Debating the Future of Foreign Aid

Event summaries from Globalization Week Fall 2004

Date: Wednesday, September 29, 2004
Time: 7:00-8:30 pm
Location: Marvin Center Amphitheater

Panelists

  • Mr. Thomas Briggs (bio)
    Managing Director for Financial Sector Development,
    Millennium Challenge Corporation
  • Dr. Michael Clemens (bio)
    Research Fellow, Center for Global Development
  • Dr. Marc Miles (bio)
    Director, Center for International Trade and Economics,
    The Heritage Foundation
  • Moderator: Dr. Daniel Morrow (bio)
    Professorial Lecturer, The Elliott School of International Affairs,
    The George Washington University

Schedule

7:00—7:10 Welcome and Introductory Remarks
7:10—7:40 Panelist Presentations
7:40—8:00 Moderated Discussion
8:00—8:30 Audience Q&A
8:30—9:00 Reception

Welcome and Introductory Remarks

John Forrer, Director of the George Washington Center for the Study of Globalization, welcomed the audience and introduced the moderator, Dan Morrow.

Dan Morrow, Moderator: I have two goals for tonight's panel. First, I hope that the audience leaves with new insights about foreign aid effectiveness. Second, I will try to limit the presentations to 10 minutes so that discussion and Q&A can proceed as planned.

Panelist Presentations

Tom Briggs, Millennium Challenge Corporation: I'm going to give a report on the Millennium Challenge Account (MCA) and the Millennium Challenge Corporation (MCC), which administers the MCA. The idea of the MCA was created in 2002 at the Monterrey conference; it was actually formed in February of 2004. It came from two ideas: first, to take advantage of recent research that suggested more efficient ways of allocating aid; and second, to provide net new funds to American development assistance. It has one purpose: poverty reduction through sustainable economic growth. The MCA can only make grants; no loans are allowed. It is set up like an investor, not a donor. We will measure returns in terms of growth in GDP per capita and changes in income distribution measures. The partner countries will be required to exercise leadership—they must improve governance, invest in people, and undertake policy reform for private-sector led growth.

In May, 16 countries were selected as eligible after passing certain tests. (See http://www.mcc.gov for more detail on the tests.) The board of the MCC includes the Secretary of State, the Secretary of the Treasury, the US Trade Representative, the Administrator of USAID, the CEO of the MCC, plus four other members. There are no guarantees of funding to the 16 eligible countries. Our main priority is country ownership. The countries propose their own programs. About 11 to 12 of the eligible countries have made proposals at this point, and they look quite good. The programs must contain accountability provisions. We work with the country broadly, not just the government. Implementation may take place through the government, or through NGOs, or through the private sector.

In recent progress, we are staffing up. We have about 70 employees, and hope to have 200 eventually. We intend for an incentive effect, with the goal that countries that are not selected have an incentive to improve. We have about one billion dollars for fiscal year 2004; Congress still needs to act on that money. Our CEO has the goal that we complete two compacts—agreements between the MCC and a partner country—by the end of the year.

Michael Clemens, Center for Global Development: I'm going to use my 10 minutes to talk about my recent paper, written with Steven Radelet and Rikhil Bhavnani, called "Counting chickens when they hatch: The short-term effect of aid on growth." (http://www.cgdev.org/Publications/?PubID=130).

The question is: Does aid work? Aid has had successes and failures, and to evaluate it, you need a single standard of success. Economic growth is the most common. There is a long literature on aid effectiveness. One prominent paper was Peter Boone's, which fund no connection between aid and growth. The World Bank came out with a paper later—written by Craig Burnside and David Dollar ("Aid, policies, and growth," 2000)—that disagreed with Boone's conclusion. The Burnside and Dollar paper concluded that aid works in countries with good policies and not in others. Other authors, using new data, disputed this finding (Easterly, Levine, and Roodman, "New data, new doubts," 2003).

So that's the context of our paper. One common mistake in the literature is to treat all aid the same. Other papers look at differences between recipients; our paper looks at differences in aid. Some aid is not intended to produce economic growth: emergency food aid and soil conservation aid, for example. And among aid intended to produce growth, some types will produce an immediate effect (building a road), while others have lags (building a school). One can try to look at short-term or long-term effects of aid, but the problem with looking at the long term is that other "things" happen during the long term that will confound your results.

