Introduction

According to Development Assistance Committee of the organization for

Economic cooperation and Development Foreign Aid is a financial flows,
technical assistance, and commodities that are designed to promote
economic development and welfare as their main objective are provided
through grants in which a Government given a certain amount of money for
a particular or a specific purpose or subsidized loans in which a foreigner by
given a certain amount of money Government should contribute a part of
project cost. Grants and subsidized loans are referred to as confessional
financing in a sense that it consider a sense of humanity, environment or a
situation of a society while loans that carry market or near-market terms are
non-confessional financing because that kind of loan should be specific,
timely and it has a limitation in refunding as it based to discount and
interest. For instance; we have a case study of a Granted loan which have
been given to Tanzanian in 1995, that loan was not timely reimbursed as a
result in 2005 World Bank reported that a Government of Tanzania has to
reimburse the loan with interest which required all Tanzania to pay the loan
with interest schedules (Bartels, 2008).
Effectiveness of foreign aid to development
Sachs Jeffrey (2004); asserts that some proponents of foreign aid claim that
overseas capital inflow is necessary and sufficient for economic growth in the
less developed countries. They argue that it is theoretically justified because
it closes the gap between investment and domestic savings, overcoming
shortages of capital and low levels of skills, it supplements export earnings
to finance imports generally and capital goods more specifically, and helps to
close the foreign exchange gap.
These conclusions are confirmed with the experience of individual countries
such as Bangladesh and India where foreign aid appears to have played an
important role in the development process. For instance, 100 percent of
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Bangladeshs development budget depends on aid which has made a

significant contribution to the reconstruction of its economy. In India, foreign
aid has financed over 8 percent of the domestic investments and about 15
percent of imports.
Some conditions applied to foreign aid can be said to indirectly benefit the
recipient country as well. Some states, such as the United States, are
increasingly rewarding democratic states with foreign aid, especially since
the end of the Cold War, regardless of strategic importance. As an example,
former-President Clinton called the promotion of democracy and human
rights the third pillar of his foreign policy. Foreign aid programs such as the
Support for Eastern European Democracy Act of 1989 and the Africa
Conflict Resolution Act of 1994 are especially geared toward promoting
democratization. This may create incentives for reform, which have the
potential to drastically increase the standards of living, including the
advancement of personal rights and freedoms, for many who would
otherwise suffer. Of course, strategic interest should still not underestimated.
In an alternative respect, multilateral agencies such as the IMF and World
Bank

promote

development

by

focusing

on

structural

adjustment

requirements in return for aid packages and loan guarantees. These

requirements include the liberalization of foreign exchange and import
controls (freer trade), devaluation of the currency (encouraging exports),
anti-inflationary programs including the abolition of price controls, and the
promotion of foreign investment. These measures are meant to encourage
responsible fiscal management in order to sponsor growth and sustainable
development.
Donors Gains from Aid
According to Moyo, Dambisa. (2009), some donors, notably the Nordic
countries,

developmental

and

humanitarian
2

motives

have

figured

prominently in the allocation of aid. Even though altruistic behaviour may be

part of the motivation in both types of aid, bilateral aid is more likely to be
oriented toward the donors economic and strategic interests. States are able
to take advantage of their direct control of the funds they bestow by
requiring, requesting or expecting certain gains (in various forms) in return.
For example, Japan concentrates its aid in the Asian region; Britain and
France give much of their aid to former colonies; political and cultural
relations are evident in OPECs aid allocations; and strategic motives
dominate the bilateral aid programs of the United States. In all these cases,
national interest shapes the style of aid in the hopes that it may allow them
to strengthen ties with recipients for economic, political, strategic or cultural
reasons.
In the economic sphere, the use of tied aid has consistently featured
appreciably in foreign aid. Tied aid is the practice of requiring the recipient
to spend a proportion of the aid given on goods and services produced by
the donor nation, specifically with reference to bilateral aid, on which the
donor has greater control. This strategy is intended to create job
opportunities

and

promote

export

industry

domestically

by

securing

increased sales to the recipient country, and allowing domestic firms to

penetrate these new markets. Tied aid also avoids the prospect of
subsidizing future competitors in other countries with ones own tax dollars.
The United States, Canada and Spain have been the greatest tiers of aid. A
total of about 30% of foreign aid is tied (Gilens, Martin, 2012).
Political and strategic motivations such as security goals, access to military
bases and strategic natural resources, diplomatic ties and prestige have
been prominent features of aid policy for the governments of states. They
link aid to exchange conditions, or quid pro quos, either expressly or
implicitly. Studies have proven the link between US and Soviet foreign aid
and international political support, especially, during the Cold War period,
3

where aid given by the United States and the Soviet Union was meant to
solidify their respective alliances and allow them access to territory from
which to involve themselves in proxy wars and political currency in order to
contain the enemy. Such politically motivated aid can be observed with
respect to American aid to its biggest recipients, Israel and Egypt, since 1977
and Soviet assistance to Cuba and Syria (Easterly, 2006).
Also in such countries as Japan, Italy and Britain governments have devised
aid and trade packages specifically in response to domestic pressures such
as political lobbying by local business and commercial interests, and public
opinion. Public outcry could result more generally in cases of humanitarian
disasters, and more specifically by ethnic groups who are asymmetrically
altruistic

to

specific

recipient

countries.

