FINANCING DEVELOPMENT

Aid and Debt Relief - Background

Overview

The term 'foreign aid' can encompass all sorts of financial transfers to developing countries that are provided on concessional terms. Aid is provided by multilateral institutions such as the World Bank or the IMF, as well as individual states on a bilateral basis and private actors such as charitable foundations or other non-governmental organizations.

A great deal of aid is provided for the ostensible purpose of promoting development in recipient countries. It is fair to say though that a non-trivial proportion of aid has been provided for more self-serving reasons such as to achieve military or political objectives. In the case of so-called tied aid -- aid provided on condition that it is used to purchase goods or services provided by actors in the donor country -- the purpose may be to redistribute wealth within the donor state by using general tax revenues to purchase goods from the sector that produces the tied good. Some scholars also question whether more altruistic donors are motivated by the desire to promote development or by the desire for the 'warm glow' that they receive from having tried to promote development.

Forgiveness of a bona fide debt is similar in economic terms to a financial transfer. Consequently, sovereign debt relief for poor countries raises many of the same issues as aid. Of course debt relief is distinguishable from aid because it does not necessarily enhance the recipient's access to liquid assets and is by definition limited to countries that are already indebted.

Recent years have witnessed several systematic efforts to forgive the debts owed by poor states. The most notable multilateral efforts have been the Debt Relief Initiative for Heavily Indebted Poor Countries (HIPC), created in 1996, and the Multilateral Debt Relief Initiative (MDRI), created in 2006, which set out conditions under which low income countries become eligibile for debt relief. Participation on the part of creditors is voluntary. Other debt relief efforts have been coordinated by the Paris Club, an organization of bilateral official creditors, and the Creditors' Committee (formerly known as the London Club), which is a group of commercial creditors.

The inherent limits of aid

The role that aid plays in promoting development is hotly debated. Some economists believe that foreign aid can play a crucial role in helping developing countries break out of poverty traps and shift onto a path of continually increasing prosperity. Jeffrey Sachs is a well known proponent of this view. Other economists argue that aid typically provides only a one-time benefit to the recipients but does not affect their societies' subsequent development trajectory, which is determined primarily by more fundamental economic factors such as the rate of technological innovation. Some commentators go even further and argue that foreign aid can be positively detrimental to prospective recipients. One reason this may occur is because projects financed by aid distort the allocation of resources in the economy toward sectors that are unlikely to contribute to long-term growth. Another concern is that the expectation of receiving aid will undermine recipients' incentives to help themselves.

Conditionality

There are also important debates about the terms upon which aid and debt relief ought to be provided.

Some debates concern the roles intermediaries ought to play in channeling funds from donors to the ultimate recipients of aid or setting the terms for debt relief. So for instance, there are debates about the advantages and disadvantages of relying upon private intermediaries such as foundations and local non-profit organizations as opposed to public actors such as bilateral or multilateral aid agencies and the governments of developing countries. There are also debates about the virtues of centralization and decentralization, which encompass the question of whether should public donors should emphasize bilateral aid and debt relief or operate primarily through multilateral institutions such as the World Bank.

A second set of debates concerns the kind of conditions that should be attached to disbursements of aid. These debates are generally similar to the debates about conditionality in relation to non-concessional transfers. Proponents of conditionality argue that conditions are designed to ensure that funds are used in a manner consistent with the donor's intentions and/or the interests of development (which may not be the same). Opponents of the practice raise the following concerns:

Complying with the reporting requirements associated with conditionality can be costly.
Overly specific conditions, and especially those associated with tied aid, limit recipients' flexibility.
Insufficiently specific conditions create uncertainty .
Conditions illegitimately undermine the autonomy and sovereignty of recipients.
Poorly conceived conditions have adverse impacts on development.
Conditions are ineffective because, for political reasons, they often are not enforced.

Proposals to address these concerns generally involve:

Making conditions either more or less specific.
Varying the extent of reliance on conditions imposed before as opposed to after the initial disbursement of funds (i.e. adjusting the balance between screening/selectivity and monitoring).
Having recipients or other actors with special expertise play a greater role in drafting conditions.

Odious debt

Several commentators have argued that instead of relying upon creditors' voluntary initiatives to secure debt relief for poor countries, legal institutions should deem certain debts unenforceable because of the circumstances in which they were incurred. As a matter of positive law it is unclear to what extent these proposals are consistent with existing legal doctrines. Different bodies of law apply depending on whether the creditor is a state - in which case principles of public international law are applicable - or a private actor, in which case private law applies.

The normative debate around these proposals revolves around not only what principles ought to be used to determine whether relief is appropriate but also what institutions should be used to apply and develop those principles. There are direct parallels to debates about the principles that ought to govern voluntary aid and debt relief.

Empirical studies

A number of empirical studies have been conducted on the impact of foreign aid and debt relief on various economic and social outcomes. However, aid and debt relief have been provided by different donors, to different recipients, at different points in time, on different terms and for different purposes. Consequently, although many people have asked, it seems unreasonable to expect social scientists to provide a clearcut answer to a question as simple as 'Does aid work?' However, a great deal of useful and important work has been done on the effects of specific transactions or types of transactions.