In our paper, we split aid in two. We looked only at aid that could possibly have an effect in 4 years. This is aid for things like infrastructure, energy, communications, banking, and balance-of-payments support. We also took great care to do months of robustness testing on the results; that's why the paper is 70 pages long. Our results: We found a large positive effect of this subset of aid (we call it "short-impact aid") on growth. Per dollar of aid, countries get $8 in benefit. This result has been difficult to find because the other bad things that happen to poor countries obscure it. For example, Africa has had zero per capita GDP growth from 1969 to 2000. During that time, Africa got 300 billion dollars of aid. This makes aid look like a failure. But you have to isolate aid's effect from the other bad things that happened during that time, such as wars and disease.

We also found that the effect of aid does depend on strength of a country's institutions, but does not crucially depend on it. We can still detect effect of aid in weak-institution countries. We looked only at short-term aid; our results do not mean that longer-term aid has no impact. The effect of aid is large, but once you get to about 18% of aid to GDP ratio, there is no marginal impact of more aid dollars. Even in good-institution countries, this ratio only goes to about 25%.

Marc Miles, Heritage Foundation: A good place to start is with the title of this forum: "The Future of Foreign Aid." It implies two things: that development involves aid, and that aid has a future. Aid is a mid-20th century redistributive concept. I argue that foreign aid has generally been a failure, and that the alternative is empowering people, not governments. This view will become dominant in the coming years.

How has aid failed? The top ten recipients of the World Bank received loans for an average of 37 years, and the loan average was 8 billion dollars. Over that period, the per capita income gain in those countries was very small; we saw little change despite huge aid inflows. Looking at the MCC, it is different from past approaches. I'm a big supporter of the MCC; I think it's a big step in the right direction. The most important thing about the MCC is that it focuses on outcomes, not inputs (the quantity of aid money).

What is the alternative to aid? We must focus on people and their empowerment to achieve their own goals. We need to remove obstacles that stand in their way. Each person has desires: to feed and shelter their family are major ones. Each person also has different abilities. If there were no barriers, each person would use their abilities to achieve their desires. So why does poverty persist? The answer is government obstacles: regulations, taxes, restrictions, tariffs. These obstacles raise the bar of success. It comes down to a simple equation: Desires + Abilities – Obstacles = Success. This is the basis for a book to be published next month called The Road to Prosperity: The 21st Century Approach to Economic Development (http://www.heritage.org/About/Bookstore/The_Road_to_Prosperity.cfm). The companion book is our Annual Index of Economic Freedom (http://www.heritage.org/research/features/index/). The Index contains case studies of 161 countries and looks at the obstacles they present. The less obstacles, the more openness, and openness means opportunities.

The Index's factors include measures of government intervention in the economy. We're working on 11th edition now. Looking over the last ten years of the Index, we see that as countries move towards increased economic freedom, economic growth increases. Also, the higher the economic freedom, the more even the income distribution. In the European Union, the countries with highest growth have been the low-tax countries. Other countries should learn from these examples.

Moderated Discussion

Dan Morrow, Moderator: I think there is a potential area of common ground amongst the panelists. The institutions and policies of the country matters most, much more than foreign aid amounts. Some questions: Does foreign aid have a role to play in inducing countries to develop better institutions? As it is conceived in the MCA, can it create an incentive? Question for Marc Miles: What do you think of the current selection criteria for the MCA? One criterion is drawn directly from the Index of Economic freedom, but other criteria conflict with the Index. Seven of the sixteen currently eligible countries are in the lowest quartile (the least economically free) of the Index.

Marc Miles, Heritage: I would recommend that the MCC simply adopt our Index. Countries with higher economic freedom should be rewarded.

Dan Morrow, Moderator: Question for Michael Clemens: The rationale behind the MCA can be traced to the Burnside and Dollar paper ("Aid, policies, and growth," 2000), which argued that aid should be directed to good policy countries. Your research contradicts those findings. Based on your research, do you think the MCA is based on a false premise?

