ABSTRACT
The study is motivated by the need to scrutinise and critically reflect upon the rationales in development assistance, to put development intervention in perspective by regarding it as part of the context where it is implemented, and to bring these two perspectives together. The starting point is an indication of a common mismatch between what is intended when aid is formulated and what happens when it is implemented.
In the study, aid is regarded as an instance of intervention and as based on commonly non-articulated assumptions about societal change and different actors’ roles, which help explain interventionist practice ‘ though few would assign to those assumptions when made explicit. Local contexts are regarded as living settings with certain specifics and dynamics with which a development intervention comes to interact, which helps explain why things do commonly not evolve as anticipated.
The purpose is to investigate how such inherent rationales relate to such local dynamics, and the research problem is formulated thus: how effective is application of Aid to the development of the recipient country? The inherent rationales are traced by situating development aid in the context of intervention aimed at creating societal change and improving human welfare.
The findings suggest that development intervention is apparently based on flawed assumptions of societal change as technical and makeable and on futile ambitions to predict and control. The study suggests that there are remaining reasons and room to intervene in poor societies, but that assumptions and ambitions need to be altered and local appropriation endorsed.
Keywords: development intervention, development aid, development cooperation,
local development, local dynamics, local governance, interplay, EU and Nigeria.
1.1. INTRODUCTION
This thesis is set to study some of the difficulties in creating or supporting development in poor countries through international aid. This is done through analysis of the research problem: ‘: how effective is application of Aid to the development of the recipient country’? The analysis is based on empirical case study of EU official development assistance to Nigeria.
1.2. Purpose and problem
Problem Statement
Topic
The topic area of this thesis is foreign aid and development: Specifically, How effective is EU Development Assistance to Nigeria? The focus of the topic will be on aid, economic policies and policy implications.
1.3. Objective
As a result of the Burnside and Dollar (2000) conclusion that aid is less effective in countries with poor economic policies, many donors have placed conditions on their aid based on good economic policies. The Burnside and Dollar (2000) findings also posit that donors were not allocating foreign aid based on good economic policies, but based upon variables that reflected their own strategic interests (Burnside & Dollar, 2000). It is therefore important to investigate from a more current perspective and with updated data, the following questions:
1. Is the effect of foreign aid on growth conditional on economic policy?
2. What are the policy implications of such results?
1.4. Hypothesis/ Research Question
Despite thorough learning and constant refinement, however, experience shows that aid activities rarely work as intended. A range of scholars have pointed to various levels of failure, with examples ranging from complete fiasco and negative effects to results below expected and results not sustaining after external resources have been withdrawn (e.g. Easterly 2008; 2006; Riddell 2007: 253ff; 1987; Corbridge 2007; Vries 2007; Gastel and Nuijten 2005: 87; Green 2002: 52; Edwards 1999; Upphoff 1996; Ferguson 1994; Porter et al. 1991; Kothari 1988).
Perhaps paradoxically, such shortcomings help explain why aid has become so firmly established. What was intended as something temporary to overcome urgent problems failed to fulfil that ambition and was instead transformed into a permanent part of North-South relations. Continuous lack of success and still burning problems have also caused a revival during the last few years, with aid being a central focus of attention of world leaders and a top agenda item, manifested in a series of top meetings on international aid policy (e.g. Riddell 2007, Li 2007).
The purpose of this thesis is to contribute to a better understanding of some of the difficulties and weaknesses in the efforts to intentionally create or support development in poor countries through international aid. The starting point is an indication, from continuous shortcomings despite continuous refinement, that there is commonly a mismatch between what is intended when aid activities are formulated and what happens when they are implemented. Things do apparently not unfold as anticipated, and I am curious about the nature of this mismatch.
My perspective, then, is to regard development assistance as an instance of external intervention into local settings. Throughout the changes of approach, aid has remained a matter of introducing new features. Brought in from outside are material resources, technical expertise, economic policies, political structures etc, along with attached norms and values. Such introduction inevitably implies interference in existing systems with the apparent, though often non-articulated, aim of changing or replacing prevailing features and thereby achieving certain societal change.
In this study, I will investigate how interventionist rationales relate to the specifics and dynamics of a local setting at implementation. The research problem is formulated thus: how effective is application of Aid to the development of the recipient country?
The first chapter of this thesis consists of a brief introduction on the specifics of Development Aid and a background on EU’s Cooperation with Nigeria. After that, two chapters follow that each answers a part of the research question from a Disciplinary point of view. Chapter two looks at the moral case for aid and gives an overview of several theories that explain why Aid giving is ineffective. Chapter three focuses on why Aid is given and is divided in two parts: the first one looks at institutional aid-giving, whereas the second one has the recipient at the core of its argumentation.
The fourth chapter puts together all the information and looks for conflicts between them. After the conflicts are resolved, chapter five finally gives an integrative answer to the question what the motives are behind development aid.
The conclusion discusses the implications of this research and proposes ideas for future research.
Defining Development Aid
Aid comes in many forms, is given by many donors and distributed to a lot of recipients. This makes defining Development Aid a hard task. Depending on the definition used, some aid flows are included in one analysis and excluded in another. Terms like Official Developmental Aid, Official Aid, Development Aid, Foreign Aid, Humanitarian Aid can all refer to the same concept or one just slightly different. Quite often they’re used interchangeable, further complicating a proper analysis.
Trying to tackle the problem of defining aid, Riddell has given an overview of the most common terms and they’re designated meaning. Foreign Aid is the broadest term and Riddell defines it as ‘all resources ransferred by donors to recipients’ (Riddell, 2008: 17).
