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Center for Global Development

Are the planned increases in aid too much of a good thing?

Working Paper Number 90

Owen Barder
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Center for Global Development

July 2006

SARPN acknowledges the Center for Global Development as the source of this document.
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Abstract

Donor countries have committed themselves to increase aid to developing countries by 60 percent over the next five years; and larger increases would be needed to meet the Millennium Development Goals (MDGs). But there are concerns that there may be a limit on the amount of aid that developing countries can absorb and use effectively—and that large aid flows might even be harmful. Could a large increase in aid be “too much of a good thing?” This essay disentangles the seven possible reasons why additional aid might not be effective. These include microeconomic effects (e.g., transactions costs), macroeconomic effects (e.g., ‘Dutch Disease’) and the impact on political economy (e.g., the ‘Resource Curse’). The paper looks at each possible constraint in turn. The paper finds that there are indeed serious obstacles to effective use of increased aid, but that none is immutable. All of the constraints which limit the effective use of additional aid can be addressed by a relatively small set of practical improvements in the way that aid is provided and used. Donors have already committed themselves to a significant program of aid reform. If the measures to which donors are committed were consistently implemented, the seven constraints to effective aid absorption could be relaxed. The paper concludes that, provided increased aid is accompanied by reforms to the way aid is delivered, the capacity of developing countries to absorb and use aid should not be presented as a barrier to the increases in aid which would be needed to meet the MDGs.

Summary1

Aid to developing countries would increase by more than 60 percent over the next five years if the international community meets its commitments. But there are concerns about whether an increase in aid of this size can be used effectively. Is there a limit to the amount of aid that can be absorbed? Might more aid be “too much of a good thing”?

Looking at these concerns in more detail, the problems identified as limits on “aid absorption” are in fact a quite diverse set of challenges. This paper groups the obstacles to aid absorption into seven distinct constraints, each of which has been identified as a possible reason why the costs of aid might rise more quickly than the benefits:

Box 1: Seven constraints on the effective use of more aid

  1. Microeconomic

    1. Transactions costs
    2. Bottlenecks (e.g. shortages of skilled people)
    3. Diminishing marginal returns

  2. Macroeconomic

    1. Macroeconomic effects of sustained aid inflows (Dutch Disease)
    2. Macroeconomic effects of short-term volatility in aid

  3. Political economy

    1. Corrosion of accountability of governments (“who pays the piper”)
    2. The resource curse


If these constraints mean that the costs of aid to the recipient become more significant relative to the benefits when aid increases, then there could be an upper limit on the amount of aid that can be used effectively. If, however, the costs of aid do not rise disproportionately, or if the problems can be alleviated by changing the way that aid is given, then increased levels of aid can, in principle, be absorbed and used effectively.

Considering these possible constraints in turn, the paper concludes that:

  1. These are indeed valid concerns which taken together constitute a challenge to the ability of developing countries to make effective use of substantial increases in aid.
  2. However, none of these constraints is immutable; each is the consequence of inefficiencies in the aid system, many of which are within the control of donors. They do not imply a fixed upper limit on the amount of aid that could be given and well used.
  3. A small number of practical changes to the aid system would relax these constraints to enable additional aid to be more effectively used. Donors have already committed themselves to making many of these changes, though progress has been slow.
  4. Although there are possible costs as well as benefits to receiving aid, these costs do not generally rise disproportionately as aid increases, and so aid would not generally become less effective on average as it is increased.
  5. In addition to providing more aid to the poorest countries, there is scope for very large increases in aid to be used well to ensure the provision of global public goods.
This analysis should not be understood as suggesting that there are no other challenges to solve if the international community is serious about meeting the Millennium Development Goals. But it does imply that donors and recipients can work together to relax the constraints which limit the effectiveness of additional aid.


Footnote:
  1. Thanks especially to Steve Radelet for his guidance and wisdom. Also thanks to Nancy Birdsall, Michael Clemens, Dennis de Tray, Mick Foster, Ruth Levine, Todd Moss, Gunilla Pettersson, David Roodman, Celina Schocken and Adrian Wood for helpful contributions and comments on earlier drafts. Any remaining errors and opinions are, of course, my own.


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