Michael Clemens, CGD: Not at all. We do find that aid works on average. But as we know, there are differences between countries. When we include institutions, countries with the best institutions can absorb more aid. But we can still see the effect in countries with weaker institutions. I'm a strong supporter of the MCA as well. To me, the MCA has three purposes, all of which are supported by our findings. First, aid money should be used efficiently. And countries with good institutions get a bit more "bang for the buck." Second, the MCA is attempting to provide an incentive for reform. This is difficult to measure, but to the extent that it occurs, it's a good thing. Third, the MCA attempts to build domestic support for aid. The MCA gives money to successful countries, and the public likes to see their taxpayer dollars go to success stories. This is very important. I would respectfully disagree with Marc Miles when he said the top recipients of World Bank aid have not been successful. There are plenty of success stories; for example, the 22 countries that have graduated from IDA, the World Bank's soft loan window. They got money from IDA, and became too rich to receive any more IDA aid. It's not true that all countries that get Bank aid don't grow. Korea got lots of sustained aid support, as did Botswana, and they are now successful.

Dan Morrow, Moderator: Question for Tom Briggs: How is the MCA going to relate to other aid organizations? The US only gives a fraction of total aid flows. How can the MCA be sure that when they give money to countries, other countries don't simply take away the same amount?

Tom Briggs, MCC: This is a significant focus of the MCC. We visited all 16 countries and talked with actors in those countries, including other donors. Our message was that the intent is to be additional, and the withdrawal of other donors would be a failure for us. We are paying a great deal of attention to the behavior of other donors, and we are working with them to avoid duplication.

Audience Q&A

Q: Should the World Bank and IMF support a return to a fixed exchange rate system?

Marc Miles, Heritage: I haven't heard anyone talking about returning to a fixed exchange rate system in years! People forget how successful the Bretton Woods regime was. Returning to the system is a great idea for all countries, both developed and developing. If you look at the major oil price spikes, they've all been preceded by declines in the dollar. The price of oil today in terms of euros is less than it was a year ago. Criticism of China's exchange rate system is misplaced; their currency policy has contributed to the country's success. When the IMF comes in and makes a country devalue its currency, that will not help economic growth.

Q: Will the MCA become a political tool of the US government?

Tom Briggs, MCC: The MCA is a part of the foreign policy of the United States. The US wants to provide assistance to poor countries in order to improve the lives of the poor. The hope is that the selection processes will protect against negative effects implied in your question. There are significant safeguards against that. We use statistical indicators to select countries, and all those indicators are produced by third parties.

Q: If Botswana is a success story, what are the criteria for a "success story?"

Michael Clemens, CGD: When I referred to Botswana as a success, I was thinking of its economic growth. From 1970 to 1999, the average annual per capita economic growth in Botswana was almost 8%. That's a miracle; no other countries in Africa come close to that. But I think Africa is full of success stories. The UN's Millennium Development Goals are problematic in that the targets are too high; they obscure significant progress in many African countries. The goals are irrelevant for many African countries.

Marc Miles, Heritage: Botswana was not unbelievable; it's totally explainable. According to the Index of Economic Freedom, Botswana has been moving towards economic freedom, and it's now ranked 39th out of 161 countries.

Michael Clemens, CGD: There are other reasons why Botswana has been successful. Botswana is small, it's ethnically homogeneous, it has diamonds, and it abuts the richest country in the region. So it's not only economic freedom that determines Botswana's success. In addition, the IMF has estimated that by 2010, Botswana will be losing half of non-mining GDP to AIDS. So in 2010, when you ask a poor person in Botswana why he's poor, he's not going to say, "It's because the government is over-regulating me." It's because everybody around him will have died of AIDS.

Q: If the MCC will take proposals from non-governmental entities, who is ultimately held responsible?

Tom Briggs, MCC: By statute, we can only enter into a single agreement with a country. Implementation of the program by our partner countries will be accomplished by them, using entities that they choose, which could be NGOs or others. Accountability will run to the government. But the government will have sub-agreements with the implementing entities, and they will hold those entities accountable. The other question was how we work with USAID. There are two ends of the spectrum. In some countries, USAID isn't even there. In other countries, a large part of the implementation will take place through the existing USAID programs. We work closely with USAID, and it has been working very well so far.

Q: Aren't the trade policies of the rich countries far more important than aid flows?

Marc Miles, Heritage: These are certainly very important topics. Subsidies beget subsidies. We subsidize American farmers, and then farmers in other parts of the world can't produce efficiently, and so they get subsidies. I don't understand why we still have agricultural subsidies; why do we even have an agricultural department?

Q: How, if at all, can the MCA avoid the problem of corruption that has plagued past aid?

Tom Briggs, MCC: We certainly hope we can avoid it. Governments that steal from their people don't produce very good results; hopefully our indicators can help avoid that. We're very serious about using systems of accountability. Ownership is important; we are going to monitor very carefully the funds being spent. We will also insist on fair, open, and transparent procurement systems.