As Riddell points out, this term does not say anything about who the donors or the recipients are, the reasons behind the transfer and whether the transaction is voluntarily or not. Development Aid further narrows this down, as it consists of the part of Foreign Aid that goes from rich to poor countries, aims to reduce poverty and focuses on human welfare and development (Riddell, 2008: 17). The term Official Development Aid [ODA] was first used by the Development Assistance Committee [DAC] of the Organisation for Economic Co-operation and Development [OECD] and is to be seen different from Official Aid [OA].
Simply put, the difference between the two lies in the recipients of the aid: aid going to the poorest developing countries or the lower and upper middle-income countries is termed ODA, whereas OA is aid targeted at more ‘advanced developing nations and countries and territories in transition’ (Riddell, 2008: 18).
Arguably the motives for giving aid to a country with a population living in extreme poverty can be different from those for giving aid to a country with an economy that is already starting to grow at a fast rate. Since most sources do not specify what form of aid they’re discussing, the picture here will not be as detailed as preferred and some generalizations have to be made to be able to draw any conclusion at all. From here on, the term Development Aid will be used with its definition as proposed by Riddell, unless stated otherwise.
Development Aid is distributed through several types of donors. Bilateral aid is ODA given from the government of one donor country to the government of a recipient country (Riddell, 2008 :). Multilateral Aid is ODA distributed through an international organization, such as the different bodies of the United Nations [UN] (Riddell, 2008 :). Non-governmental organizations [NGOs] are becoming increasingly important as a player in the field of Development Aid (Riddell, 2008 :). NGOs can be locally based or acting on a global level and are based in both donor and recipient countries (Riddell, 2008: 259).
The term can refer to an agency consisting of hundreds of people handling dozens of projects or a small group carrying out one small-scale project. Those that are relevant in the world of Development Aid do however have some characteristics in common. According to Riddell, those are the following three: they are in some way involved in humanitarian and development work; the nature of their activities is ‘not-for-profit’; and they are distinct from both governmental and private for profit organizations (Riddell, 2008: 259,260). Although aid is generally distributed on an institutional level, the importance of individuals should not be overlooked, since government budgets for Development Aid are to a great extent depending on public support. In addition, every organization, be it governmental or non-governmental, consists of individual people who, although they’re part of a larger institution, still have their own minds.
Cooperation Agreement between Nigeria and the European Union (EU)
Nigeria’s cooperation with the European Union (EU) dates back to 1975, through the African Caribbean and Pacific (ACP) group. Nigeria has received increasing allocations: ’50 million, ‘213.5 million, ‘365 million, ‘552 million and ‘677 million under the 5th, 6th, 7th, 9th and 10th EDF, respectively. There was no allocation to Nigeria under the 8th EDF, due to diplomatic concerns between Nigeria and the EU.
The general objectives of Nigeria’s cooperation with the EU are to foster sustainable economic and social development and to mount campaign against poverty. Nigeria is an important partner for the EU, for several reasons, including its economic and social strength; young and growing democratic institutions; role in Africa in general and particularly in the process of regional integration in West Africa; her role as a key energy supplier for the EU’s energy security; and its central position in the management of inward and outward migration flows, both to support the development agenda and to control human trafficking.
The European Union under the relevant provisions of the Cotonou Partnership Agreement is also providing financial assistance to Nigeria through Investment Facility of the European Investment Bank (EIB). The EIB was established in 1958 as the European Union’s long-term lending institution to further the integration, balanced development and economic and social cohesion of its Member States. The EIB is policy-driven and adapts its lending activity to European priorities, including its external development aid and cooperation objectives. The EIB has been entrusted with a series of external regional mandates to support European policies abroad over the course of its 50 years’ existence.
The EIB’s overriding aim in the African Caribbean and pacific (ACP) region and in the Overseas Countries and Territories (OCTs) is to support projects that deliver sustainable economic, social and environmental benefits. The Bank’s goals in these regions are aligned with the ACP-EC Partnership Agreement (Cotonou Agreement), the European Consensus for Development and the United Nations Millennium Development Goals.
The EIB house concentrates its efforts on fostering private sector-led initiatives that promote economic growth and help to reduce poverty. The Bank also supports public sector projects that are critical for private sector development and the creation of a competitive business environment. The EIB has been an active development finance partner in the ACP countries since 1963. Its cooperation in the OCTs and South Africa dates back to 1968 and 1994 respectively. Since the inception of its successive development mandates in these regions, the EIB has lent ‘12.2 billion in favour of almost 1200 projects in 92 different countries.
The EIB provides medium to long term funding through a complete range of financial instruments, from senior secured loans to flexible risk bearing financial instruments such as junior loans, equity, quasi-capital, guarantees and in particular cases, interest rate subsidies. The terms are adapted to the nature of each project and to the country’s economic situation. These instrument are denominated in euro, in widely-traded foreign currencies and, increasingly, in certain local currencies.
The EIB encourages flexible use of its financial instruments to support higher-risk operations-the Investment Facility was set up for this specific purpose. The EIB adds further value to its operations in the ACP countries and OCTs through the provision of grants for technical assistance to ensure efficient and effective project identification, preparation and implementation. Through the project cycle, the EIB aims to transfer the technical and economic know-how that it has gained from operations across the world to its beneficiaries.
Major investment projects are generally financed directly by the EIB. In addition, the Bank cooperates with a network of local financing institutions and investment funds that act as financial intermediaries for the EIB. They receive EIB credit lines or equity which they then use to finance smaller scale projects, normally of less than EUR 10 million. This is particularly the case for the financing of micro, small and medium-sized enterprises.
The beneficiaries of EIB financial support are private enterprises and commercially-run public sector entities established in an ACP country or the OCTs, with local and/or foreign investors; investment funds and other financial intermediaries active in the ACPs/OCTs; ACP small and medium-sized enterprises, through EIB lines of credit to ACP financial intermediaries and investments in private equity funds; in the case of water project preparation facility, public and private promoters; and cross-border infrastructure projects with regional benefits in Sub-Saharan Africa financed by the EIB with the support of the EU-Africa infrastructure Trust Fund.
