The ideology made sense because it had worked

The aid model gained its notoriety
during the 1950’s/60’s. During this period, the justification of aid had been
made reputable following the Marshall plan (American assistance of $15bn loan
for the reconstruction of Europe following WW2). (Moyo, D. 2009). The diligence
of aid derives from the economics acceptance that- savings result in investments
(Papanek, 1973)., ceteris paribus investment will result in economic
growth. Post the prominence of the aid model (1950/60’s) many African
economies were emerging from extreme racism and colonial rule and others were
still fighting for liberty, thus, most of Sub-Saharan Africa did not have a
strong savings culture and they continue to struggle to recover from the
ruthless pillaging and systematic destabilising. Consequently, the purpose of
the aid model would be to replace savings thus aid would boost
investment. Conceptually the ideology made sense because it had worked for
Europe.

 

Aid may be
categorised into three parts; Emergency aid which is given in cases such as
droughts, floods, outbreaks. As part of a global community there is a
responsibility to act to help and combat these situations…

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NGO/Charitable is
the second form of aid and this is small amounts of money which may be given to
help purchase mosquito nets, send rural children to schools etc. As good as
this sounds, it does seem slightly delusional to believe that this form of aid
will be enough to miraculously boost Africa’s economic growth, create jobs and lead
to lessening poverty levels. It must be noted that approximately 60% of
Africans are under the age of 24; there is no need for pity or sympathy, job
creation is necessary. Sending money may send several children to school
however without economic growth and innovation the purpose of this type of aid
becomes redundant.

 

This thesis will
be focusing on analysing the third form of aid which are Government-Government
aid flows. These are large billions of dollar packages that go from western
governments to African governments and other large international agency to
African governments. About 100bn dollars a year projected yearly. This research
project will analyse the impact of government-government aid flows and focusing
on a few of the unintended consequences aid has had on Africa.

 

Foreign aid is the international
transfer of public funds and they are received in the form of grants which can
be either directly from one government to another (bilateral assistance) or
indirectly through the vehicle of a multi-lateral assistance agency such as the
World Bank. Economists have therefore defined foreign aid as any flow of
capital to a developing country, it must meet two criteria. 1) the objective
must be non-commercial form the point of view of the donor. 2) it should be
characterized by concessional terms (for the extension of credit that are more
favourable to the borrower than those available through standard financial
markets); that is the interest rate and repayment period for borrowed capital
should be softer than commercial terms.  

 

This research project has been motivated
through learning that 34 out of the 48 least developed countries (LDC’s) are in
Africa even though over the last 50 years Sub-Saharan Africa has received over
a trillion dollars’ worth of aid from developed economies. It is plain to see
that the trillions of dollars have not contributed nor has this money helped
economic growth or development in Africa. Following 1980, after the aid model
gained its dominant stature in Africa, there has been inadvertent effects. Aid
was to be used as a way to satisfy the Millennium Development Goals
(MDG’s-2000) which have now changed into Sustainable development goals (SDG’s)
and since the prominence of the model, Africa has witnessed declining
development due to increased poverty levels, conflict, famine, gender inequality,
stagnant life expectancy etc. 

 

Generally, it is believed that the
purpose of aid is to serve two purposes, which are; increase economic growth
and to reduce poverty levels. growth in sub-Saharan Africa has been very slow
and poverty levels have continued to rapidly increase

Former British
Prime Minister Tony Blair believes aid has transforms Africa Now is the time
for growth and governance that Africa has been made huge advances following
the 2005 Gleneagles summit, however there is still room for improvements.

 

Poverty has increased since the
prominence of the aid model, in 1970, 10% of Africans lived in poverty, she
states over 77% of Africans live on $1.25 a day or less today.

 

Over 70% of African government budget
is aid money; this has proven to be destructive according to Moyo. Africa has
become dependent on the aid system and in order for economies to grow; we need
private sector development, no representation without taxation. Moyo strongly
believes that African governments are corrupted through aid because they do not
need tax and can survive on aid money. Due to this, the aid model has
discouraged investment.

 

 

PURPOSE

This research
project is to analyse the issues of aid, the world bank states “We face big
challenges to help the world’s poorest people and ensure that everyone sees
benefits from economic growth. Data and research help us understand these
challenges and set priorities, share knowledge of what works, and measure
progress” This paper research paper aims to answer the question of whether
foreign aid encourages economic growth since there is a controversy

 

 This paper attempts to examine the aid-growth
relationship under a variety of settings

The purpose is to examine
the issue of endogeneity -the possibility that aid flows could go to countries
that are doing particularly badly, or to countries that are doing well,
creating a spurious correlation between aid and growth.

Today there has
been $100tn following colonial regime most African countries did not have a
strong savings culture and therefore most of these economies have very little
excess which may be used for savings (investment).

 

 As part of the effort to help countries meet
the Millennium Development Goals, the international community has committed to
scaling up aid and improving aid delivery. For its part, the IMF is working to
ensure an enabling macroeconomic environment for the effective use of aid. The
IMF Executive Board met recently to discuss Fund’s role, policy advice and
program design issues in light of these efforts. Reasons for slow development
and growth in Africa despite being the largest aid recipient and how the global
society can address the issue of aid to Africa with a more realistic and
sensible lens. Finally analysing the several unintended consequences, the aid
model has had on sub-Saharan Africa.

