Promoting development: aid, institutions, debt and trade

Overview

Foreign aid, tied and untied aid and world Bank and what does it do.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is foreign aid, and what are its main forms?

   Model answer

   Foreign aid is the transfer of resources from one country or international body to another on concessional terms, that is, more favourably than commercial markets would offer. It takes the form of grants, which need not be repaid, and concessional loans at below-market interest rates or with long grace periods. It may be bilateral, given directly by one government to another, or multilateral, channelled through international institutions. It may be untied, leaving the recipient free to spend it as it chooses, or tied to the purchase of goods and services from the donor country. Emergency humanitarian relief is distinguished from long-term development assistance.

2. 2

   Analyse the arguments in favour of foreign aid as a means of promoting development.

   Model answer

   Aid can close the savings gap by financing investment a poor country cannot fund itself, and close the foreign exchange gap by paying for essential imports. It can fund goods with large external benefits that markets and thin tax bases will not provide, such as vaccination, clean water, basic schooling and rural roads, where the returns to human welfare are extremely high. Emergency aid saves lives directly after disasters. Aid can also carry technical expertise alongside the money, and it is cheaper for the recipient than commercial borrowing, avoiding the accumulation of expensive debt.

3. 3

   Analyse the arguments against foreign aid as a means of promoting development.

   Model answer

   Aid can create dependency, substituting for the development of domestic tax capacity and giving governments revenue without accountability to their own citizens. It may be captured by corrupt elites and never reach the intended recipients, and large inflows can raise the exchange rate and damage the recipient's export sector. Tied aid forces the purchase of donor-country goods at above-market prices, so a large share of the value returns to the donor. Aid can distort domestic markets, as when free food shipments undercut local farmers. It also fluctuates with donor politics rather than recipient need, which makes it a poor basis for planning.

4. 4

   Evaluate the effectiveness of foreign aid in promoting development.

   Model answer

   The evidence supports the view that aid works well for specific, measurable purposes such as disease control, vaccination, water supply and emergency relief, where the technology is known and the results can be verified, and here it has demonstrably saved millions of lives. It works much less reliably as general budget support in countries with weak institutions, where it can substitute for domestic revenue effort and be diverted. The strongest conclusion the evidence supports is that the effectiveness of aid depends on the quality of governance in the recipient country and on whether the aid is untied, predictable and aligned with the recipient's own priorities. Aid is therefore neither the engine of development its advocates claimed nor the obstacle its critics allege; it is a tool whose value depends heavily on how it is delivered.

5. 5

   Distinguish between tied and untied aid, and explain why the distinction matters.

   Model answer

   Tied aid requires the recipient to spend the money on goods, services or contractors from the donor country, while untied aid can be spent wherever the recipient chooses. The distinction matters because tying prevents the recipient buying at the lowest world price, so the real value of the assistance is reduced, sometimes substantially, and it can prevent the development of local suppliers who would have gained the contract. Tying benefits producers in the donor country, which is often precisely why it is politically attractive there, so the arrangement transfers part of the aid budget back to the donor's own economy.

6. 6

   A country has gross national income of 40 billion dollars and receives aid of 5 billion dollars in a year. Calculate aid as a share of national income and discuss what this implies.

   Model answer

   Aid is 5 divided by 40, which is 0.125, or 12.5 per cent of gross national income. A share of this size means aid is a major component of the resources available to the economy, most likely funding a large part of government spending, which makes the country highly vulnerable to changes in donor policy and may weaken the incentive to build domestic tax capacity. It also raises the risk that the inflow of foreign currency appreciates the exchange rate and damages exporting sectors.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.