IMF Survey: Foreign Aid: Good or Bad?

IMF News, September 9, 2010

Source details

Publication date: September 9, 2010.
Framing: A point-counterpoint IMF Survey Online interview that pits two economists—Andrew Berg (IMF Research Department) and Arvind Subramanian (formerly with the Fund, then with the Peterson Institute and the Center for Global Development)—against each other on whether foreign aid promotes economic development.
Contextual reference: “Just 10 short years ago, the 189 member states of the United Nations signed a declaration...” noting commitments to reduce extreme poverty affecting “more than a billion” people.

Core claim: “There is no compelling evidence that aid actually does promote growth.”
Two principal mechanisms by which aid can harm long-run development:
- Undermining institutional development:
- Aid can sever the taxation–accountability link: taxation creates a two-way link between governed and government; aid can weaken this link and retard institutional development.
- Donors’ conditionalities are cited as insufficient to offset this organic effect.
- Distorting incentives and tradable-sector performance:
- Increased aid can reduce export incentives (and export volumes) by creating upward pressure on the exchange rate.
- Reduced exports undermine long-run sustainable growth because countries that export more tend to grow more in the long run.
Form of aid most problematic: “government-to-government aid is probably the most problematic or the least compelling.”

Core claim: Doubling aid to Africa “could have very strong positive effects on growth,” conditional on use and policy response.
Conditionalities and caveats:
- Positive effects depend on what the aid is used for, how efficiently it’s invested, and the recipient’s policy response.
- Aid is not a “magic bullet” or a substitute for broader institutional and policy reforms.
Potential benefits highlighted:
- Saves lives and reduces poverty substantially.
- Frees up domestic resources so skilled workers and capital can be used for domestic needs (e.g., treating AIDS) instead of producing exports to buy medicines/food.
- Long-run support to exports is possible if aid finances infrastructure, education, and health improvements (counteracting “Dutch disease” effects).

Historical and empirical themes:
- Debate exists: some claim aid works under some conditions; others claim it never produces positive results.
- Donors tend to give more to “aid darlings” (examples given: Tanzania, Mozambique) that show institutional improvements.
- Model scenarios show two-sided effects on exports: aid can induce Dutch disease-like competitiveness losses, but if invested in productive public goods (ports, roads, education, health), it can raise exports in the long run.
Specific mechanisms described:
- Freeing-up effect: aid supplies needed goods (medicines, food), allowing domestic resources to be allocated to other productive or social tasks.
- Incentive effect: aid can create upward pressure on the exchange rate and reduce incentives to produce tradables, harming long-term growth.

From the debate:
- Targeting and selectivity: prioritize giving aid to countries where institutional improvements suggest aid will be used effectively (current donor practice has improved in “the last 10 or 15 years”).
- Use aid efficiently: invest in infrastructure, health, and education to generate long-run productivity and potentially boost exports.
Alternatives and complementary international actions recommended by Subramanian:
- Finance international public goods (e.g., R&D for health).
- Reduce opportunities for dictators to park illicit money:
- Example policy: require foreign banks to disclose illicit funds to reduce incentives for corrupt capital flight.
- Provide greater market access for developing-country exports.
- Broaden the debate beyond government-to-government financial assistance to other non-aid forms of international support (e.g., technology diffusion, governance measures).

Source: IMF Survey Online interview, September 9, 2010.