Aid recipients must be more accountable
Ownership of aid programs by recipient authorities has fortunately been given a lot more prominence since poverty reduction strategy papers (PRSPs) became the cornerstone of World Bank and IMF programs. Still, the reality is that the staff of multilateral institutions and their consultants draft substantial portions of these papers and then ask recipient governments and civil society representatives to sign off on them. Result: true ownership remains limited. Finally, penalties for noncompliance with aid program rules and reporting requirements rarely go beyond the temporary suspension of aid disbursements. Donor competition ensures that these penalties are soon forgotten. Specific penalties should not only be imposed at the country level but should also affect the remuneration of key government officials in recipient countries.
Why not limit new borrowing?
I would respectfully disagree. If the country cannot repay its debt, what is the point of providing it with additional debt to repay old debt? Such an approach adds up to a Ponzi pyramid scheme aimed, it would seem, at keeping up appearances on the balance sheets of multilateral institutions. In the above example, even though the $100 million in new loans may help the country increase budget outlays (for poverty alleviation or some other purpose), the unpaid debt service will still be there. Accordingly, receiving debt forgiveness of $100 million (thereby reducing the stock of debt) is not equivalent to receiving a new loan of $100 million, which will further increase the debt stock if it is used to increase fiscal expenditure, as is most likely.
I fully agree with Rajan when he says that debt forgiveness will not by itself spur growth. But the debt overhang issue remains a major problem for many poor countries. The initiative for Heavily Indebted Poor Countries, which was supposed to deal with the debt problem for good, has just been complemented by the Group of Eight Gleneagles initiative. It is more than likely that these initiatives will have to be followed by others down the road. Instead of increasing new flows as advised by Rajan, it might, therefore, make more sense to require a limit to new borrowing in poor countries through a fiscal rule.
The question is why aid (grants or loans) has not resulted in growth in the majority of developing countries. What are the bottlenecks that prevent aid from promoting development? Growth is a multidimensional problem encompassing not only economic factors (investment, savings, fiscal and monetary policy, and customs) but also noneconomic factors (institutional, political, and social). For growth to happen, aid policy must be rethought based on a more integrated approach. For their part, developing countries must modernize their institutions, fight corruption, implement rational fiscal policies, and take steps to control aid flow volatility. Without such reforms, development aid amounts to no more than a halfhearted effort.