Chapter

9 Review of Issues of Aid Effectiveness

Author(s):
Claire Liuksila
Published Date:
December 1995
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Author(s)
Benedicte Vibe Christensen

For Africa, making effective use of aid is as crucial as having adequate volumes. Aid budgets of most of the major bilateral donors are under great pressure. Globally, this decline has not yet shown up in disbursements, which still reflect past commitments at higher levels. But in the coming years, present levels of concessional flows are unlikely to be sustained. Consequently, improvement of aid effectiveness is high on the agenda of both bilateral and multilateral aid agencies.

Donor Issues

Following the end of the Cold War, most aid agencies have undergone a fundamental review of their policies and are partly shifting from strategic considerations to long-term development issues such as social sector issues and poverty reduction. This is not surprising, given the increasing disparity in income levels among developing countries and the increase in the incidence of poverty in some countries. This shift in aid objectives is being facilitated by the graduation of several middle-income countries from aid support as they gain access to international capital markets. Private flows can be highly volatile, but it is natural and desirable that developing countries increasingly become integrated in the international capital markets and benefit from private foreign investment and savings. Indeed, some of the more advanced developing countries are themselves beginning to provide aid to poorer countries. The concept of “North-South” collaboration has been replaced by a more complex picture that includes “South-South” collaboration. Despite this encouraging trend for some, many poorer countries will continue to need to rely on aid.

Focusing aid on the poorer countries is important from several standpoints. First, from a humanitarian perspective, the plight of the poorest among the developing countries cannot be ignored.

Second, from an economic standpoint, the poorer countries today are much more dependent on aid than are the richer developing countries. Reduction in this reliance needs to be gradual given these economies’ limited capacity to transform and to avoid a disorderly adjustment. In sub-Saharan Africa, concessional aid in net terms accounted for 13 percent of GNP during 1990-93 against less than 1 percent for middle-income countries. And among low-income countries, there is wide disparity, with aid accounting for as much as 25 percent of GNP in low-income Latin American countries against 4 percent in low-income Asian economies, excluding China and India, and as little as 2 percent including them.

Third, even a relatively modest diversion of aid from the middle-income developing countries would have a major positive impact on poorer countries. The middle-income countries received more concessional flows in absolute terms during 1990-93 than did low-income countries in Africa. Comparing the period 1990-93 to the preceding 1985-89 period, concessional flows actually rose by more to middle-income than to low-income countries, reflecting concessional support for Eastern Europe. However, among the traditional aid recipients, there was a shift in concessional flows toward low-income countries.

In sum, there are good reasons to shift aid toward the poorest. However, even if such a shift continues in the coming years, competition has become fiercer for the scarce funds, and aid will need to be used more effectively.

Another key element in aid effectiveness from the donor perspective is assuring an appropriate balance between the different forms of aid, taking into account the specific situation of each country. Many aid agencies are beginning to shift from balance of payments support for broad policy reforms and traditional development projects toward social sector support, including financing health and education programs and more targeted poverty interventions. We are also seeing a trend toward channeling more aid through non-government organizations (NGOs) and the private sector, thereby fostering more participatory development.

Taking these developments together, there is a risk that the aid balance may shift too quickly for the poorest countries, with adverse economic consequences. These consequences arise from the complementarity between program and project assistance. Broad policy reforms and a stable macroeconomic framework are necessary to ensure private sector growth, the basis for lasting poverty reduction. Policy reforms also enhance the benefits from development projects by removing price and other market distortions and fostering successful project implementation in a low-inflation environment. Appropriate macroeconomic policies also help ensure that sufficient local financing is available to supplement foreign financing. Well-designed development projects are also essential for laying the foundation for long-term growth, through the development of human resources and economic infrastructure. Technical assistance is an essential component of development projects and it also supports policy reform.

Given these interlinkages, too rapid a shift in donor policies and too narrow a focus of aid could result in overfunding of certain expenditures and underfunding of others. When there is a shortage of balance of payments support, the process of regaining or maintaining macro-economic stability could also be slower or more difficult. This, in turn, could mean that the environment for projects to be successful will be weaker. Thus, there is a compelling need for strong donor coordination to ensure an appropriate mix of aid for individual countries.

In the end, the appropriateness of the financing mix has to be considered on a case-by-case basis. In general, the recipient country’s medium-term adjustment strategy has to aim at reducing reliance on official financing to sustainable levels; ensuring that the financing is consistent with a sustainable debt service level; attracting adequate balance of payments support where needed to back up strong programs; and making the transition from balance of payments support to project assistance, and eventually, to private financing. Most countries in sub-Saharan Africa are not yet able to rely entirely on project assistance, nor have they received private flows of substantial size. The limited private flows have been associated mainly with remittances or short-term flows rather than foreign direct investment. Given these features, it remains important that donors show flexibility in applying their instruments to the particular needs of individual countries.