To date, Nigeria through the office of the National Authorizing Officer (NAO) for the EU-ACP Cooperation has approved 709.62 Million Euros for the financing of core investment projects. The financial support granted by the EIB to Nigeria covered financial, industry and private equity sectors.
CHAPTER TWO
REVIEW OF RELEVANT LITERATURE
Aid effectiveness: What does past research tell us?
Economic theory and development thinking have been influential in identifying criteria for and evaluating aid effectiveness. Most important in this respect has been the two-gap model (Chenery and Strout 1966 and others), which identifies inadequate domestic savings and foreign exchange earnings as a binding constraints on economic development (growth) in developing poor countries. Thus, the objective of promoting economic development and welfare in recipient countries became an important part of the OECD’s definition of ODA in the 1970s.
During this time the criterion for aid effectiveness was whether aid is effective in promoting economic development and welfare in recipient countries. This criterion has been explored from different methodological and ideological perspectives. Studies have evaluated aid effectiveness at both the micro- and macroeconomic level, relying on both cross-country Comparisons and single country case studies, and by using broad surveys of a qualitative and multi-disciplinary analysis as well as empirical analytical studies. A complete survey of aid effectiveness studies is neither feasible nor essential task for this thesis. Instead I focus on summarizing the main results and weaknesses of this literature. Before moving to the analysis of empirical studies on aid effectiveness, I will briefly discuss some conceptually different approaches to potential impact of foreign aid in recipient countries.
There are two conceptually different broad views in this context. On the one hand, proponents of foreign assistance to developing countries argue that most poor developing countries lack domestic savings to finance existing profitable investment opportunities and have limited or no access to international private capital markets; thus, official foreign assistance could play an important role (the only source in many developing countries) in filling the financing gap in order to attain a needed investment level and targeted growth rate. Contemporary proponents of foreign aid, such as Sachs (2005), Stiglitz (2002), Stern (2002) and others argue that although aid has sometimes failed, it has prevented worse performance in many countries and even supported poverty reduction and successful development efforts in several others. They provide a number of successful examples of
programs that have been supported by western donors, such as the green revolution in Asia, eradication of various infectious diseases as a result of the Global Alliance for Vaccines and
Immunization, the spread of family planning, the success of export processing zones in East Asia and so forth. OECD,
The contemporary advocates of foreign assistance mainly use some modified versions of initial rationale for foreign aid. For example, Sachs (2005) argues that the basic mechanics of capital accumulation in poor countries fall into a poverty trap. Since all household income goes to consumption, there are no taxes and no personal savings. However, rising population and depreciation leads to a fall in capital per person and a negative growth rate of per capita income. This further impoverishes the poor households in the future and leads to a vicious circle of falling incomes, zero savings and taxes, private and public investment, and falling capital per capita. Sachs (2005) argues that the solution is foreign assistance, in the form of ODA, which ‘helps to jump-start the process of capital accumulation, economic growth, and raising household incomes’19. He identifies three channels into which foreign aid goes: households for emergency situations, government to finance public investment, and private businesses (for example, farmers) through microfinance programs and other schemes to finance private investment. Finally, Sachs (2005) claims, ‘If the foreign assistance is substantial enough, and lasts long enough, the capital stock rises sufficiently to lift households above subsistence’.
On the other hand, Freidman (1958), Little and Clifford (1965), Bauer (1972), and other earlier critiques of foreign aid argued that the objectives of foreign aid are worthwhile but its premises are wrong and it would just be a waste of money. As Milton Freidman argued ‘The proponents of foreign aid have accepted the view that centralized and comprehensive economic planning and control by government is an essential prerequisite for economic development’. They also argued that aid flows have largely contributed or will contribute to the failure of development efforts in many developing countries by enlarging government bureaucracies, perpetuating rent seeking and corruption, and enriching the elites in poor countries. According to Easterly (2003 and 2006), one of the strong contemporary critics of foreign aid, there is too much corruption in recipient countries and
unaccountability in aid delivery mechanism. He claims, therefore, that foreign aid has done Sachs, Jeffrey (2005).
Much bad and little good to recipient countries, and argues against up scaling of foreign aid flows. However, while influential, these high level studies seldom provide empirical evidence to support their arguments (Easterly, 2003; 2006 and Sachs, 2005 are exceptions). Having briefly discussed the higher-level conceptually different views regarding the role of foreign aid in promoting development, the main thrust of this section is to provide a review of empirical literature on the effectiveness of aid. Although, my main focus is on most recent developments, I will start with a short background debate by discussing some earlier studies.
Early studies on aid effectiveness mainly used the framework of the Harrod-Domar growth model and two-gap models, in which incremental capital-output ratio is a key determinant of the economic growth. Assuming that there is a savings gap that constrains investment and growth, these studies emphasized the role of aid in financing investment and proposed a causal link running from aid to savings to investment to growth. First, I briefly focus on and discuss studies that attempt to estimate the direct impact of aid on domestic savings, and then I concisely examine studies that make an attempt to estimate a causal link between aid and domestic investment. The studies available overwhelmingly suggest that there is a negative relationship between foreign aid and domestic savings (Hansen and Tarp 2000). For example, Snyder (1990), using data for 50 aid recipient countries, demonstrates that after controlling for per capita income, aid has no statistically significant effect on domestic savings. However, he does not rule out the possibility of some negative association between aid and domestic savings in some recipient countries because the relationship between aid and domestic savings were consistently negative, though statistically insignificant, in various specifications.
