Does Aid Work?

Today we are going the review the article "Does aid work?" published in the 1989 in the book "Leading Issues in Economic Development".

The article aims to evaluate the effectiveness of foreign aid as a tool for stimulating economic and social development in LDCs countries.

Since the article has been published in the 1989, we are first going to review the article in  the light of its findings, then on the basis of its conclusion we are going to see the eventual progress that have been made in the suggested direction.

Foreign Aid as highlighted in the article has been intense scrutiny from both the sides of the political arena for the failure to show solid improvements in the recipient's economies 

The right wings, in fact, see aid as the umpteen proof that government intervention does not work, indeed it only produce a welfare mentality and in most case filling the pockets of corrupt bureaucrats    

On the other hand, the critics of the left even argue that foreign aid can be a force of anti-development, widening the gap between the rich and poor, perpetuates dependency, and increase the influence of the donor over recipient

Regardless of the ideology a first assessment is presented by the 

According to the former director of OECD DEVELOPMENT ADVISORY COMMITTEE 

• record is mixed
• achievements , where aid has acted as catalyst (eg South Asia, agriculture programme with a very thin spread of aid per capita and Taiwan , S.korea with massive aid 
• high correlation with decline in birthrates
• very importantly without aid the growth registered in the '60 and '70 would have been slower

The rationale behind the use of foreign aid to promote economic growth can be traced in the Harrod-Domar model, a model that promised poor countries growth right away through aid-financed investment.

According to the theory there is a direct relationship between a country's rate of net saving and its rate of output growth 

hence g= s/K where K is the national capital output ratio (Y/k)

If a rate of growth is targeted at 5% and K is 3, it is required a net saving rate of 15%, therefore if a country can only produce an annual rate of net saving rate of 10%, it is said that 5% saving gap exist

Therefore donors fill the financial gap with foreign aid to attain target growth.

However the main criticism from both the parties regards whether substitute for domestic saving and not complementing it

According to the critics the domestic rate of saving is less than it would be without foreign aid investment is lower than it would be without aid

Regarding the first contention 

Most of  studies suggest a positive marginal propensity to save while in the worst case scenario a study cited in the article found that only 23% of foreign capital inflows were offset by a decline in domestic saving

It is difficult to stimulate the desired level of domestic savings
- Meeting a savings gap by borrowing from overseas causes debt repayment problems later, so there is only a short-term gain 
- Diminishing marginal returns to capital equipment exist so each successive unit of investment is less productive and the capital to output ratio rises.

The second  is not empirically testable, although we may expect that because in many case the dividend of the induced economic growth are not reinvested because of the string attached to the aid and in the case of FDI,  very often there is evidence of crowning out local investment , hence the real gain in investment level in the best case is minimal 

although in Asia there is evidence that govt selection of FDI did stimulate crowding in of domestic investment 

Conclusions 

with experience failures have diminished

more effective collaborations between recipient and donors

end of cold war has reduced the need the politicisation of aid