Recipient Country Contribution to Aid Effectiveness

Without an appropriate policy framework, aid is not likely to be used effectively. In many parts of sub-Saharan Africa, much has been done over the last decade to liberalize prices, foreign trade, and the exchange system. This has been no small achievement and the results have been visible in a pickup of growth and exports in countries sustaining such reforms.

However, more needs to be done to ensure a sustained increase in domestic savings, which provide complementary resources to foreign assistance. The distinction between domestically and externally financed investment is artificial. Effectiveness in foreign-financed investment spending has to be married to effectiveness in the domestically financed component of investment. More is needed to reform public enterprises and the financial sector—two areas that are major impediments to the expansion of private sector activity and therefore sustainable growth. I would add improving public sector management, tax reform, and civil service reform, including an adequate incentive structure for employees, all preconditions for governments to carry out the broader reforms and take charge of the development process themselves.

We are at a crossroad where these reforms need to be tackled promptly and with more vigor. In the design of the macroeconomic framework, with greater caution in projecting aid inflows and exceptional balance of payments assistance, policy reforms will have to be strengthened to promote domestic savings, including in the key areas of public enterprise reform and financial sector reform.

A number of actions can be taken to enhance aid effectiveness:

Transparency. In several countries, there is still a lack of transparency about the use of foreign assistance. In particular, commodity grants and concessional loans to public enterprises as well as technical assistance are often not fully recorded in the government budget, thereby underestimating implicit government subsidies financed by foreign resources. All kinds of foreign assistance should be integrated in the government budget and full transparency ensured in the accountability of counterpart funds.

Public expenditure reviews. Governments are responsible for establishing expenditure priorities and fitting donor-financed expenditure within the established framework. With scarce resources, more attention will need to be paid to prioritizing public expenditure. The overall size of the public sector may need to be reassessed. Civil service reforms might permit a functional review of the roles of the government, and facilitate streamlining of operations, demobilization, and other policy actions. The IMF also is in the process of intensifying its collaboration with the World Bank in this area to provide better policy advice.

Public investment programs. Public investment programs—an area where the World Bank also has expertise—need to be strengthened. In several cases, governments have attempted to execute too many projects, which in the end have not been completed because of inadequate domestic financing, counterpart funds, and implementation capacity. This is also mirrored in large amounts of undisbursed committed assistance to Africa, hardly an effective use of assistance. A much more radical screening of projects is needed. In addition, attention needs to be paid to the relationship between the investment cost and recurrent costs so that the medium-term fiscal implications become clear.

Donor support of government programs. Donors are increasingly financing specific government expenditure, for example, health and education expenditure or within a sectoral approach such as the broad sectoral approach promoted by the World Bank in the Southern Africa region. The challenge will be that a coordinated approach requires donors to give up the bilateral negotiations on priorities and conditionality, which in many cases have not proved effective. From a macroeconomic perspective, there are issues of consistency between the project or sector expenditure and the overall level of government expenditure. There is a need to ensure consistency between the budget and all the individual programs. Ideally, sectoral policies should be framed in the context of a public expenditure review. However, realistically, it will take some time for countries to be able to undertake these reviews regularly. In the meantime, there is a need for closer coordination and exchange of information, including with the IMF.

Medium-term fiscal programming. Both project and other forms of assistance have to be programmed in a medium-term fiscal context to ensure consistency with a sustainable fiscal position and government debt profile. Thus, public expenditure policies—whether sector or project related—should be formulated in a medium-term context and recurrent costs as well as revenue from user charges should be transparently factored in. Similarly, the associated need for mobilizing revenue, and the form of such revenue, should be planned. In this respect, the Policy Framework Paper (PFP) might have a useful role to play to provide more specific information to donors than has been the case so far.

Conclusion

The call for improvements in aid effectiveness can be compared with the need to improve the productivity of a company in financial trouble. It involves painful decisions and commitments on the part of the company’s owners and its employees to carry out restructuring but also a willingness of the financiers to support restructuring plans. It touches on all aspects of economic performance. Similarly, aid effectiveness goes to the heart of the relations between donors and recipient and the macroeconomic and economic reforms. Aid effectiveness is not an end in itself, but a means to achieve the objective of this seminar: growth in Africa.

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