The findings of Reichel (1995) support this conclusion. He found a strong and statistically significant negative relationship between domestic savings and aid, and concludes that there is considerable evidence of foreign aid substituting for domestic savings. However, Hadjimichael et al (1995) demonstrate that there is a strong evidence of heterogeneity among aid recipient countries. This last study also initially finds a negative relationship between foreign aid and domestic savings in a sample of Sub-Saharan African countries. However, when they controlled for differences in growth performance and the degree to which macroeconomic and structural adjustment efforts were sustained, they find that the negative impact of foreign aid on domestic savings is concentrated in those countries with prolonged imbalances and negative per capita growth.
In countries with sustained adjustment efforts and positive growth rates, foreign aid appears to have stimulated domestic savings. Papanek (1992) also doubts the negative relationship between savings and net aid inflows, and argues that exogenous factors, such as political factors, are likely to cause both high aid inflows and low savings rates. Griffin (1970) attempts to explain the estimated negative effect of foreign aid on savings as follows. He argues that aid inflows will increase income but would not increase savings (investment) one-for-one. The reason for this is that marginal propensity to savings is always less than one, and marginal propensity to consumption is always above zero. Therefore, when income rises as a result of foreign assistance, part of the additional income goes to current consumption, thus, savings increases by less than the value of aid flows. Further foreign aid displaces domestic savings and in this sense, aid has a negative influence on savings.
There are two problems with this argument (White 1992). First, the above reasoning is static in nature and it ignores potential feedback from higher income into future higher savings and higher growth. Second, the bulk of foreign assistance goes to health and education sectors that are considered as consumer goods but helps to build human capital that plays an important role for future savings, investment and the economic growth. Therefore, the results of static analyses that show a negative or insignificant effect of foreign aid on savings are flawed on methodological grounds.
The aid-investment relationship has also received noteworthy attention of researchers from academia and international financial institutions. Overall, the available studies seem to indicate a positive relationship between foreign aid and domestic investment in recipient countries (Hansen and Tarp 2000, Mavrotas 2003). Hansen and Tarp (2000) summarizes the results of 29 earlier studies that attempt to test the proposition that asserts that foreign aid stimulates domestic investment. Their meta-analysis provides overwhelming support for the proposition that aid helps to increase the level of investment ratio in recipient countries, with fifteen out of sixteen estimates providing a positive and statistically significant result. Levy (1987) shows that much of aid transfers to developing countries go to finance investment. His results, based on a cross-sectional analysis of data from 39 LDCs, show that the estimated coefficient of aid with respect to domestic investment is approximately 0.86, thus suggesting that one point increase in aid to income ratio will lead to a 0.86 point increase in investment ratio22.
Thus he concludes that the evidence overwhelmingly supports the proposition that most development assistance intended for fixed capital formation is indeed invested and a sustained increase in the aid ratio caused an almost equal increase in the investment ration. In another study, Levy (1988) also reports positive and statistically significant impact of aid on investment based on a cross-section of 22 Sub-Saharan African countries. Results of regression that controlled for fixed country effects suggested that ‘countries that experienced an increase in the flow of foreign aid found that their investment increased on average by an equal amount’. Lensink and Morrisey (2000), in a cross sectional study of 75 aid recipient countries, also find a positive and statistically significant impact of aid on investment. Furthermore, Hansen and Tarp (2001), in a panel data analysis of 56 developing countries, obtained similar results. However, there are some studies that report a negative relationship between aid and domestic investment in recipient countries. For example, Snyder (1996) finds, using a 22 when aid net of technical assistance is used the coefficient rises to 0.96.
This highlights the notion about heterogeneity of different aid flows and the importance of aid disaggregation in evaluating the impact of aid on development outcomes. Pooled data for a sample of 35 aid recipients, a negative and significant impact of aid on private investment. Easterly (1999) investigates the relationship between foreign aid and domestic investment country by country for the period 1965-95. He finds that out of 88 aid recipient countries for which he performed the investigation the relationship between aid and investment was negative and significant, in 36 countries negative but insignificant in17 countries, positive and significant in 23 countries positive and significant, and positive but insignificant 12 countries.
This study investigated the relationship between ODA/GDP ratio and Investment/GDP ratio using a simple ordinary least squares (OLS) model and did not control for potential sources of bias, and thus should be taken with precaution, but it still suggests that there is heterogeneity in the relationship between aid and investment across aid recipient countries. Later the focus shifted away from simplistic Harrod-Domar and two-gap models towards more sophisticated models based on the neoclassical and other growth models and most of the academic and policy debate on aid effectiveness focused on the relationship between aid and growth despite the fact that a substantial part of foreign assistance is not primarily intended to support growth.
Some of the studies based on these models estimate the impact of aid on the presumption that only temporary aid can increase investment and permanent aid merely increases consumption and does not increase investment, hence growth. Others assume that aid can help a recipient country to reduce poverty or even to escape from a ‘poverty trap’ onto a higher steady-state growth path. A more sophisticated theoretical framework also led some researchers to give prominence to human capital, policies and institutional factors that may support or constrain growth. This new approach produced a broad but contradictory literature on the aid-growth relationship. There is no agreement on the effects of aid. Some authors argue that aid helped to promote growth and structural adjustment in many less developed countries while Hansen and Tarp estimates that from the 1970s to 2000 no less than 72 cross-country studies have tested the link between aid and growth in reduced form equations. others oppose it. As stressed by many authors, the review of the results of these studies suggests three competing observations on the aid-growth relationship (Radelet et al 2004). The first group of studies found that foreign aid has no effect on growth, and sometimes may even harm the economic growth in recipient countries.
The most widely cited studies about aid-effectiveness that found a negative relationship between aid and growth are those by Mosley et al (1987 and 1992). They performed two empirical tests: one using cross-section data and the other, using time series data. The cross-section evidence consists of comparing the rate of change of income due to the change of aid among countries exhibiting high-aid and high-growth patterns with those exhibiting high-aid and low-growth patterns. The time series evidence is based on several growth regressions for 1960-1970, 1970-1980 and 1980-1983 for all developing countries in the sample, and also by region.
