FOREIGN AID AND THIRD WORLD DEVELOPMENT: THE UNENDING CONTROVERSIES

OBI, EMEKA ANTHONY***

Introduction

The role, desirability and effect of foreign aid on third world development have
continued to generate intense debate and controversies. While some tend to believe that
foreign aid has been very helpful to recipient nations and is borne out of nearly altruistic
convictions on the part of the donors, other have countered this stand by insisting that foreign
aid is actually part of the problem and not a solution to third world under development. Yet a
third group has emerged in the debate. To this group foreign aid has actually posed a problem,
but the problem is not with the aid itself or the donors but with the recipients, due to poof
management.

This paper intends to look at this debate and controversies dispassionately in order to be
able to see through the strong curtains of the various groups and present to the reader the real
effects (positive and negative) of foreign aid on third world development. It intends to answer
the questions of whether foreign aid is what the third world actually need to kick-start rapid
economic and social development which it urgently needs. In doing this we are going to start
with a definition of foreign aid.

Meaning Of Foreign Aid

Foreign aid has been defined by Todaro & Smith (2004 6:4-8) as encompassing “all
official grants and concessional loans, in currency or in kind, that are broadly aimed at
transferring resources from developed to less developed nations on development or income
distribution grounds”. In his own definition, Goldstein (2003: 522) sees it as “money or other
aid made available to third world states to help them speed up economic development or
simply meet basic humanitarian needs ”. Todaro & Smith have pointed out the fact that
Economists usually define foreign aid as any flow of capital to LDCs that meet two criteria: (1) its
objective should be noncommercial from the point of view of the donor, and (2) it should be
characterized by concessional terms: that is, the interest rate and repayment period for
borrowed capital should be softer (less stringent) than commercial terms. They criticized this
definition on the ground that it could include military aid which in actual fact is both
noncommercial and concessional of foreign flows: they also raised the problems associated
with the measurement and calculation of actual development assistance flows. The three major
problems are; first, one cannot just add together the dollar values of grants and loans since
each has a different significance to both donor and recipient countries. Since loans must be
repaid, they therefore cost the donor and benefit the recipient less than the nominal value of
the loan itself. Ideally, one should deflate or discount the dollar value of interest bearing loans
before adding them to the value of interest grants. The second problem has to do with the fact
that aid can be tied either by source in which case loans or grants have to be spent on the
purchase of donor-country goods and services or by project which specified the projects on

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which the funds will be spent In either case, the real value of the aid is reduced because the
specified source is likely to be an expensive supplier or the project is not of the highest priority
(otherwise there would be no need to tie the aid). Lastly, there is the need to distinguish
between the nominal and real value of foreign assistance, especially during periods of rapid
inflation.

Patterns Of Foreign Aid

Most of foreign assistance in the world today comes from the twenty-two developed
countries that are members of the Development Assistance Committee (DAC) of the
Organization for Economic Cooperation and Development (OECD). Some oil producing countries
also provide foreign assistance to poor countries.

Foreign assistance is mainly extended through bilateral aid, which is state- to state while
a smaller amount of it goes through multi-lateral aid (through bodies like the U.N, the I.M.F and
World Bank among others).

Foreign assistance, which includes bilateral grants, loans and technical assistance and
multilateral grants, has grown from an annual rate of $4.6 billion in 1960 to $56billion in 1999.
However, in terms of the percentage of the developed-country GNP allocated to official
development assistance, there has been a steady decline from 0.51% in 1960 to 0.29% in 1999
(Todaro & Smith 2004: 648-649) What this implies is that though the money seems to be
growing in absolute terms, it has been declining in real terms. In other words as the GNP of the
developed countries keep increasing they keep giving lesser aid to developing countries.

Though the DAC countries decided on their own to contribute 0.7 percent of their GNP
in foreign aid, they generally give less than this. It is only Norway, Sweden, Denmark, Holland
and Luxemburg that are close to this mark. The U.S. gives the least among the OECD countries in
terms of percentage of GNP. See table 1.

