Why has Foreign Aid Been Untied?

by on June 4, 2012 at 7:30 am in Data Source, Economics, Travels | Permalink

The more cynical among us have sometimes thought that rather than recipient welfare the purpose of “foreign” aid is to provide a cover for domestic aid. Foreign aid pork, i.e. using foreign aid to subsidize special interests in the donor country has certainly been common. Historically, most foreign aid has been tied; that is, the recipient was required to spend the money on the donor country’s exports. Relative to cash, tying raises prices and reduces choice and recipient welfare–the deadweight loss of Christmas problem.

US food aid is a classic example. US food aid tends to peak after a glut. It’s cheaper for us to give food away when we have lots and not coincidentally giving food away after a glut helps to keep prices higher, benefiting US farmers. It’s precisely when food is plenty, however, that prices are low and aid is less needed. When food is scarce, prices are high and aid is more needed but then we would rather sell our food than give it away. In addition, we typically require food aid to be transported on US ships which raises costs. Finally, the food we give away is not always best suited to the recipient’s preferences or needs.

For a public choice theorist the fact that foreign aid benefits domestic special interests is not at all surprising. What is surprising is that tied aid is way down. Great Britain banned most tied aid in 2002 and indeed tied aid is down across all of the major OECD donor countries. Food aid and technical assistance are still tied but these aid categories are down and untied grants and loans are up. In 1984-1986, for example, about 60% of aid was tied and today only 10-25% of aid is tied (depending on source).

Why has aid become untied? Could this be a case of improved public policy due to lobbying from the aid industry? It is interesting to note that although tied aid is down in the US, the US continues to tie a lot of aid, considerably more than the Europeans. One explanation may be that the decentralized US political system gives more weight to local domestic interests so tied aid continues to sell here despite opposition from most aid groups.

Special interests are also not the only explanation for tied aid. Tied aid can reduce corruption in the recipient country. If donors have become less worried about corruption, perhaps because governance has improved in the developing world, this could offer a public interest explain for an increase in untied aid.

Overall, I find it puzzling that foreign aid has become untied as the major beneficiaries appear to be poor foreigners with little political power.

Tomasz Wegrzanowski June 4, 2012 at 8:35 am

“Overall, I find it puzzling that foreign aid has become untied as the major beneficiaries appear to be poor foreigners with little political power.”

What a wonderful world we live in, good deeds are puzzling.

Jacob June 4, 2012 at 10:07 am

+1

Douglas Knight June 4, 2012 at 11:38 am

Any change is puzzling.

rjs June 4, 2012 at 11:40 am

i was under the impression that the major recipients of aid were egypt & israel…

John June 4, 2012 at 11:24 pm

Certainly not in Europe and also I think this is referring to non-military aid.

Anonymous June 4, 2012 at 8:54 am

This would be a good question for Bill Easterly. My cynical take is that since aid organizations are mostly staffed by Westerners from the “aid industrial complex”, foreign aid still functions as a jobs program for the host country.

The link is dead, by the way.

Tyler cowen June 4, 2012 at 8:54 am

Maybe foreign policy goals have increased in relative importance?

mulp June 4, 2012 at 9:27 pm

Or perhaps morality is playing a bigger part.

President Bush seriously wanted to demonstrate a conservative humanitarian face in fighting disease in Africa, thus PEPFAR which was influenced by Gates and Bono, so Bush put his support behind:
– breaking US patent monopoly so India-Israel pharma could produce AIDs drugs without patent royalties
– allowing US dollars to be used to buy drugs made outside the US boosting the fortunes a bit more of generic drugs
– limiting the preconditions for providing aid to nations

And the principles behind PEPFAR are being applied more broadly.

And the impact of Bono and crew can’t be ignored – they have influenced the public and stroked the political leaders to make fighting poverty a cause and not a foreign policy quid pro quo.

And Bono et al are more responsive to criticism of their policy implementation and more willing to examine the results and thus speak with greater authority to political leaders.

If there are any foreign policy goals, they are less concrete: improving world opinion of the West, cutting disease in the Rest to protect the West from disease, hoping better health will lead to better economies which will buy more national exports.

Rahul June 4, 2012 at 11:59 pm

Or perhaps, the capabilities of the third world aid recipients have matured?

Antibiotics, farm machinery, clothing, baby formula etc. is a lot more manufacture-able in the third world now. 30 years ago importing it from the donor nation was the only option.