Based on both cross-sectional and time series analyses, they concluded that it is more likely that foreign aid does not stimulate the economic growth. They explained this with the possible leakage into non-productive expenditure in the public sector and the transmission of negative price effect into the private sector. Another widely cited study by Boone (1994) concluded that there is no significant relationship between aid and growth. This and other studies with similar findings have suggested crowding out of private investment and savings, the Dutch disease effect of aid, corruption, embezzlement, and rent seeking behavior among a variety of reasons why aid might not promote the economic growth.
However, Ovaska (2003) argues that there is no considerable evidence that development aid is effective in promoting economic growth in developing countries even with better governance. The results of Mosley et al (1987 and 1992), Boone (1994) and other similar studies have been fairly criticized on the grounds of their underlying structural model and econometric methodology. Their results were mainly based on simple OLS regression analysis (with some exceptions) and assumed only a simple linear relationship between aid and growth.
Besides above, another important criticism of Boone (1994) is the use of a static model over a 20-year period of time, which does not allow dynamics of adjustment. Furthermore, a recent study by Rajan and Subramanian (2005a), using crosssectional and panel data and more sophisticated econometric methodology found no robust evidence of a positive (or negative) relationship between aid flows into a country and its economic growth, with their conclusion holding across time periods and types of aid. They also find no evidence that aid is more effective in better policy or geographical environments. Another work by Rajan and Subramanian (2005b) suggests that this may be due to aid flows causing the real exchange rate overvaluation in recipient countries, thereby weakening their competitiveness, as reflected in a decline in the share of labor intensive and tradable industries.
The second group of studies suggests that foreign aid in all likelihood positively influences economic growth, but with diminishing returns26, and its effect is unconditional to policy environment (Durbarry et al 1998, Hansen and Trap 2000 and 2001, Dalgaard and Hansen 2000, Lensink and White 2001, Dalgaard et al 2004 and others). Most of these studies conclude that while aid has not always worked, on average higher aid flows have been associated with more rapid growth. For instance, Hansen and Tarp (2000 and 2001) formulate an empirical framework to allow for nonlinearities in the aid-growth relationship such as quadratic aid and policy along with aid policy interactions. They also control for some economic, political and institutional variables. They found that the coefficient for aid variable is positive and statistically significant, but the coefficient for aid squared is statistically significant and negative. In other words, that the causal relationship between aid and growth is positive but this positive impact diminishes as the volume of aid increases. Apparently most of the studies on aid-growth relationship tested a linear relationship using simple OLS methodology. Some suggest that the diminishing return reflects absorptive capacity constraint, an idea that dates back to 1950s and 1960s and stems from limits in the quality and quantity of human capital and physical infrastructure (Quibria 2004).
Lensink and White (2001) claimed that aid might not merely have diminishing returns but that, after a certain level, returns become negative. They found the threshold for negative marginal returns to be 50 percent of the ratio of aid to GNP. However, this can be downplayed because 50 percent of GNP threshold for aid ratio exceeds the average aid ratio for most aid recipient countries. Some other authors found that the threshold for negative marginal return to aid is about 25 percent of GDP (Hansen and Tarp 2000, Hadjimicheal et al (1995).
The third group of studies suggests that aid has a provisional positive impact on growth, only helping recipients in certain circumstances. This conditional strand indicates that aid supported growth only in certain circumstances but not in other situations. For example, Guillaumont and Chauvet (2001) find that aid works positively in countries with difficult economic environments, as characterized by unstable terms of trade and natural disasters. The findings of Collier and Dehn (2001) also support the result obtained by Guillaumont and Chauvet (2001). They measure vulnerability by the change in export prices and show that the interaction term involving the change in aid and the change in export prices is significant.
Another well-publicized and influential study that belongs to the conditional strand is the study by Burnside and Dollar (2000). They applied the empirical strategy of making the impact of aid dependent on a summary measure reflecting the quality of policies instead of vulnerabilities. They define a ‘good policy environment’ as a weighted combination of low inflation, low budget deficits, and trade openness. Then they introduced aid (as share of GNP) as well as the interaction of aid and the composite policy variable in a standard growth regression. Their results show that the coefficient for aid by itself is not significantly different from zero, but the coefficient for interaction term is positive and statistically significant, implying that aid works in ‘a good policy environment’ but has little impact in ‘a poor policy environment’ (Burnside and Dollar 2000, and World Bank 1998).
The findings of Burnside and Dollar have been extremely influential, and decisively changed the debate on aid effectiveness and donors’ aid allocation policies. If foreign aid stimulates economic growth in countries with good policies, then foreign aid should be given selectively to countries that have adopted sound policies. Multilateral and bilateral donors have already recognized the importance of this finding and started moving towards new policies (World Bank 1998 and 2002, USAID 2004, U.K. Department for International Development (DFID) 2000). The findings of Burnside and Dollar (2000) suggested also specific criteria for targeting aid. This criterion is called a ‘poverty efficient allocation of aid’ which focuses on those countries with a combination of high rates of poverty and a good policy environment (Collier and Dollar, 2001 and 2002). The basic message of this criterion is that poor countries with good policy environment, as measured by the World Bank Country Policy and Institutional Assessment (CPIA) index, should be eligible for aid, while countries with low CPIA score should not be eligible for aid, or alternatively receive less aid.
This idea has been adopted by the International Development Association (IDA) and DFID (Dalgaard et al 2004). The Millennium Challenge Corporation (MCC) of the United States also uses similar methodology to determine the eligible countries for its aid.
However, some researchers have questioned the robustness of the Burnside and Dollar (2000) findings and concluded that there is need for more research on the subject. First, Hansen and Tarp (2000) found that ‘the basic Burnside-Dollar results turn out to be sensitive to data and model specification’. They argue that by changing the number of observations and the model specification one can make the crucial aid-policy interaction term significant and also turn off this result.
