive activities – Entrepreneurs exploiting monopoly opportunities or government contracts – Bureaucrats in patronage-based states Insufficient demand: Slow growth in demand for educated labor Poor schools: Education system provides few skills

19. Other determinants of growth Solow Model (based on Cobb-Douglas) – y = Ak α l β ; α + β = 1 – Diminishing returns to capital & labor – Growth determined by exogenous technology Improve technology – Improve incentives to invest with better policies How to improve policies? Conditionality (?)

20. Source: H. Doucouliagos, M. Paldam 2008

21. Problems with Conditionality Structural Adjustment Loans in 1980s emphasized conditionality – aid now for policy changes Many governments received the aid and then didn’t change the policies, because of vested interests and lack of “ownership” in policy design Donors continued to give aid

22. Donor goals of aid Altruistic – Economic growth, human development, democracy Commercial – Trade and investment Geostrategic – UN votes, military allies Organizational

23. Determinants of aid flows Altruistic – Income level, political liberalization Commercial – Trade flows, colonial history Geostrategic – UN votes, military allies Organizational – Small population, history of aid

24. Burnside & Dollar (2000): Aid x Good Policies => Growth

25. What is Good Policy? (According to B&D 2000) Open economy (few trade restrictions) Macroeconomic stability (low inflation) Low budget deficits

26. B&D’s results were driven by outlier cases, esp. Botswana & Zambia

27. If additional observations are included, the relationship between AidxPolicy and Growth turns negative

28. Why might aid have negative effect on growth? Dutch Disease – Aid makes economies less competitive Aid volatility – Volatlile aid undermines ability of governments to plan, encourages short-time horizon thinking (roving bandit vs. stationary bandit) Rentier State/Enclave Economy/Fungibility – Aid enables bad policies & bad institutions

29. Burnside & Dollar (2004) Aid + Good Institutions => Growth Donor behavior changed after Cold War – 1980s: Aid went to countries w/good & bad institutions – 1990s: Good institutions attracted more aid Institutions condition affect of aid (in 1990s) – Aid + good institutions => positive growth India, Botswana – Aid + bad institutions => negative growth Pakistan, Zaire/DRC

30. Aid x Good Institutions => Growth Doucouliagos & Paldam 2008 – Aid x institutions: robust – Aid x policy: not robust

31. Some conditions under which aid has been found to be beneficial for development Civil liberties (Isham, Kaufmann, and Pritchett 1995) Good policies (Burnside & Dollar 2000, Economides et al 2004) Good institutions (Burnside & Dollar 2004) Democracy (Kosack 2003) Sufficient human capital (Kosack and Tobin 2006) 31

32. Trends in foreign aid Post-WW2: IBRD, Marshall Plan 1960s: Bilateral aid focused on former colonies 1973: McNamara Revolution, focus on poverty reduction 1980s: Structural adjustment, focus on economic liberalization policy, conditionality 1990s: Increased focus on institutional quality, selectivity, and donor-government partnership – HIPC, Millenium Challenge Account – Increased funding for non-government bodies 32

33. Lessons of Foreign Aid Selectivity works better than conditionality Government ownership of policy increases probability of implementation

34. Recommendations to address “Resource Curse” Countries with good institutions: Help with natural resource extraction (and give aid) Countries with poor institutions/policies and seek to develop natural resources: Do not give aid until institutions improve Countries with poor institutions that already have natural resource production: boycott

35. Possible solutions Tracing production / embargos / consumer action campaigns – the Kimberley Process and “blood diamonds” Creating greater transparency of who is paying what to whom and holding gov’ts to account for those funds (EITI) Developing national savings mechanisms Privatization Anti-corruption commisions & improved sector legislation and regulation. Direct distribution of benefits to people Choosing not to exploit the resource in the first place Reduce demand for oil from the US, etc. Clean Trade Acts & Clean Hands Trusts Sources: www.sebstrategy.com, www.cleantrade.org, Birdsall & Subramanian 2004, Ross 2011www.sebstrategy.com

36. Solutions

37. Pay oil revenues into independent escrow account for national development – Worked for Norway-- Didn’t work for Chad Why?

38. EITI compliant & candidate countries

39. Solutions Privatization didn’t work so well in Russia