Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa by Dambisa Moyo Page B
Authors: Dambisa Moyo
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(mainly the export sector) that face international competition and depend on that resource more uncompetitive, and almost inevitably they close.
The IMF has stated that developing countries that rely on foreign capital are more prone to their currencies strengthening. Accordingly, aid inflows would strengthen the local currency and hurt manufacturing exports, which in turn reduces long-run growth. IMF economists have argued that the contribution of aid flows to a country’s rising exchange rate was one reason why aid has failed to improve growth, and that aid may very well have contributed to poor productivity in poor economies by depressing exports.
In other work, their research finds strong evidence consistent with aid undermining the competitiveness of the labour-intensive or exporting sectors (for example, agriculture such as coffee farms). In particular, in countries that receive more aid, export sectors grow more slowly relative to capital-intensive and non-exportable sectors.
Aid inflows have adverse effects on overall competitiveness, wages, export sector employment (usually in the form of a decline in the share of those in the manufacturing sector) and ultimately growth. Given the fact that manufacturing exports are an essentialvehicle for poor countries to start growing (and achieving sustained growth), any adverse effects on exports should
prima facie
be a cause for concern.
Moreover, because the traded-goods sector can be the main source of productivity improvements and positive spillovers associated with learning by doing that filter through to the rest of the economy, the adverse impact of aid on its competitiveness retards not just the export sector, but also the growth of the entire economy.
In the most odd turn of events, the fact that aid reduces competitiveness, and thus the traded sector’s ability to generate foreign-exchange earnings, makes countries even more dependent on future aid, leaving them exposed to all the adverse consequences of aid-dependency. What is more, policymakers know that private-to-private flows like remittances do not seem to create these adverse aid-induced (Dutch disease) effects, but they largely choose to ignore these private capital sources.
As a final point, in order to mitigate the Dutch disease effects (and depending on their economic environments), policymakers in poor countries generally have two choices. They can (in a fixed exchange rate regime) either raise interest rates to combat inflation to the inevitable detriment of the economy, or they can ‘sterilize’ the aid inflows.
Sterilization implies that the government issues bonds or IOUs to people in the economy, and in return they get the cash in the economy. Through this process the government can mop up the excess cash that aid brings in. But, as discussed later, even sterilization has its costs.
Aid causes bottlenecks: absorption capacity
Very often, poor countries cannot actually use the aid flows granted by rich governments. At early stages of development (when countries have relatively underdeveloped financial and institutional structures) there is simply not enough skilled manpower, or there are not enough sizeable investment opportunities, to put the vastaid windfalls effectively to work. Economic researchers have found that countries with low financial development do not have the absorptive capacity for foreign aid. In countries with weak financial systems, additional foreign resources do not translate into stronger growth of financially dependent industries.
What happens to this aid money that can’t be used? In the most honest of outcomes, if the government did nothing with the aid inflow, the country would still have to pay interest on it. But given the policy challenges of large inflows discussed earlier (for example, inflationary pressure, Dutch disease effects), policymakers in the poor country must do something. Since they cannot put all the aid flows to good use (even if they wanted to),
The IMF has stated that developing countries that rely on foreign capital are more prone to their currencies strengthening. Accordingly, aid inflows would strengthen the local currency and hurt manufacturing exports, which in turn reduces long-run growth. IMF economists have argued that the contribution of aid flows to a country’s rising exchange rate was one reason why aid has failed to improve growth, and that aid may very well have contributed to poor productivity in poor economies by depressing exports.
In other work, their research finds strong evidence consistent with aid undermining the competitiveness of the labour-intensive or exporting sectors (for example, agriculture such as coffee farms). In particular, in countries that receive more aid, export sectors grow more slowly relative to capital-intensive and non-exportable sectors.
Aid inflows have adverse effects on overall competitiveness, wages, export sector employment (usually in the form of a decline in the share of those in the manufacturing sector) and ultimately growth. Given the fact that manufacturing exports are an essentialvehicle for poor countries to start growing (and achieving sustained growth), any adverse effects on exports should
prima facie
be a cause for concern.
Moreover, because the traded-goods sector can be the main source of productivity improvements and positive spillovers associated with learning by doing that filter through to the rest of the economy, the adverse impact of aid on its competitiveness retards not just the export sector, but also the growth of the entire economy.
In the most odd turn of events, the fact that aid reduces competitiveness, and thus the traded sector’s ability to generate foreign-exchange earnings, makes countries even more dependent on future aid, leaving them exposed to all the adverse consequences of aid-dependency. What is more, policymakers know that private-to-private flows like remittances do not seem to create these adverse aid-induced (Dutch disease) effects, but they largely choose to ignore these private capital sources.
As a final point, in order to mitigate the Dutch disease effects (and depending on their economic environments), policymakers in poor countries generally have two choices. They can (in a fixed exchange rate regime) either raise interest rates to combat inflation to the inevitable detriment of the economy, or they can ‘sterilize’ the aid inflows.
Sterilization implies that the government issues bonds or IOUs to people in the economy, and in return they get the cash in the economy. Through this process the government can mop up the excess cash that aid brings in. But, as discussed later, even sterilization has its costs.
Aid causes bottlenecks: absorption capacity
Very often, poor countries cannot actually use the aid flows granted by rich governments. At early stages of development (when countries have relatively underdeveloped financial and institutional structures) there is simply not enough skilled manpower, or there are not enough sizeable investment opportunities, to put the vastaid windfalls effectively to work. Economic researchers have found that countries with low financial development do not have the absorptive capacity for foreign aid. In countries with weak financial systems, additional foreign resources do not translate into stronger growth of financially dependent industries.
What happens to this aid money that can’t be used? In the most honest of outcomes, if the government did nothing with the aid inflow, the country would still have to pay interest on it. But given the policy challenges of large inflows discussed earlier (for example, inflationary pressure, Dutch disease effects), policymakers in the poor country must do something. Since they cannot put all the aid flows to good use (even if they wanted to),
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