December 13, 2014    5 minute read

Is Aid is in Need of a Helping Hand?

   December 13, 2014    5 minute read

Is Aid is in Need of a Helping Hand?

Looking at figures

For more than six decades, since the birth of aid in 1944, there has been searing discourse on using aid as an effective inroad to emancipate Africans from poverty. Looking at the present figures, slightly more than USD 1 trillion of aid has been transferred to Africa, but there is no telling change can be seen. There is data pointing to the negative relationship between Africa’s growth and poverty while most aid dependent countries tend to fall into growth rates of an average of minus 0.2 percent per year. Just in the span of 30 years, between 1970 to 1998, poverty in Africa increased approximately 500 percent to 66 percent. That is almost 600 million people subject to poverty (Moyo, 2010).

What is the problem?

One overriding factor contributing to the high poverty rate stems from relatively underdeveloped financial and institutional structures, which affects the growth rates. Heller and Gupta’s study explains the inability to absorb a large  inflow of foreign aid or Official Development Assistance (ODA) will lead to the Dutch Disease effect. Subsequently, a series of undesirable events will entail to the detriment of the African population. In particular, ODA will undermine competitiveness, encourage poor productivity and hamper export sector due to the strengthening of local currency.

Naturally, in such an adverse investment climate private investment in the economy may also decline. Such information should serve as an indictment that it is of paramount importance to improve investment climate in order to provide incentives and opportunities for poor economies to grow and mitigate poverty. That being said, we should not immediately discount the success that aid has achieved in both poor and developing countries like China (poverty headcount ratio, from 84% to 6% in the past 30 years) and Botswana (poverty headcount ratio, from 44.8% to 24.3% in the last decade) but turn to them for a glimpse of hope.

Shifting paradigm

Governments should mobilise ODA to improve the investment climate through financial development for poverty reduction. A former World Bank Economist, Beck Thorsten demonstrates convincingly that Gini coefficient (measures of income inequality) decreases with financial development, after taking average growth and lagged values of income inequality into consideration. Another study by Guillamont and Kpodar paint an optimistic picture that financial development has a stronger direct effect on the poor than through economic growth.

One veritable success story in financial development was written by Professor Muhammad Yunus, founder of the Grameen Bank in 1976 to offer microcredit to the poor. His use of a unique trust-based financial scheme has welcomed a lot of attention for overcoming the credit barriers—lack of collateral and data to assess credibility of borrowers, that are often encountered by poor communities. Microfinance programme participants are responsible for monitoring each other in their own respective groups to ensure repayment of loans. Once loans are repaid, people are allowed to borrow more. In other words, microfinance presents an opportunity for the previously unqualified poor to demonstrate their creditworthiness. Unsurprisingly, Panjaitan-Drioadisuryo, D.M. Rositan, and Kathleen Cloud’s study on Indonesian borrowers from Bank Rakyat Indonesia reports that the mean income of clients had increased by 112 percent and that 90 percent of households graduated from poverty.

Adding on from the justification above, echoes from Kofi Anan, Former United Nations Secretary-General

“Microfinance is an idea whose time has come”

Additionally, the recent movements by big banks such as Citigroup or Deutsche Bank into the microfinance business heralds positive feedback for financial development. In the meantime, there is also a growing recognition that social impact investing might be the new weapon to poverty reduction. Sub-Saharan Africa and South Asia will be expecting at least 100 million over the next decade from the Impact Programme by UK Department of International Development (DFID) to prepare the market for impact investment and achieve development. Other government initiatives such as Feed for Future, Aid for Trade or WHO Community-Based Initiatives are also joining the international effort to eradicate poverty. Nonetheless, we must not allow ourselves to slip into the danger of complacency but to iron out the bumps ahead.

One might argue that the poverty rate has halved since 1990, but let us not forget three quarters of that approximately 1 billion are attributable to China, where the government encourages private businesses to grow. In regards to India and Africa – there is a need to push for the use of ODA to help bring about economic balance through financial development. This would be in tandem with the objective to lower cost of investment, reduce risks, improve competition and build capacity for public and private sector to be more involved in development as drafted by OECD policy guidance in March 2006.

Perhaps another heartening statistic is that the ODA grew 6.1% in 2013 to $134.8bn by OECD countries, governments seem willing to lavish more money to finish the job they started during the Bretton Woods era and we should expect it to increase further until these countries are in sound economic footing. This could mean another opportunity to set things right. The effectiveness of ODA has now been made clearer but unless we stride for financial developments to be made a priority, future progress is uncertain.

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