More recently Easterly et al (2004) reassessed the links between foreign aid, policy, and growth using extended data. While the Burnside and Dollar (2000) results were based on a panel of 56 countries and six four-year time periods from 1970-73 to 1990-93, Easterly et al (2004) extended the number of observations by adding additional countries and one more time period (1994-1997). Thus, using the same methodology, this study re-examines whether foreign aid has a positive effect on economic growth in the presence of sound policies. They no longer find that foreign aid promotes economic growth in good policy environments.
These new findings cast doubt in the previous conclusion that aid will promote growth in countries with good policies. All of these studies have one common feature: they examine the impact of aggregate aid on growth over four or five years. In the late 1990s and early 2000s, some researchers started to focus on disaggregating aid flows by using different criteria and then estimating the impact of disaggregated aid on development outcomes. Owens and Hoddinott (1999) find that aid to infrastructure and agricultural extension in Zimbabwe increased the household welfare far more than by humanitarian (food aid and emergency aid) aid. Mavrotas (2003) disaggregates aid to Uganda into program, project, technical assistance, and food aid. He then uses a time-series error-correction model to test the growth impact of aid and finds a significantly positive impact of program aid much larger than of project aid. He also finds significantly negative impacts of technical cooperation and food aid. Cordella and dell’Ariccia (2003) disaggregate development assistance into program and project aid, then find the evidence that shows that program aid is preferable than to project aid when donors and recipients’ preferences are aligned.
A recent study by Clemens, Radelet, and Bhavnani (2004) divides aggregate aid into three mutually exclusive, collectively exhaustive categories: ‘short-impact’ aid, ‘long-impact’ aid, and ‘humanitarian’ aid. Then they focus on ‘short-impact’ aid (about 53% of all aid flows) and find a positive causal relationship between the ‘short-impact’ aid and the economic growth. They find at the mean a $1 increase in short-impact aid raises output (and income) by $1.64 in present value in the typical country. This impact is two to three times larger than in studies using aggregate aid. The study also finds diminishing returns to aid: the maximum growth rate takes place when the ‘short-impact’ aid reaches 8 percent of recipient’s GDP.
CONCEPTUAL FRAMEWORK
In reality, as suggested by previous studies, multiple factors influence the allocation of foreign aid and its effectiveness. In order to improve the effectiveness of foreign aid, donors aid allocation decisions should be guided by evaluation of the results of past policies. Nevertheless, previous research on the topic rarely linked the effectiveness of official development assistance to foreign aid allocation policies. Studies aiming to explain determinants of aid flows do not consider effectiveness issues and vice versa. This thesis addresses this weakness by linking aid allocation policies and development effectiveness through recipients’ quality of governance. Within this framework, there are three transmission channels by which aid might influence development outcomes. The first transmission channel is through its potential impact on easing government budget constraints and investment needs of recipient countries. Depending on the nature of government’s fiscal response and the degree of aid eligibility, foreign aid may lead to greater consumption and investment or reduced taxation. The second channel is through its interrelationship with governance and policy. Foreign aid might encourage governments to improve the quality of governance and policy or support bad governance and unsustainable policies damaging long-term development prospectus. The third channel is through improving the access to international capital markets.
In general, differences in access to international private capital markets have important implications for foreign aid allocation and effectiveness. Foreign aid, through its positive impact on governance, policies and economic infrastructure, might lead to increased access to international capital markets and, thus, decrease the aid dependency. The magnitude and composition of foreign direct investment and changes in sovereign and corporate credit ratings might serve as approximate measures of the access to international private capital markets.
There are complex interactions between governance, foreign private capital, public expenditures and growth outside of foreign aid. While I try to control for other transmission channels in the analysis, my main focus is in the interaction of governance and aid flows. What role does governance play in recipient countries in donors’ aid allocation policies? And how do aid allocation patterns impact the aid effectiveness? Why is there a concern about the quality of governance? How is governance defined? What dimensions of governance are important for promoting development outcomes? How In developing this theoretical framework, drawing from George Mavrotas (2003). Assessing Aid Effectiveness in Uganda: An Aid-Disaggregation Approach, Oxford Policy Management is it measured? The most important reason is that, as evidenced in chapter 2, theory and evidence suggest that countries with good governance are more likely to achieve better development outcomes, including income per capita, educational attainment, health and so forth (Knack and Keefer, 1995; Mauro, 1995; Hall and Jones, 1999; Acemoglu, Johnson and Robinson, 2001 and 2002; Feng 2003, Baldacci at el, 2004; and many others).
Also recent research identifies poor governance as a major reason for ineffective public spending (Mauro 1998, Abed and Gupta 2002, Rajkumar and Swaroop 2002). Since foreign assistance works similarly to public spending in many ways, the lack of control for governance could plausibly lead to biased and inconsistent results regarding aid effectiveness in some previous studies. In this context, as suggested by Mavrotas (2003), there could be two contrasting experiences within which individual national practice may lie. At one extreme, foreign assistance may contribute to a virtuous circle of development through initiating required institutional and policy changes, relaxing savings and foreign exchange constraints, and easing the access to international capital markets.
The experiences of several Asian countries, such as Korea Republic, Taiwan, and some others, appear to lie close to this extreme. These countries benefited from extensive foreign assistance in earlier years, allowing them to develop their economies and build democratic governance. At the other extreme, foreign
Assistance may contribute to a vicious circle by delaying necessary institutional and policy reforms, and encouraging rent seeking behaviour and corruption both within society and inside government structures.