Table 1

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 A ssistance G iven
a
Do no r B illio n $ % of GN P C ha n ge f ro m 1 9 92
Wo rld to tal 5 6. 4 0 .2 % - 2 5%

Tota l G 7 42 .4 0. 2% -3 0%
Ja pa n 1 5. 3 0 .4 % + 15 %
Un ite d Sta tes 9. 1 0 .1 % - 35 %
Fra n c e 5. 6 0 .4 % - 25 %
Ge r m a ny 5. 5 0 .3 % - 40 %
B rita in 3. 4 0 .2 % - 10 %
C a na d a 1. 7 0 .3 % - 45 %
Ita ly 1. 8 0 .2 % - 60 %
Ne the r la n ds 3 .1 0 .8 %
Sw ed e n 1 .6 0 .7 %
De n m a rk 1 .7 1 .0 %
No rw a y 1 .4 0 .9 %
Oth er “ No rth ” 6 .1

Ar a b Co un trie s 0 .3

Source: United Nations, World Economic and Social Survey 2001 (New York: United Nations,
2001), p.274. UN estimates based on OECD data; governmental aid only. Cited in Goldstein J.S.
(2003) International Relations. Delhi: Pearson Education.

According to Goldstein (2003:522), in total economic aid given, the U.S ($9billion) has
slipped Behind Japan ($15 billion), while Germany, Britain and France gave between $ 3 billion
to $6 billion. The U.S foreign assistance dropped by about half from 1992 to 1995 and is yet to
return to its former levels. After the 2001 attacks, Britain proposed a $50 billion increase in
foreign aid and nearly doubling current levels, to tackle poverty which breeds extremism. This
made the U.S to raise its aid budget sharply. While it is quite impressive to talk about foreign
aid in tens of billions of dollars, it is less impressive when aid is measured on a recipient per
capita basis.

Table 2

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Sources: Rourke, J.T & Boyer, M.A (2004) International Politics on the World Stage. McGraw Hill:
Boston.

Looking at table 2 we see that Bangladesh, one of the worlds poorest countries received
per capita aid of only $ 9.15 in 2002, which is just enough in the United States for a large
cheese pizza (Rourke & Boyer 2003:335). Further, Todaro & Smith (2004:649) have argued that if
the U.S. for instance can increase its aid by an additional $10 billion, this would make a dramatic
impact on development goals such as reduced infant mortality rates. Also while $10 billion is a
huge sum by LDC standards, it represents only one- thousandth of U.S. income. Quite
insignificant you might say, but it can save millions of lives and reduce misery and suffering
among the worlds poorest countries.

Another interesting aspect of foreign aid is its distribution, looking at the regional
distribution for instance; we find out that South Asia that harbours about 50 % of the worlds
poorest people receives $3 per person in aid. The Middle East, which has nearly five times
South Asia's per capita income receives six times their per capita aid. Europe and central Asia,
with more than four times the per capita income of sub-Saharan Africa, receives more per
capital aid (Todaro & Smith 2004 650) Tables 3&4 clearly illustrates the picture.

Table 3

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Table 4

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Table 4 Continues

Source: World Bank, 2001 World Development Indicator (Washington, D.C.: World Bank, 2001).
Cited in Todaro, M.P & Smith, S.C. (2004) Delhi: Pearson Edication.

Forms Or Types Of Aid

Aid can be classified into two broad categories; tied and untied aid, and can still be
further classified in terms of bilateral and multilateral aid.

Tied Aid: Tied aid is an aid in the form of bilateral loans or grants which require the
recipient country to use the funds to purchase goods and services from the donors' country
(Anyanwu 1993:355) The aid may be tied by source (where), by project/commodities (what). In
some cases it may be tied by both project and source.

Untied Aid: Aid is said to be untied if it is a general-purpose aid. It is the assistance

whose disbursement is tied to the recipients expenditures on wide variety of items justified in
terms of the total needs and development plan of the country rather than any particular project
(Anyanwu 1993:355).

Bilateral Aid: This is the type of aid given directly on a state-to-state basis. It can be in
different forms. These are Grants, Credits, Loans, Loan guarantees and military aid. Grants are
funds given free to a recipient state, usually for some stated purpose. Technical cooperation
refers to grants given in the form of expert assistance on some projects rather than just money
or goods. Credits are grants that can be used to buy certain products from the donor state.

