Reasons for Foreign Aid

"There is bad aid and there is good aid. The bad aid is that one which creates dependencies, as we've known for a long time now. But good aid is that which is targeted to create capacities in people so that they are able to live on their own activities."― Paul Kagame

The term 'foreign aid' usually refers to the financial assistance provided on an intergovernmental or international level. It may take the form of economic, technical, or military assistance. It generally involves the transfer of resources like capital, as well as goods and services from the donor to the recipient country.

In general, aid is given by a donor country, or an international organization like IMF or World Bank for three main purposes - humanitarian, political, and developmental. Sometimes, the term 'foreign aid' may also include military assistance. For example, military assistance was considered aid by the United States until 1957.

But today, the most widely accepted measure of aid is "Official Development Assistance" (ODA), a term coined by the Development Assistance Committee (DAC) of the Organisation for Economic Co-operation and Development (OECD).

Economic Growth in LDCs
As claimed by many donor countries, aid is basically given to augment economic development in the less developed countries (LDCs). These countries are characterized by low income and unemployment, which results in low savings and investments.

Therefore, their capital stock is small, while the rate of population growth is comparatively higher than the developed countries (DCs).

In order to sustain such a large population, they need rapid economic development, which is simply not possible due to the low level of savings and investments.

So, these countries turn to the DCs for external help in the form of financial and technical assistance. The financial and technical assistance are given by the DCs mainly for promoting economic development of the recipient country, along with the balanced growth of the world economy.

Development of Basic Infrastructure

A great majority of the LDCs lack the basic infrastructures like transport and communication, power, education, health services, and heavy industries such as iron and steel.

The development of these key areas is a prerequisite for economic growth, but the public and the private sectors of the LDCs are not strong enough to undertake such capital-intensive projects which require huge investments. Foreign aid can play an important role in developing these economies by investing in these key area.

Humanitarian Aid

Humanitarianism is another reason for giving aid. Humanitarian aid, also known as emergency aid, is basically given in the situation of man-made (such as wars) or natural disasters. Such aid is usually directed towards providing the vital goods and services like food, drinking water, and medical services to the affected countries.

Establishment of Political Ties

Historically, foreign aid has been used as an instrument for establishing better ties with a country. In fact, aid is often given to support an ally in international politics. Sometimes, it can be given to establish strong military ties with the recipient countries as well.

Market Expansion

Foreign aid is also used as a means to expand the market of the donor country. 'Tied aid', which constitutes a major portion of foreign aid is a good example in this regard.

In the case of 'tied' foreign aid, the recipient country is often required to purchase goods and expertise that originate in the donor country, or the countries suggested by the donor. This expands the market for the products of the donor country and its allies.

To Influence Internal Politics

Sometimes, aid can be used to serve some ulterior motives. For example, sometimes aid can be given to influence the political process of the recipient country. In fact, aid can be given as a reward to a country for changing its political process and economic policies.

For example, during the era of the Cold War, both the United States and the former Soviet Union provided aid mainly to influence the internal politics of the recipient countries, and also for strengthening their weak allies.

The Success Stories

Foreign aid is generally provided in the context of fostering social and economic development of the developing and the less developed countries. It basically helps reduce the shortage of domestic savings and investments.

It also helps the LDCs overcome their technical backwardness by providing technical assistance, along with financial and physical capital. This in turn, helps raise the productivity of labor and capital in these countries. Moreover, aid helps these economies in tidying over the problems related to the balance of payments (BOP) and inflation.

The following are some success stories that are often highlighted by the advocates of foreign aid:
» Both South Korea and Taiwan, the Asian tigers, used to receive a large amount of aid from the United States. But today, they are the economic powerhouses of the world, having exceptionally high growth rates and rapid industrialization.

» The developmental assistance provided by the United States was instrumental in eradicating smallpox.

» The aid extended by the United Kingdom has helped Nepal reduce the rate of child mortality, and the number of deaths during pregnancy and childbirth.

In fact, Nepal is on the way to reach the Millennium Development Goal in reducing child mortality before 2015, and this success can be largely attributed to the aid received by the country.

» Maternal deaths in the world have also reduced considerably from 543,000 in 1990 to 287,000 in 2010, while mortality rates for children under 5 years of age has dropped from 12 million in 1990 to 6.9 million in 2011, mainly due to the medical services funded by aid.

» Foreign aid is often criticized to be a wasteful investment. It is observed that the aid fund is often invested in wasteful projects and in the production of luxury goods, instead of essential commodities. This increases the burden of public debt, besides increasing external dependency.

» It has been argued that aid is not always essential for promoting economic development. In fact, many experts are of the opinion that aid can inhibit domestic savings and investments, and prove counterproductive for the less developed economies.

Many critics reject the very notion that the third world countries are trapped in the vicious cycle of poverty, which can be broken only with foreign aid. In fact, a country can come out of poverty with the help of proper incentives, and by establishing transparent governance.

It is not possible to develop sound economic policies without the rule of law, even if a country receives massive amounts of foreign assistance.

» Critics also allege that foreign assistance is often used as an instrument to influence the domestic policies of LDCs. It has been observed that much of this financial help goes into the pockets of corrupt politicians and bureaucrats of the recipient countries, instead of being invested in developmental projects.

According to a report composed by the World Bank in 2006, almost half of the funds donated for health programs in Sub-Saharan Africa did not reach the hospitals and clinics, but ended up in the pockets of corrupt bureaucrats and politicians.

» The 'tied aid' is often criticized for being detrimental for the development of LDCs. Developed countries often subsidize their own agricultural sector, and then ask the LDCs to liberalize trade in order to receive aid.

In other words, DCs give aid, but they deny market access to the poor countries. But they use aid to open up the markets of the LDCs for their products.

» Another drawback of tied aid is that the donor country often attaches structural adjustment conditionalities, as well as the elimination of state subsidies, and the privatization of state services as the prerequisites to get financial assistance.

The donor countries undermine the necessity of subsidies on certain products like fertilizers in LDCs, where a large number of farmers cannot afford them at the market prices. The elimination of the fertilizer subsidy in such countries can prove counterproductive for their economies.

» Yet another disadvantage of tied aid is that the recipient country has to spend on the products and expertise of the donor country or its allies, even if such products are available in the local market at much cheaper prices. This discourages local farmers and industries.

Moreover, the recipient country has to purchase overpriced goods and services from the donor country.

» Critics also point out that aid is in no way helping the African countries, though they are receiving massive amounts of foreign aid. In fact, the situation in many African nations is becoming worse, mainly due to the high level of corruption that exists.

They are of the opinion that these countries can be pulled out of economic stagnation and poverty only by establishing better and transparent governance and eliminating corruption, and not by allocating more and more aid.

There is no doubt that foreign aid has the potential to foster economic development in many less developed economies, if appropriate measures are taken to prevent the misutilization of funds. However, it should not be considered a permanent solution to the economic problems of the LDCs.

An effort to raise domestic savings and investments can only help solve the socioeconomic problems faced by these countries.