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Aid effectiveness is the effectiveness of development aid in achieving economic development (or development targets).

Aid agencies are always looking for new ways to improve aid effectiveness, including conditionality, capacity building and support for improved governance.

Micro-Macro Paradox

The major findings by Paul Moseley and others concludes that it is impossible to establish any significant correlation between aid and growth rate of GNP in developing countries. One reason for this is the fungibility and the leakage of the aid into unproductive expenditure in the public sector.

However, at a micro level, all donor agencies regularly report the success of most of their projects and programs. This contrast is known as the micro-macro paradox.

Moseley’s result was further confirmed by Peter Boone who argued that aid is ineffective because it tends to finance consumption rather than investments. Boone also affirmed the micro-macro paradox.

Research by Burnside and Dollar

Burnside and Dollar recently found that the impact of aid on growth is positive in countries with a good political environment for making policy. This is indicated by a significant and positive coefficient on the ‘aid’ policy interaction in the growth regression.

Burnside & Dollar advocated selectivity in aid allocation. This means that aid should be allocated in countries where it works best, then that would exclude countries that are less fortunate in terms of policies and require help most.

Burnside & Dollar’s findings have been placed under heavy scrutiny since its publication. Easterly and his colleagues re-estimated the Burnside & Dollar model with an updated and extended dataset but they could not find any significant aid-policy interaction term. New evidence seems to suggest that Burnside & Dollar’s results are not statistically robust.

Studies and Literature on Aid Effectiveness

One problem of the studies on aid is that there is a lack of differentiation between the different types of aid. Some type of aids such as short term aid do not have an impact on economic growth while other aids used for infrastructure and investments will result in a positive economic growth.

The emerging stories from the aid-growth literature are that aid is effective under a wide variety of circumstances and that nonlinearities in the impact of aid reduce the significance of the aid-growth relationship. However, returns to aid show diminishing returns due to absorption capacity and other constraints. Also, geographically challenged countries would display lower effectiveness with respect to aid and that should be taken into account in allocation.

Therefore, the challenge to aid allocation is to identify and eliminate the overriding institutional and policy constraints that will reduce the impact of aid on growth. The real challenge is thus to develop a framework of ‘growth and development’ diagnostics to help identify the constraints.

Politics of development aid

Some politicians in donor countries are expressing concern over the failure of aid to achieve economic growth. In the United States, a very prominent donor of development aid, the Bush administration appears to be moving towards a position of reducing aid to corrupt countries, and concentrating aid on less corrupt countries. This approach is discussed in other donor countries, particularly Europe and Japan, but is not applied.

A similar though distinct hypothetical concern is that unless aid is either very project-specific or disaster-specific, economies may become counter-productively dependent on aid. The relative abundance of aid in comparison to the profits of work might lead to a confusion of fundamental economic signals (profit, supply, demand, etc.) and thus a weakened economic system.

Corruption and Justice

Some observers suggest that aid can only be effective if corruption is suppressed and a fair and credible justice system is in place. Without these preconditions, large amounts of development aid is lost to corruption. Investment projects can be debilitated and halted by corrupt bureaucracy. Furthermore economic progress is held back because, for all but a wealthy minority of the population, the link between personal enterprise and profit is broken by the loss of increased earnings to crime and corruption.

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