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 Loans are funds given to help in economic development, which must be repaid in the
future out of the surplus generated by the development process (they too are often tied to the
purchase of products from the donor state). Government loans are usually given on
concessionary terms with long repayment times and low interest rates, quite unlike commercial
loans. Loan guarantees are rare, and are promises made by a donor state to back up
commercial loans to the recipient. The terms are such that if the recipient state is unable to pay
back, the donor state will pay on its behalf. This guarantee, which reduces the risk for the
lending banks leads to lower interest rate for the recipient state. Military aid is usually not
included in development assistance but in a broad sense it is, because it is money that flows
from North to South and it really brings a certain amount of value into the third world economy
(Goldstein 2003:523). For some countries like Egypt’s military aid from the U.S forms about two
thirds of foreign assistance in some years from that source.

Reasons for Giving Aid

Giving foreign assistance to the third world countries, means a transfer of resources
from the developed to developing countries. Since no nation would just give out part of her
resources without any serious reasons, we therefore would want in this section of our study to
probe into the real reasons behind giving aid to the LDCS outside the seemingly moral or
humanitarian grounds which is not a serious factor in foreign assistance.

The real reasons behind foreign aid can be categorized into two. These are economic
and political.

Economic

Most donor countries seriously consider their own economic interests before giving aid.
According to Todaro & Smith (2004: 561-657) this tendency manifests in the fact that most
donors prefer loans to outright grants and these loans which are interest-bearing now
constitute over 80% of all aid. Aid is also tied to the exports of donor countries, thereby saddling
may LDCs with debt repayment problems while limiting the freedom of the LDCs to shop for low
cost and suitable capital and intermediate goods. A clearer picture of this is borne out by the
studies by Birdsall, Claessen and Diwan (2003). They found out that:-

Over the pat 25 years, sub Saharan African countries have been major recipients of
overseas development assistance. Aid in the form of grants and loans has amounted to
about $359 billion dollars (in nominal terms)…. meanwhile much of the high level
of development assistance took the form of loans, producing a growing stock of debt-
from about $60 billion in 1980 to $230billion in 2000. Annual debt service paid also
increased, from an average of $6bilion a year in the early 1980's to about $11bilion in
the late 1990's.

Further, it has been found out that a large fraction of U.S. aid has been spent on
American consultants and other U.S. businesses while a former British Minister of Overseas
Development. Said that “about two thirds of our aid is spent on goods and services from Britain.

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Trade follows aid. We equip a factory overseas and later on we get orders for spare parts and
replacement (Aid) is in our long-term interest” (Quoted in Todaro & Smith 2004:657).

Relying on the essay by George Burrill with the title “ U.S foreign Aid Helps Americans at
Home ” Offiong (2001:120-121) outlined the benefits of foreign aid to the American economy
thus:

1. By encouraging reform in developing countries overall economic policy, the aim

coincides with that of SAP, and it is no surprise. After assisting the Czech Republic to transform
its economy from a command to a free-market system, U.S exports to that country increased
by 11%.

2. The U.S works to dismantle laws and institutions that “prevent free trade ”. an example
of where this succeeded very well is Guatemala which now “exports specialty fruits, vegetables
and flowers ” This increased buying power has resulted in a 19 percent increase in U.S exports
to Guatemala since 1989.

3. The US helps to privatize state dominated economies. A $3million assistance to support

privatization in Indonesian energy sector led to a $2 billion award to an American firm for
Indonesia's first private power contract

4. Foreign assistance encourages developing countries to create business codes and the
rule of law as dictated by the US. Thus foreign assistance helps to create “the stable business
environments” that American companies need to operate.

5. Foreign assistance helps to create a new class of consumers in developing countries.

Having developed the appetite for western products, this very elite class or group are willing to
drain their meager foreign exchange to import those items, an experience that practically every
African country has encountered.

6. Foreign assistance helps to build small business. Community run learning programmes
managed by the US government help to expand small businesses and increase per capita
income in many developing countries. US companies are the greatest beneficiaries in all this
exercise.

The essay ends by stating that “the relatively small amount of money” the US spends on
foreign assistance “serves as an engine” for American economic Growth.

Political

Political considerations in some cases play even a major role than economic in foreign
assistance. During the cold war era, most foreign aid granted to LDCs by America was aimed
toward containing the spread of communism. In most cases, “aid programmes to developing
countries were therefore oriented more toward purchasing their security and propping up their
sometimes shaky regimes than promoting long- term social and economic development”
(Todaro & Smith 2004:653). Thus political consideration helps in deciding which countries would
receive aid and in what proportion and not need. Thus countries that are considered strategic

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like Egypt and Israel receive more aid from the US than other needy states. This consideration
explains why the US and the Soviet Union, during the cold war era, supported some of the most
tyrannical and rogue regimes, in so far as those regimes continued to remain subservient to
their imperial interests.