David Krych June 4, 2012 at 9:00 am

This isn’t really all that shocking. A model would be that policymakers get utility from helping their own re-election prospects, but nonetheless get SOME utility from actually helping the poor (or policy they believe in in general). Before it was shown that tied aid wasn’t actually very effective at the second goal, actions that appeared to help both goals simultaneously (tied aid) were the dominant way of achieving the second goal– “kill two birds with one stone”, as it were. Once it was shown that you couldn’t meet the second goal with tied aid, the proportion of tied aid declines.

Toni June 4, 2012 at 9:40 am

Have you thought about the fact that the majority of aid givers are very dispersed and thus public choice theory is not as important as one would think? I work for a professional services company which receives some business through foreign aid (audits of development projects, etc.) exactly because its tied aid. However, the business is such a small share of our revenues and profits that it’s really not that important for lobbying purposes. The business doesn’t even have a dedicated director in my country, it’s handled by middle-management.

If you look at aid breakdown, all the major constituents are a small minority of overall aid and thus there is no interest group, the industries are too dispersed and heterogenous to coordinate. If you also look at aid as a share of the respective business’s revenues or profits, it’s quite meager.

larry June 4, 2012 at 10:34 am

I seldom look at the writer’s name before reading the post. Since Tyler writes far more posts than Alex, my default assumption is that Tyler is the author. But as I read Alex’s posts I can now tell that it’s him writing. My ability to do this is improving. This time I recognized that it was Alex by the end of the first sentence. It’s sort of like the TV show “Name That Tune”.

Rahul June 4, 2012 at 11:52 pm

Tyler links more; Alex writes more.

idle wondering June 4, 2012 at 11:19 am

Does this include foreign military aid? I imagine this aid is all “tied”, and is the vast, vast majority of foreign aid spending…

Alex Tabarrok June 4, 2012 at 11:49 am

Good question and the answer is no; this is Official Development Assistance which is aid supposed to promote development or welfare. It does not include military aid (although aid to promote development or welfare could be given for military/foreign policy objectives).

Nathan June 4, 2012 at 11:35 am

Another likely factor is that leaders of emerging nations are becoming more vocal and converging on a shared narrative regarding the weaknesses (and harmfulness) of tied aid. So, for instance, one of the speeches that made the biggest splash at the Fourth High Level Aid Forum in Busan, SK this year was Paul Kagame, whose words made clear his disdain for tied aid and his philosophy on how and why poor countries must more actively manage the process of aid delivery than they have in the past. As the relative importance of commercial ties with these countries increases, it’s more important to us to respect the goals set by their leaders.

Another point supporting this notion is that when it comes to countries with less political clout, like Haiti, our proportion of tied aid is not dropping as it is with other countries.

On a bitter and slightly ironic note, this could result in a situation where our aid practices become more helpful for countries that are doing relatively better, and become even worse (or simply remain ineffective) for countries with the greatest need.

Nathan June 4, 2012 at 11:36 am

Addendum: link to Paul Kagame’s speech: http://www.youtube.com/watch?v=YY4EAucvz2s

Nathan June 4, 2012 at 11:38 am

Ahem. That was his presser afterwards. Here is his speech: http://www.youtube.com/watch?v=WH39ci5w06Q&feature=relmfu

The perils of internet multi-tasking…

Collin June 4, 2012 at 11:47 am

Why are we surprised by this finding????? Haven’t a lot people noticed the quality of the charity has also diminished and people would be a lot smarter to hand food banks a check instead buying grocery coupons to give to food banks. Reasons:

1) Since Vietnam, a popularity of aid has diminished and it is always one of the items most population wants to cut first. (Although the population always over-estimates its budget impact.) Why feed people in Country X when we have hungry people here.
2) When the aid is tied to a good then they release the power of two lobbies. Just think Israel. Isreali aid is the highest because now you have two lobbies working the aid. Then a congress person on the borderline of supporting aid to Country X and supports more military spending can justify the decision easier.

CR

EM DC ECONOMIST June 4, 2012 at 11:47 am

The consequences of state failure, civil conflict and chronic underdevelopment have a much broader impact in a globalized world. These include sharp increases in illegal immigration, the rapid emergence of terrorist incubators, and perhaps as importantly, the wider availability of video documenting the ensuing human suffering. The potential net gains from a dollar spent on preventing such outcomes therefore outweigh the net gains from an alternative than involves little benefit to a beneficiary country.

Edward Sabatine June 4, 2012 at 11:53 am

It may be helpful for this issue to differentiate more between the United States and Europe.

Sam June 4, 2012 at 12:09 pm

Perhaps, having read Tyler’s book, European countries realize that Vietnamese food offers better value, and consequently their foreign food aid has become un-Thai’d

Zachary June 4, 2012 at 4:04 pm

Heey–oohh!!