The experiences of many countries in Sub-Saharan Africa appear to lie close to this extreme. Given this discussion, it is then appropriate to hypothesize an important role for the quality of governance in analyses of aid effectiveness and allocation. A focus on governance does not imply that the variables emphasized by previous studies are unimportant, but it is necessary to mention that there are some economists who support the reverse idea, namely growth in income and human capital causes institutional improvement.
This line of research is most closely associated with the work of Seymour Martin Lipset (1960) and seems to accord well with the experiences of South Korea and Taiwan, which grew rapidly under one-party autocracies and eventually turned to democracy. Glaeser et al (2004) is most recent work in this line, does lead to a different emphasis in empirical inquiries. In this thesis, the simple hypothesis is that differences in governance and their interactions with different categories of aid flows play an indispensable role in exploring the effectiveness of foreign aid in promoting development outcomes. If differences in governance and their interaction with different categories of foreign aid were often a decisive influence on aid effectiveness, then the lack of control for these interactions would plausibly lead to biased and inconsistent results regarding aid effectiveness.
By explicitly incorporating governance into the model, this dissertation helps to mitigate this problem. This allows us to evaluate the role of governance in improving the impact of aid in order to inform critical policy questions such as the allocation of aid between recipient countries. As mentioned in the previous chapter, there are several definitions of governance. It is sometimes narrowly defined in terms of public sector management. However, in this study, a broad and comprehensive view of governance is taken; governance is defined as the combination of rules and institutions by which a country is governed. This includes (1) the way governments are selected, monitored and replaced, (2) the capacity of the government to effectively formulate and implement policies, and (3) the respect of citizens and the state for the rules and institutions that govern political, social, and economic interactions among them (Kauffmann, Kray, and Maztruzzi, 2003). There are a number of approaches to measuring the quality of governance. In this dissertation, I use two dimensions of governance. First, the democratic quality of governance is approximated by combination of political rights and civil liberties indicators from Freedom House. Second, the institutional quality of governance is approximated by rule of law, bureaucratic quality, stability of government, and corruption indicators from the International Country Risk Guide. The detailed discussion of these and other measures of governance, and issues related to using them in empirical panel analysis is provided in the next chapter.
RESEARCH HYPOTHESIS
I will test the following three hypotheses:
(1) Aid to production sector impacts the economic growth through its impacts in capital accumulation by enlarging the pool of resources available for investment and growth. If foreign aid to the production sector supplements the domestic resources then the impact of this sectoral
aid flows on investment should be positive. If foreign aid substitutes for domestic resources rather than supplementing them, then its impact on investment and growth could be negative or trivial. There are two plausible cases when aid flows might substitute for domestic resources. First, since aid flows are similar to public investment, they may crowd out private investment. Second, if a recipient is able to reduce its own public investment expenditures and replace them by foreign aid.
Further, I assume that the magnitude and sign of this impact could be affected by the quality of governance in recipient country. Therefore, aid to the production sector enters the investment equation by its interactions with the quality of governance. In general, one might expect that the impact of better governance on the effect of aid to production sector would be positive. Even in a favourable policy environment, however, this impact might be negative or trivial, particularly if foreign aid causes crowding out effect. Vice versa foreign aid might help raise the level of investment in countries with poor governance if (1) it helps to ease the constraints on public funds available for necessary public investments and (2) it funds profitable investment projects in the private sector.
(2) As mentioned before, aid to economic infrastructure might impact growth through one of or more of the three potential channels of influence. First, it may improve total productivity in the economy. If it does so at all, it must do so by reducing the private cost of production. For example, a reduction of communication costs can make international knowledge more accessible to local businesses and other establishments. Thus it seems likely that countries with better communication infrastructure will have easier and cheaper access to knowledge stocks, which in turn, should lead to higher rates of total productivity growth. However, empirical evidence suggests that in least developed countries economic growth is primarily input-driven, i.e., capital accumulation and utilization of additional labor, and that total factor productivity increases are negligible if not zero (Forstner et al 2001, Krugman 1994, Young 1995, Collins and Bosworth 1997).
Therefore, one can expect this impact to be very small if it does exist at all. Second, aid to economic infrastructure by improving its quality may reduce cost of capital, and therefore increase the demand for investment. Third, aid to economic infrastructure directly adds to investment and helps to ease the constraints on public funds available for necessary public investments. Correspondingly, I assume that the magnitude and sign of these impacts could be affected by the quality of governance in a recipient country.
(3) Aid to social sector aims to improve human capital and living standards in recipient countries, for example, by supporting primary education or basic health care. Therefore, it is expected that this portion of aid may impact the growth by creating additional human capital.
CHAPTER 3.
Methodological Approach
The purpose of this chapter is to describe a conceptual approach and heuristic model that outlines basic causal relationships between foreign aid, governance and development outcomes, and present propositions that will be tested in subsequent sections
Outline of Basic Causal Relationships between Foreign Aid, Governance and Development Outcomes
Furthermore, as seen earlier, past research on this topic has mainly focused on aggregate aid flows trying to match aid flows to a realistic time period over which they might influence economic growth and other development outcomes. However, as OECD’s DAC suggests that aid flows are allocated to different sectors depending on ‘which specific area of recipient’s economic or social structure is the transfer intended to foster’. While one category of contributions might intend to promote education, another category might intend to foster agricultural development, and third category might just aim to provide balance-of payments support. These different categories of aid flows might not influence the economic growth in the same way and uniformly.
Also, it is plausible to expect that the interactions of different categories of aid with various levels of governance in recipient countries will produce different results. One category of aid might help to foster economic development in a recipient country by building physical capital while another type of aid might harm incentive structures and encourage rent seeking behaviour. Therefore, any evaluation of aid effectiveness trying to estimate the impact of aggregate aid flows on economic growth and other development outcomes is flawed.
The four mutually exclusive, collectively exhaustive aid categories include the
following:
‘ Aid to production sectors is defined as aid funding for projects in agriculture, manufacturing, mining, construction, trade, and tourism industries. This aid should plausibly help recipient countries to accumulate physical capital.