Why Developing Countries Accept Aid

The reasons behind the acceptance of aid by the LDCs can be grouped into three. They
are economic, political and moral justifications.

Economic

There is this widely held belief that LDCs are poor because they have problems of
shortage of domestic savings to match investment opportunities or a shortage of foreign
exchange to finance needed imports of capital and intermediate goods (Two-gap model). It is
then assumed that the easiest way to get out of the problem (especially the foreign exchange
gap) is to go for foreign assistance. This foreign aid would then be used to import capital goods
and technical expertise that would be used to kick-start the economy to the take-off stage
(Rostow ). Since the picture is painted that all LDCs need aid for them to record substantial
economic growth, what the LDCs argue about is not whether aid is desirable, rather about the
amount and donor conditions. The success story of the Asian tigers is usually depicted as the
picture of what foreign aid can do. Nobody talks about the fact that most LDCs that are
presently, caught in the debt trap, got there through foreign aid, which came as loans.

Political

The key political reason for the acceptance of aid by LDCs according to Todaro &Smith
(2004: 658) is that in some countries aid is seen by both the donor and recipient as providing
greater political leverage to the existing leader to suppress opposition and maintain itself in
power. This is where the aid comes in form of Military aid and internal security reinforcement.
Examples of this type of aid are, Vietnam in the 1960's, Iran in the 1970's and Central America in
the 1980s. In Africa most francophone countries in the 1980s and 1990s were also in this
category.

Moral Justification

Many proponents of foreign aid try to justify it from the angle that the LDCs are poor
because they were and are being exploited by the developed countries. Since the LDCs are
victims of exploitation, the exploiters (developed countries) owe them something. They ought
to give them aid so as to ameliorate their suffering which they contributed to in the first place.
It is from this reasoning that the issue of reparations emerged. Thus when the west gives
foreign aid to the LDCs, they are not being kind, rather they are paying back a little of what they
took from the LDCs. The money they give, is simply conscience money.

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The Effects Of Aid

In terms of the effects of aid on the developing countries, there are two schools of
thought. The first group are those who argue that aid has indeed helped to promote economic
development in the LDCs while the second group argue that instead of promoting economic
growth, it may have been retarding it by “substituting for, rather than supplementing domestic
savings and investment and by exacerbating LDCs balance of payments deficits as a result of
rising debt payment obligations and the linking of aid to donor- country exports ” (Todaro &
Smith 204: 659). They further contend that foreign aid has focused on and stimulates the
growth of the modern Sector, which leads to an increase in gap in the living standards between
the rich and poor in the LDCs. Yet some believe that foreign aid has been a positive force for
anti-development, because it retards growth through reduced savings and worsens inequalities.
Aid has also created a welfare mentality among the LDCs and aid weariness among the aid
donors, who now feel that the monies they donate to LDCs end up in the pockets of corrupt
third world leaders who have little interest in their own people and whose perception of both
economic growth and development, centers on their own bottomless pockets.

Writing on the impact of aid, Rourke &Boyer (334-335) argue that aid is neither a story
of undisguised generosity nor one of unblemished success. They further buttressed their
assertion by listing five factors that have reduced the impact of aid.

They are first political consideration:- Bilateral aid which form the bulk of foreign aid is
given based on political military interest than on economic needs or to promote human rights.
For example in 2001, about 40 percent of all U.S bilateral aid went to just two countries: Israel
(2.7 billion) and Egypt ($1.9 billion), while sub-Saharan African countries received only 10
percent of this bilateral aid.

MILITARY CONTENT: Of the total amount given to Egypt in 2001, more than two third was
military aid, and indeed in that year, over 25 percent of all American bilateral assistance was
military aid.

Measuring recipient per capita aid rather than gross aid is also useful to gain a real
picture of the impact of foreign economic aid. In 2001, the LDCS received about $19% per
person as shown in table 2.