 

LIT REVIEW (10%)

 

The study of foreign aid and its
relationship with macroeconomic factors such as economic growth and poverty
eradication along with satisfying the SDG’s has been subject to a vast number
of studies.

 

Dreher and Langlotz
(2015) produced an empirical paper which went on to examine the relationship
between aid and growth. Their paper runs a comparison on previous literature to
measure the effect of aid on economic growth. The paper aims to answer the
question of whether foreign aid has an effect on the recipient countries
economic growth. According to previous literature, population size and bilateral
political relations are some of the strategies used to identify the effect of
aid on growth. In their research, Dreher and Langlotz highlight that some
previous work found no significant relationship between the recipient country’s
economic growth and aid.

Werker et al. (2009)
use the use of oil price fluctuations that substantially increase the aid
budgets of oil-producing Arab donors. Dreher and Langlotz built their argument
for aid; based on the relationship between government fractionalization and increased
aid budgets. They collected from 1974 to 2009 from a sample 96 countries to
construct the following model:  

In this model they
have ‘Growth’ as the dependent variable, while the independent variables are Aid,
X is a control variable which was used in Burnside and Dollar (2000).

“N” is the recipient
country fixed effects, and ‘Pi’ is the period of fixed effects.

Dreher and Langlotz
reached the following conclusion; there is no correlation between GDP per capita
and aid, none-the-less they found there to be a negative correlation between growth
and aid in the period following the Cold War. They find that the impact of aid
on growth is stronger when aid is lagged. Aid has no effect on GDP
constituents. Fractionalization increases aid budget Dreher and Langlotz
explain the results they find from their study might be attributed to the size
of the sample is less than 800 observations time period and the fact that aid
might be effective in some group of countries but not in others.

 

Literature on aid
effectiveness took a new turn, in Boone’s (1996) published paper which
concludes that aid has no impact on growth. This issue has been taken up in a
very influential paper by Burnside and Dollar (2000), and another one by
Svensson (1999), convincingly proving that an appropriate assessment of the
impact of aid requires taking into account the heterogeneity of the recipient
countries. Burnside and Dollar, adopted a medium-term perspective, it conveys
that the impact of aid is positive in countries pursuing a good set of
macroeconomic policies, while Svensson (1999), empirical evidence in a
longer-run perspective, that what matters is the checks and balances provided
by democracy. This literature has led to the advocacy of a switch in aid policy
from conditionality, whereby donors try to influence policy-making in recipient
countries, to country selectivity. 

 

Hollis Chenery (1981) pioneered the two-gap model which states foreign
borrowing as a supplements to foreign exchange and it may assist with
generating growth and development.  The
model requires the gap between foreign exchange earning from exports and
necessary imports is greater than domestic investment savings gap, when
domestic and foreign resources are not substitutable for one another.

The idea of Chenery’s model supports Rostow’s (1964) illustrious paper
which is a key historical model of economic growth and development- the economy
is operating at a pre-take off stage where there exists a large investment
savings gap (Most Sub-Saharan African economies are considered to be here). The investment-savings ratio must be greater
than 5%. Under this school of thought borrowing takes place and turns into
export surplus the borrowing country should be able to repay the debts and
become a net creditor. However, this may only work if the marginal savings
ratio exceeds average (i.e. eliminates the investment savings gap) or if the
marginal propensity to export exceed the marginal propensity to import. This is
not necessarily what really happens as developing economies don’t want to cut
resource inflows as this disrupts the economy and it proves to be difficult to
convert domestic resources into foreign exchange (e.g. exports are income
inelastic and tend to be low value (raw materials)).

 

In national
accounting, an excess of investment over savings results in an excess of
imports over exports.  as a result we can manipulate the previous
equation which results in  recalling that growth requires investment in
capital goods and technology. Investment in capital
goods can be purchased domestically and abroad in open economies remembering that
domestic investment requires savings and foreign investment requires foreign
exchange. Harrod-Domar
g = s ? ? ?      gave
the growth model which switches savings for aid.

Arthur Lewis (1954),
argued that development occurs as labour shifts from an unproductive
“traditional” sector—activities such as subsistence farming, or petty
trade—into modern, capitalist activities.

 

 

To overcome the
savings gap problem, foreign aid may be given. Borrowing may take place from
countries receiving foreign aid and they turn into export surplus.

Borrowing country
should repay debt and become net creditor, in essence this only works if the
countries marginal savings ratio exceeds average (eliminate investment-savings
gap). Alternatively, if marginal propensity to export exceeds marginal
propensity to import. (X>M).

 

LDC’s growth should
be greater than HDC’s growth due to LDC’s having capacity to grow nevertheless
Africa has proved to be divergent. This could be because exports from LDC’s
tend to be income elastic, and of low value. Raw materials that are worth a lot
but have been sold at lower costs because LDC economies cannot convert domestic
resources into foreign exchange. Therefore, aid may not actually be effective
in bridging this gap for LDC’s.