‘ Aid to economic infrastructure is defined as an aid to build networks and services that facilitate economic activity. This type of aid goes to energy distribution, auto and railroad construction, equipment for communication and electronic networks, and to financial infrastructure. This aid should probably help recipient countries by improving the overall economic efficiency and boosting the demand for investment.
‘ Aid to social sector, including education, health, and water supply. This aid is more likely to help recipients to build their human capital.
‘ The remaining aid flows are combined with other aid. This includes assistance for the environment, gender projects, food aid, action relating to debt, budget and balance of payments support, emergency and distress relief, aid for refugees, etc. This aid has no pre-imposed sectoral allocation and is intended to smooth short-term fluctuations or to support longer-term activities.
Method of Data Collection
The thesis developed a template for collection of data on EU development assistance in flows to the country. The data included the reports on general activities of the EU and usually stating their commitment and disbursement.
Collection of Primary Data
Given the insufficiency of data gathered from the secondary sources, it became necessary to collect data from primary sources. A template was designed and administered to the EU. The data collection method relied largely on the information obtained from this source. A questionnaire was administered
Data Processing and Analysis
The data collected was processed and stored in SPSS 17 package. The data coding mechanism also take into consideration allocation to programmes and projects in the country. This attempt is to ensure that the pillars of the Paris Declaration are respected by the donor and our country.
The data collected were analyzed using descriptive statistical tools from the SPSS 17 Package. These include frequency, percentages, sum, mean and standard deviation, cross tabulation, where applicable. The pie chart, bar chart and histogram were also used for data analysis. Finally, the data collected were disaggregated into sectoral intervention, programme-specific intervention and interventions in the states of the federation.
CHAPTER FOUR (4)
FINDINGS
SECTORAL DISBURSEMENT BY THE EUROPEAN UNION IN PROJECTS
The results in table below show the intervention of the European Union (EU) in the sector-wide project. The European Union, through its cooperation strategy and Cotonou Agreement Framework is intervening in five sectors of the country.
Its intervention in Real/Productive sector is prominent in water and sanitation project. The overall objective of water and sanitation project is to contribute to poverty eradication, sustainable development, and to achieve the water and sanitation Millennium Development Goals (MDGs). The specific objectives are to increase access to safe, adequate and sustainable water and sanitation services in Nigeria and to improve water governance at the state and local government levels, as well as water service delivery in urban areas.
For example the period 2008-2011, a sum of $ 94,488,940.63 was disbursed. The intervention covers water supply and reform of institutions responsible for water and sanitation activities in Nigeria, a sum of $ 13,012,410.13 was disbursed to water and sanitation project.
On regional development sector, the EU is intervening in Niger Delta with micro-projects in the states of Niger Delta. The objective of the micro-project in the Niger Delta is to reduce poverty in rural and semi urban communities of the participating states through the promotion of participatory and gender equitable local development governance in order to contribute to the attainment of the MDGs; and institutionalising reforms resulting in local and state governments to provide infrastructural facilities, income generation activities as well as promoting transparency.
For the same period, 2008-2011, a sum of $ 84,001,704.36 was disbursed by the EU to micro-projects in the Niger Delta; and for the mid-point contribution to the first NIP of the NV20:2020, a sum of $ 73, 199,824.00 was disbursed.
The EU is committed to project under the knowledge base sector of the NV20:2020 with disbursement of $ 9,174,361.54 for the four years period. Its contribution to the achievement of the objective of the first NIP at the mid-point is in the sum of $8,912,813.00. This amount was disbursed under the Technical Cooperation Facility for Pre-feasibility study, project formulation and identification and Joint Annual Review of Technical Cooperation and Programming of the European Development Fund.
On Human Capital Development sector of the NV20:2020, the EU is intervening on variety of health sector development projects in Nigeria. The objective of the health project is to reduce the burden of vaccine preventable diseases (VPD) including polio in Nigeria by providing vaccines, materials, equipment and logistic support, capacity building for staff and the health institutions at the federal, state and local government levels; and to also reduce mortality for children less than 5 years of age, associated with vaccine preventable diseases.
For the four years period, the EU has disbursed fund in the sum of $114,750,315.62 for implementation of health development project in Nigeria; and for the period 2010 and 2011, mid-point of the first NIP, the EU has disbursed $ 60,236,319.02.
The EU’s intervention in the general administration, defence, security and reforms of the government institutions is the largest. The intervention covers federal, state and local governance reforms; electoral cycle, census, anti-corruption; Public Financial Management System; Support to Non-State Actors; Support to the office of the National Authorizing Officer for the management and coordination of EDF programmes in Nigeria, among others. The total disbursement for the four years amounted to $ 114,750,315.62; while disbursement to the implementation of the first NIP at the mid-point is in the sum of $66,908,425.09.
It suffices to note that the EU is currently not intervening in the physical infrastructure sector of the NV20:2020.
Table 1: Sectoral Disbursement by the European Union in US Dollars
Sectors/years 2008 2009 2010 2011 Total
Real/Productive
Water and Sanitation 8,130,589.87 170,633.14 4,824,329.13 8,188,081.49 94,488,940.63
Regional Development
Niger Delta 3,212,917.46 7,588,962.09 6,622,412.97 66,577,411.84 84,001,704.36
Environment – – – – –
Knowledge Base and ICT
Study/Research 728,424.05 353855.06 1,955,022.77 6,957,790.23 9,174,361.54
Human Capital Development
Education – – – – –
Health 37,653,804.36 16,360,192.24 1,955,022.77 58,781,296.25 114,750,315.62
General Administration, Governance and Security
Governance – 195,044,573.56 19,038,222.91 47,870,202.18 523,905,997.30