The

government

accepts

contributions from the lobbyists and the level of contribution depends on the
policy that the government pursues. For example, the African lobbies in
France, the Indian lobby in the United Kingdom and the Turkish lobby in
Germany are well known for their activities in these multi-cultural donor
countries (Gilens, 2012).
Another aspect of the political motivations for aid donation has been the
provision of assistance for democratic political reform, institution building,
and better governance. There are self-regarding causes for the disbursement
of foreign aid and conditionality, including the Pacific thesis, which argues
for the impossibility of the existence of warring democracies, where a world
populated by democracies would enhance the potential for national security.
A second theory considers the effects on national security as civil unrest may
create a refugee crisis that destabilizes immigrant-accepting countries.
Another cynically considers whether aid conditionality may simply provide
the donor with another way of exercising its power for its own sake (Gilens,
2012).
General Findings of Effectiveness
4

Measures of development and growth in the majority of the following studies,

as most of them have been conducted by traditional conservative
economists, have by and large centered on GDP statistics.
While some research has shown that aid has a positive effect on economic
growth, the majority of studies have found that foreign aid has had no
relationship with investment and growth in developing countries. Some even
assert that it has had a negative effect on domestic savings and economic
growth in some states. Clearly, although a negative effect on growth tends to
be the consensus, the results do vary, most likely depending on the pools of
subjects selected and periods observed. What is also evident is that much of
the literature concerning the effectiveness of foreign assistance using growth
models are too broad in scope, failing to isolate variables that may shed
more light on the complexity and nuances involved in aid effectiveness.
The Traditional Shortcomings of Bilateral Aid
In evaluating the potential negative effects on aid effectiveness (for recipient
country development) that donor restrictions and specifications could
produce, we may focus our attention on each form of conditionality in turn
(Gilens, 2012).
Tied aid, to begin with, has a tendency to reduce aid effectiveness, value for
money, and sustainable development in developing countries. By forcing aid
money to be spent on the donors goods, competition in the market for the
provided goods is eliminated, allowing firms to charge noncompetitive prices,
resulting in excess costs of between 15-30%. The recipient countries are thus
receiving a lesser value for their aid money. The funds, at the same time, are
funneled away from firms in the recipient country that are not provided with
the capital to develop, for the country to become self-sufficient. The
developing country, in the process, is also denied any decision making on
resource allocation, inhibiting the enhancement of administrative skills. Tied
5

aid also encourages dependency and wasteful spending. Goals of poverty

reduction and sustainable development are in these ways hampered (Gilens,
2012).
Tied

aid

also

distorts

trade.

By

subsidizing

domestic

producers

or

uncompetitive firms in declining industrial sectors, tied aid acts as a

mercantilist device that deepens international protection and retards
economic restructuring at home.

As for donors choice of recipient, the

donor country may favour higher-income countries or lite groups in lowincome countries, as there is incentive to initiate a relationship with a
country that will more easily become a stable consumer of the donors
exported goods. It also results in capital-intensive infrastructural projects
being chosen over labour-intensive ones.
Aid given to developing nations for strategic and/or political purposes can
also have detrimental consequences. As the well-being of the recipients is
not of premium concern, the interests of the LDCs become secondary to
those of the benefactors. When desperation for funds is acute, some states
may find themselves in precarious positions for accepting the explicit or
implicit terms of agreement. Vietnam, for example, was converted into the
fighting ground for a major war as the superpowers became intrinsically
involved in their internal affairs (Gilens, 2012).
Multilateral

agencies

have

several

advantages

for

development

effectiveness, besides the obvious element of better coordination of donor

states. They are built to be largely apolitical; their bidding procedures for
procurement are relatively transparent; the pooling of resources widens the
range of feasible activities; and the multilaterals size gives them the
competence to handle large projects and the experienced personnel to
conduct the missions. The recipients also tend to stock more trust in
multilateral institutions as opposed to bilateral ones which they see as
manipulative. As Douglas Dillon once stated, In the delicate area of fiscal
6