Enrique June 4, 2012 at 12:31 pm

Yet again, I very much enjoyed Alex’s post today — however, the link to the Christmas problem was not all that great — Tim Harford conflates two separate problems: 1. the gift problem, and 2. the Christmas card problem — with respect to the first problem, Harford’s analysis is way too oversimplified — he neglects that gift-giving makes sense when the recipient himself wants a certain gift but is not willing to purchase it himself, and of course, he neglects the whole signalling purpose of Christmas — i.e. to signal generosity — and he also neglects children — one may criticize this signalling game as lame (when adults plays the game with each other), but that is a normative point, and normative preferences or aesthetic are not within the purview of economics proper — in the alternative, one may criticize this signalling game as inefficient, but to do so, one must balance costs AND benefits (Harford only looks at costs), and one must compare c and b at the margin

samot June 4, 2012 at 1:05 pm

Foreign aid – or at least the money that goes into foreign aid – is not a uniform substance, and so has all kinds of different interests. One piece of it is the food aid/commodities portion. In the US these are represented by the ag lobbies. There’s been a ton of international pressure from Oxfam and others on the US and others to get away from tied aid of commodities – its silly to send grain from farmers in America to farmers in Africa; it distorts markets for food in the recipient country; and since distribution or the right to distrubute is controlled by governments or existing power structures it reinforced often malevolent forces by giving them something of value to give to allies or sell for their own benefit or to finance violence. There’s been a couple of decades of pressure to get rid of this and it seems to be less and less common. Another piece is the contractors and NGOs who implement many aid projects on the ground. There’s a lot of rhetoric coming out of State and USAID about the abuses of the donor/implementer ecosystem, and how the implementers keep a big chunk of the money for their salaries, profits or (in the case of NGOs), their inflated overheads. In response USAID has been away from private sector contractors and toward US-based NGOs (though many of the big NGOs, like IRD, are effectively run like private companies for the benefit of their directors) and away from both of those toward local systems like local NGOs and sovereign governments (which is what Kagame wants), though there’s a lot of things that its hard for local organizations to do, especially when donors and, in the US case, the US congress, imposes very rigorous requirements for how to spend money, how records are kept, etc. The USAID IG just accused two Nigerian NGOs that had gotten a couple of million in USAID funds of fraudlent spending. Holbrooke’s efforts to do this in Pakistan have been a spectacular failure. Those are usually local set asides and is different than “untied” funds which allow anyone to compete against US businesses; its still hard for a non-US contractor to win USAID business. AusAid and DFID have gone further in the direction of untied funds. They made a move to local systems a couple of years back, but were not satisfied with the results and so have been moving back to a more implementer-based model, ironically just as USAID is rushing in the other direction. A third piece are limitations on the ability to procure goods and services from local or third country sources. Here there are still some ridiculous limitations. US contractors have to “Fly America” on US airlines, even when it results in much higher fares. Some of the requirements to buy US-made cars are being loosened. (It used to be US made and not just US car companies, so a Chrysler made in Mexico or Canada was theoretically not an allowable expense). Most these things can be waived but tthat takes time and paper and signatures.

spandrell June 4, 2012 at 5:02 pm

It’s the growth of justice!!

Now foreign governments get to send the money directly to Swiss banks.

Ellen June 4, 2012 at 5:41 pm

Certainly in Canada, non-governmental organizations involved in international development, such as Engineers Without Borders, lobbied the government to change the policy so that aid would no longer be tied. The Canadian federal goverment untied all foreign aid in 2008.

Over time, as people look at aid projects that have failed, one of the common reasons for failures is that the project did not use local resources, or make sure that the system would be maintained in the long term by local people. Growing recognition that tied aid makes a project likely to fail probably helped make the change more politically palatable.

S June 4, 2012 at 5:49 pm

I would guess more efficient global agriculture markets, crop usage in biofuels, and the shift from price subsidies towards crop insurance programs would reduce the frequency of “gluts” that encourage dumping via foreign aid.

David June 5, 2012 at 8:29 am

In the case of Europe it may be a side effect of the Single European Act which does not allow subsidies for “national champions”.

Adam June 5, 2012 at 12:18 pm

It’s truly mind-blowing that Alex has so internalized his public choice theory to be astounded by the possibility of actors actually being motivated by altruism and good intentions.

Steve June 6, 2012 at 2:42 am

It’s probably because of Bono and Bill Gates. They won Times’ Person of the Year (w/ Melinda Gates) in 2005 for lobbying for better (and more) aid so you’d figure they had an impact.

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