Foreign-aid follies

By Kenneth Rogoff

Former chief economist of the IMF, is Professor of Economics and Public Policy at Harvard University.

The huge gap between the world's richest and poorest countries remains one of the great moral dilemmas for the West. It also presents one of the greatest challenges for development economics. Do we really know how to help countries overcome poverty?

In his eloquently written and deeply researched new book The Great Escape: Health, Wealth, and the Origins of Inequality, Princeton University's Angus Deaton urges caution. For those interested in world poverty, it is unquestionably the most important book on development assistance to appear in a long time.

Deaton suggests that far too often, Western aid serves to assuage donors' guilt rather than improve recipients' plight. This is particularly the case when naïve assistance serves to reinforce a dysfunctional status quo. Although Deaton supports select initiatives, particularly for delivering medical and technological knowledge, he questions whether the vast majority of aid passes the basic Hippocratic litmus test of "first do no harm."

For starters, assessing and implementing aid policy requires developing tools to gauge accurately where need is greatest. Economists have developed some useful indicators, but they are vastly less precise than politicians and the media seem to understand.

Most experts agree, and Deaton concurs, that at least a billion people on the planet live in desperate circumstances resembling conditions that prevailed hundreds of years ago. Our failure to alleviate their plight is morally reprehensible. But where, exactly, are the greatest concentrations of poor people? Data are hard to come by and even harder to interpret.

Attempts to convert national incomes into a common denominator are fraught with complications. To take one prominent example, there is a 25% margin of error on purchasing-power-parity comparisons between GDP in the United States and China. In other words, we cannot say whether Chinese output today equals 55% of US GDP or 92%. So much for precise forecasts of the date when China will overtake the US as the world's largest economy; we won't even know for sure when it happens!

This problem is hardly unique to comparisons of China and the US; it applies with perhaps even greater force when comparing incomes of the poor in Mumbai with those of the poor in Freetown. Another major problem is measuring progress in a given country over time. How can one compare cost-of-living indices in different periods when new goods are constantly upending traditional consumption models? Consider the impact of cell phones in Africa, for example, or the Internet in India.

Deaton goes on to offer a revealing critique of some of the most hyped and fashionable approaches to improving aid. For example, the "hydraulic model" of aid - the idea that if we simply pumped in more aid, better results would gush out - ignores the fact that funds are often fungible. Even if aid is narrowly targeted at say, food or health, a government can simply economize on expenditures that it might have made anyway and redirect them elsewhere - for example, to the military.

Direct delivery of medical help is one of the best options, but it still can be a huge drain on already-scarce local resources - hospitals, doctors, and nurses. An influx of Western NGOs often bids talent away from nascent businesses that could help the country long after the NGOs reset their priorities and move on.

Indeed, there is a striking parallel between the problems caused by aid inflows and the "natural resource curse" (or "Dutch disease" as it is termed in Western countries), whereby inflows into one economic sector - typically oil or minerals - drive up economy-wide prices (including the exchange rate), rendering other sectors uncompetitive. Moreover, a great deal of this aid is delivered in kind and for strategic reasons, often supporting ineffective and kleptocratic governments.

Deaton observes that, in general, Western countries developed without receiving any aid. (Perhaps America's post-World War II Marshall Plan in Europe is an exception, but that aid was intended more for reconstruction than for development.) China and India, too, have succeeded in lifting hundreds of millions of people out of poverty with relatively little Western aid (particularly China). Deaton argues that aid providers must be extremely careful not to interfere with political and social forces that, over time, can generate organic - and therefore more lasting - internal change.

Another intellectually fashionable approach is to conduct small randomized trials to examine, say, the effectiveness of school-attendance incentives or immunization campaigns. Deaton rightly argues that this approach, now enshrined in World Bank procedures, is of very little use for understanding how to help a country develop more broadly. The results are often specific to a particular country's circumstances, and there is no reason to presume that they would scale up when fully confronted with a developing country's governance problems. The fact that people in several African countries appear to be worse off now than in 1960 is far more related to despotism and internal conflict than it is to the effectiveness of aid-delivery programs.

Despite these caveats, Deaton's message is fundamentally positive. For most of mankind, now is a better time than ever before to be alive. The path to development remains for others to follow. Highly targeted Western aid and advice can help, but donors must take more care not to stand in the way of the beneficiaries of their assistance.

Copyright: Project Syndicate