Donor aid relative to wealth: This helps to show that the aid figures are really
insignificant. When you look at it generally you will find out that overall aid as a percentage of
developed countries total GNP has been steadily declining in the last 25 years. For instance in
1965 aid equaled 0.46 percent of the OECD total GNP while in 2001 it stood at 0.22percent.

THE WAY AID IS APPLIED: aid has often been used to fund highly symbolic but economically
unwise projects like airports and sports arenas, while inefficiency and corruption have also
taken their toll on the impact of aid.

Still on the impact of aid, they further contend that aid is used to maintain the local elite
and does not reach the truly poor and therefore only continues the dependency relationship

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between North and South. This argument is extended by saying that aid can actually retard
growth because giving people food reduces their incentives to farm.

In his own assessment of the impact of aid, Offiong (2001:117) has argued that why aid
is given for many reasons, poverty reduction is the last of the reasons. Thus political, strategic
commercial reasons, supercedes poverty reduction. Even in cases where poverty reduction is
given high priority, it is mainly in strategic countries like Egypt and Israel; while French and
British aid goes disproportionately to former colonies.

The implications of this trend are: first; not all aid goes to low-income countries. For
instance in 1988 about 40 percent of it went to middle-high-income countries. Second, there
are certainly wide disparities in the per capita allocation of aid; and the most generous per
capita allocations, do not go to the poorest countries. Third, many “aid” programmes in donor
countries cover an assortment of activities such as commercial and strategic initiatives, which
often have at least, a tenuous association with development. Only about 8% of US aid
programmes in 1986, for example, could be labeled as “development assistance devoted to low-
income countries ” that is to say recipients are required under the terms to buy goods and
services from donor countries. Approximately two thirds of all aid applied by DAC members are
in this category. This means that a significant amount of aid is spent in the donor's country,
often on irrationally exorbitant consultancies. Fourth, donors of aid prefer to finance physical
capital installations that help their own firms and exporters and they are quite unwilling to
support the operating (recurrent) costs of aid-funded undertakings. This is despite the fact that
it is well known that the key initiatives for poverty reduction in the LDCs should be in sectors like
health and education.

Conclusion:

While the argument on whether aid is desirable or not and whether it has caused more
harm than good on third world nations continues, we may not be interested in joining in the
debate. Our interest in the remaining part of this paper is to look at ways through which aid can
be made much more useful and responsive to the developmental needs of the LDCs.

The first step in this direction should be a change in the main donor considerations in
giving foreign aid. Presently, political considerations over shadow need which ought to be the
key consideration. Alesina and Dollar (2001) cited in Gunning (2001:134) found out that
allocation of bilateral aid is driven by political and strategic considerations, such as colonial ties
and UN voting records. Thus, the economic policies and political institutions of the recipients
are unimportant determinants of aid flows. The result is that “a non democratic former colony
gets about twice as much aid as a democratic non colony”.

The same goes with military assistance, which is usually given to countries that donors
see as strategic. In the first instance, military assistance ought not be seen as been part of
development assistance because as Todaro & Smith (2004:648) have argued, the concept of
foreign aid that is now widely used and accepted, is one that encompasses all official grants and
concessional loans in currency or in kind that are broadly aimed at transferring resources from
developed to less developed nations on development or income distribution ground. Military

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assistance does not aid development and in fact actually retards it. In most cases it is even used
to prop up and maintain bad governments which the donors think serve their interest. Its net
effect is that “Countries with meager coffers drain their treasury to purchase weapons of war
while their people are subjected to unconscious able poverty”(Offiong 2001:122). When we
remove military assistance in our calculations of foreign assistance, the urgent need for donors
to increase aid to the worlds poorest becomes very clear.

Arising from the above therefore is the need to channel more development assistance
through multilateral assistance agencies and non-governmental organizations. This would
reduce the incidence of bilateral assistance being tied to political and strategic considerations
more than economic need.

The imposition of conditionality on recipients is a practice that has recorded minimal

success. As Gunning (2001:133) has observed:

the ex ante approach weakens ownership, the ex post approach enforce it…but the
problem with ex ante conditionality goes beyond feasibility: one may well question its
desirability if donors are to succeed in achieving objectives that are not (fully) shared by
the government, they inevitably will under mine the governments accountability. In the
limit, conditionality is effective in the same way as colonialism and hence, suffer from
the same objection.