Q: Can we rely on available statistics when designing aid programs?

Michael Clemens, CGD: Yes. The paper we wrote was in a certain context; the literature concluded there was no relationship between aid and growth. We noted that much aid is not intended for economic growth. And even if aid does not produce economic growth, it can do other wonderful things that might not be reflected in statistics.

I'd like to transition to four quick points about the future of foreign aid:

  • We give a lot of aid that isn't intended for economic growth; aid to promote the war on terror, for example. Evaluating it in the context of economic growth might not be appropriate. Aid plays a huge symbolic value, among many other roles.
  • We have a plan for strong countries now: the MCA. We don't have a plan for weak countries. I agree absolutely with Marc Miles and have great respect for his Index of Economic Freedom. It makes a good point, which is that getting a good government in Zambia would do so much more than any aid dollar we could ever give to Zambia. The question is: What do we do until Zambia gets a better government? Do we let these countries fester until they adopt better government and policies?
  • Something else that matters a lot is trade policy. Having a little more economic freedom here at home in reducing subsidies and tariffs could have much larger effects than anything we do with economic aid.
  • There are a lot of proposals for massive "big bangs" in aid. Jeffrey Sachs has asked for massive amounts of aid. I don't think the evidence is out there that that would help. We need bold experimentation, and I think the MCA is a great experiment. For example, the Global Health Fund attempts to bypass corrupt governments and give aid to NGOs that are trying to help people. We need to try new things.

    • Participant Biographies

    Dr. Daniel Morrow (Moderator)
    Professor Morrow received his PhD in Public Policy from Harvard University's Kennedy School of Government in 1981. His career has focused on international development. From 1979 through 2001, he held various positions in the World Bank, including lead adviser on poverty reduction strategies, chief of country operations for the Andean countries, and economist on Indonesia. During 1997-98 he was a senior associate at the Carnegie Endowment for International Peace, studying the politics of economic reform. His professional experience before joining the World Bank included positions in the US government and The Brookings Institution.

    Mr. Thomas Briggs
    As Managing Director for Financial Sector Development, Mr. Briggs is responsible for Millennium Challenge Corporation's programs to improve the effectiveness of the financial sector in promoting poverty reduction through sustainable economic growth. Over the past decade, Mr. Briggs has worked in 49 countries around the globe developing financial markets. Prior to undertaking international development work, Mr. Briggs had experience as an investment banker on Wall Street, as a commercial banker, and as Chief Financial Officer for one of America's largest cities.

    Dr. Michael Clemens
    Michael Clemens joined the Center for Global Development as a Research Fellow in 2002 after completing his PhD in economics at Harvard. He has written on foreign aid effectiveness, historical trends in educational achievement in developing countries, and historical changes in the long-term determinants of private capital flows to low-income countries. His writings have appeared in the Economic Journal, the Journal of Economic Growth, and the World Bank Economic Review. Dr. Clemens has served as a consultant for the World Bank, Bain & Co., the Environmental Defense Fund, and the United Nations Development Programme. He is currently an adjunct professor at the Georgetown University Public Policy Institute. He has lived in Colombia and Brazil.

    Dr. Clemens holds a Ph.D. (2002) in economics from Harvard University; a B.S. (1997) in geography and environmental engineering from The Johns Hopkins University; and a B.S. (1994) in engineering and applied science from the California Institute of Technology.

    Dr. Marc Miles
    As Director of The Heritage Foundation's Center for International Trade and Economics, Dr. Marc Miles directs research and promotes public awareness on the role of free markets and democracy in fostering economic growth around the world. He is also co-editor of the Center's annual "Index of Economic Freedom." Dr. Miles has taught at Rutgers University and at Brandeis University; he also served as an economist at the Federal Reserve Bank of New York. He holds an economics degree from the London School of Economics and bachelor's, master's, and doctoral degrees in economics from the University of Chicago.

    His articles on the globalization of financial and commercial markets have appeared in The New York Times and The Wall Street Journal. He also has written three books: "Beyond Monetarism" (Basic Books, 1984); "International Economics in an Integrated World" (co-authored with Laffer) (Scott, Foresman & Co., 1982); and "Devaluation, the Trade Balance and the Balance of Payments" (Marcel Dekker & Co., 1978).