and monetary policy, governments find it much easier to accept the counsel
of an objective, impartial, and highly competent international organization
rather than the advice of other governments, no matter how good or wellintentioned. Savvy of the motives of individual states, developing nations
expect multilateral arrangements to prohibit unfair tied aid practices (to
which countrys industry would the aid be tied?) and political exploitation.
The traditional belief concerning the potential effectiveness of aid is thus
that bilateral aid should be less effective than multilateral aid due to the
biases associated with it. Since bilateral aid is often used as a tool of a given
countrys foreign policy to secure political, military or economic interests,
that aid is expected to benefit less, if not impair, growth capabilities in the
recipient country, as compared with multilateral aid that is presumed to have
diluted donor control and neutralized ulterior motives.
Data collected by Burnside and Dollar (2000) and analyzed by Ram,
however, have shown that one percentage point increase in bilateral-aid
raises the growth rate by one-third to three-fourth of a percentage point. On
the other hand, one percentage point increase in the multilateral-aid variable
lowers the growth rate by one-half to one percentage point. These results
beg the question of how aid that so often is guided without the interest of the
recipient in mind has a much more positive effect on the development of
developing countries than assistance from a supposedly impartial agency
that has growth and development as its goal. The following will attempt to
resolve this seeming discrepancy.
Bilateral aid has many advantages. Countries often are peculiarly well placed
to assist others with which they have long-standing relationships. They have
specific technical skills often developed in, or because of association with,
the

countries

concerned.

They

often

times,

as

is

the

case

with

imperialist/colony relationships or other historical ties, have linguistic and

personal affinities which may facilitate the ability to render appropriate
7

technical assistance. Their institutional structures are often derived one from
the other, as well (Gilens, 2012).
Moreover, some factors neutralize bilateral aids negative points. Tied aid, for
example, can be seen as a tool to increase effectiveness in a way, as it is
contractible. That is, contrary to many international agreements where there
are no third party or institution that can enforce contracts, tied project aid is
contractible within the donor country. Furthermore, such a contract is
credible not only because of the use of legal institutions within the donor
country, but because the third party involved, i.e., private firms within the
donor country, is likely to enforce the contract for profit-maximizing reasons.
By introducing a third party into the game between the donor and the
recipients, a conflict of interest between the beneficiaries of aid is created.
This in turn constrains the donors ex post incentives, thereby providing the
necessary incentives for the recipient governments to induce effort (Gilens,
2012).
Concurrently, multilateral flows, particularly in the case of the World Bank,
have come under severe criticism. One main argument is that these
institutions are influenced unduly by the North or even by one country; the
United States. It has been noted by former-US Treasury Secretary Nicholas
Brady that for every dollar provided to these [multilateral] banks, the U.S.
economy gets back $9 in U.S. procurements. Some critics of aid have thus
contended that there actually has been little distinction between bilateral
and multilateral aid decision making, as the Bretton Woods institutions
include weighted voting tied to subscriptions and contributions. These
institutions then impose conditions that allow for easier and cheaper access
by trade and investment of developed nations. Even within the United
Nations Development Program (UNDP) and other UN programs, where there
is no such weighted voting, formal and informal arrangements and pressures
put the United States in a position to play an important role.
8

Conclusion
The World Bank also has been accused of undertaking too many
environmentally, socially and economically detrimental projects at the
expense of the poorest nations. It can also be hypothesized that the
stringent conditions placed on aid by multilateral agencies do harm, at least
in the short term, relative to the growth prospects of the recipient countries.
Egypt, for example, acquiesced to IMF directives to reduce subsidies and
government spending in 1977, which resulted in civil unrest, riots, and
destabilized the governments authority.

References:
Bartels, L. M. (2008). Unequal democracy : the political economy of the new
gilded age. New York Princeton, Russell Sage Foundation; Princeton
University Press.
Easterly, William. 2006. The White Mans Burden. NY: Penguin Press.
Gilens, Martin. 2012. Affluence and Influence: Economic Inequality and
Political Power in America. Princeton University Press and Russell Sage.
Moyo, Dambisa. (2009). Dead aid : why aid is not working and how there is a
better way for Africa. New York, Farrar, Straus and Giroux.
Easterly, William. 2006. The White Mans Burden. NY: Penguin Press.

Gilens, Martin. 2012. Affluence and Influence: Economic Inequality and

Political Power in America. Princeton University Press and Russell Sage.
Moyo, Dambisa. (2009). Dead aid : why aid is not working and how there is a
better way for Africa. New York, Farrar, Straus and Giroux.
(Sachs Jeffrey 2004); Ending Africas Poverty Trap; Brookings Papers on
Economic Activity, Volume 1

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