One of the most ardent critics of ex ante conditionality, Joseph Stiglitz, a former Chief
Economist of the World Bank, most elaborately analysed its pitfalls. According to him;

Rather than learning how to reason and develop analytical capabilities, the process of
imposing conditionality undermines both the incentives to acquire those capacities and
confidence in the ability to use them. Rather than involving larger segments of the
population in a process of discussing change thereby changing their ways of thinking it
reinforces traditional hierarchical relationships. Rather than empowering those
who could serve as catalysts for change within these societies, it demonstrates their
impotence. Rather than promoting the kind of open dialogue that is central to
democracy, it argues at best that such dialogue, is unnecessary, at worst that it is
counter productive.

The alternative to ex ante conditionality is ex post conditionality. Since the effectiveness

of aid depends so much on the policy environment, donors can adopt the concept of selectivity.
Selectivity works, because when donors base the allocation of aid on the policy environment,
recipients try to become more effective so as to attract more aid. Selectivity can be seen as the
most radical form of ex post conditionality because it treats the policy regime as exogenous and
hence abandons all pretense that aid can buy policy change (Gunning 2002:134).

One key problem with foreign aid, which we have already pointed out in this study, is the
issue of tying aid to the import of goods and services from the donors' country. With this type of
system, a high percentage of the aid is spent in the donors country on exorbitant goods and
consultancies, thus leaving the recipient in a precarious situation. This exacerbates rather than

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ameliorate the problem. Thus Todaro & Smith (2004:660) have argued that the less aid is tied to
donor exports, the more autonomy is permitted in its allocation, and the more it is
supplemented by the reduction of donor-country tariff and no tariff trade barriers against LDC
exports, the greater will be its development impact.

It cannot be disputed that while aid may be quite helpful to the LDCs in their present
state, better terms of trade or rather a New international Economic order that makes for more
equitable distribution of the world's resources would help the LDCs more than a remarkable
increase in foreign aid.

This brings us to the most important issue in third world underdevelopment; the issue of
leadership. Leadership has remained the single most worrisome stumbling block to real
development in most third world countries. The leadership we have seen is basically corrupt,
visionless, vicious, tyrannical, blood-thirsty, anti-development and anti-people. It neither
comprehends nor serious about development. The unpatriotic acts of third world leaders have
made most LDCs to remain firmly in the debt trap, while they maintain horrendous bank
accounts in western nations. There is thus the urgent need for a re-orientation in the leadership
of most LDCs. With a new leadership that is patriotic, humane and committed, they can set their
countries on the path of development and with time most would cease to rely on aid thereby
freed from its debilitating effects.

It is already bad that the LDCs have developed a welfare mentality, but what makes it
worse is that there is really no silver lining in the sky as economic hardship forces many more
LDCs to line up with their empty bowls begging for aid. When this will end, remains a question
that truly begs for an answer. Most unfortunately we do not claim to have an answer to this
except that with better governments, strengthened institutions, focused policies and a firm
commitment to developmental goals, most LDCs with time will rely less on foreign aid as they
become increasingly self reliant.

REFERENCES

Anyanwu, J.C (1993). Monetary Economics Theory, Policy and Institutions. Onitsha: Hybrid
Publishers Ltd.

Birdcall, N., Claessens, S., & Diwan, 1 (2003) “Policy Selectivity forgone: Debt & Donor
Behaviour in Africa.” In The World Bank Economic Review Vol. 17 No. 3. Washington D.C.
Oxford university press.

Goldstein, J.S. (2003). International Relations (8THed). Delhi: Pearson Education.

Gunning, J. W (2001) “Rethinking Aid” in Pleaskovic , B, and Stern, N. Annual World Bank
Conference on Development Economics 2000 Washington D.C: The World Bank.

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Offiong, D.A. (2004). Globalization: Post New dependency and poverty in Africa. Enugu: Fourth
Dimension Publishers

Rourke, J.T. & Boyer, M.A (2004). International Politics on the world stage (5 th ed). Boston:
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Stiglitz, J.E (1998) “Distribution, Efficiency Voice: Designing the sound Generation of Reform”
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Todaro, M.P. & Smith S.C. (2004). Economic Development. Delhi: Pearson Education

**** Obi, E. A.(2008).Foreign Aid and Third World Development: The Unending Controversies.
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