Wednesday, February 2

Cargo Cult Economics 2 - All About the Benjamins?

is development really all about the benjamins?

No it is not.

One faulty argument for the purely cash approach to development asks for a Marshall Plan for Africa and sees the MDG as such an opportunity. Chipla’s Weblog argues that
The success of American assistance to Europe after the second world war cannot be replicated in Africa, where unlike in pre-war Europe, there was already a high standard of living and experience with the markets.
Western Europeans already had the basic institutions of developed economies in their very recent collective memory - so simple rebuilding was a logical and relatively easy aim. What would probably have happened anyway in a matter of a decade or two was accelerated because of the political exigencies of the Cold War.

It was a good deal for all concerned given the alternative of decades of economic and political dead ends offered by the Soviet empire. Those circumstances are not to be found in Africa nor will ritual handing out of money create them. Africans are literally dying for the want of decent institutions above all else. Chipla quotes the IHT
Africa is already relatively flooded with aid. The continent as a whole receives development assistance worth almost 8 percent of its gross domestic product. Exclude South Africa and Nigeria, and aid jumps to more than 13 percent of GDP - or more than four times the Marshall Plan at its height - for the other 46 African countries.
Some African countries such as Uganda, Tanzania and Ethiopia are dependent on foreign contributions to the tune of 40-50% of their national budgets in addition to other aid projects. During the 1990s, AdamSmithee reveals that even with that volume of aid that Sub-Saharan Africa saw an increase in the poverty rate.

Insisiting, as the almost delirious NYT editorial does, that more and more money can fix anything leads to the problem of absorptive capacity. AdamSmithee points out that the day after the release of the Millenial Development Goals that Ethiopia is already the first 'victim' of the promise for massive levels of aid.
Wealthy nations must quadruple aid to Ethiopia if it is to escape the mire of poverty and meet the 2015 international goals, Prime Minister Meles Zenawi said on Tuesday.

Meles also called for debt cancellation and fair trade if the country - one of the poorest nations on earth - is to overcome massive and entrenched poverty. Ethiopia, he added, receives around US $13 per capita in foreign aid compared to other African countries that receive around $30.

Officials estimate that Ethiopia needs $122 billion over the next decade if it is to wipe out poverty and hunger. It currently receives $1.9 billion in aid a year.
AdamSmithee notes that the $122 billion dollar figure is
... considerably more than the country's total GDP in non-PPP terms. In 2000, total government expenditure in Ethiopia was about 30 percent of GDP. At the moment, Ethiopia gets about $1.4bn in ODA a year [already some 20% of a GDP of about $7 billion]. It does seem, all in all, that it is somewhat implausible that Ethiopia would get the aid, or could absorb it if it did.
Questioning such aid is somewhat difficult to do from and Ethiopian perspective - who wouldn’t want to see a promise of prosperity actually delivered or at least see that much cash end up in Ethiopian hands? The problem is, such amounts would transform Ethiopia beyond all recognition, maybe in more negative ways than positive.

what might happen?

One obvious consequence would be levels of inflation that are hard to imagine. Discussing the ongoing highway projects and how vital they are it was shown that "Ethiopia itself has spent $1 billion on roads in the past seven years - half from international donors".

In and IRIN interview Berahanu Nega, director of the Ethiopian Economic Association noted that "in terms of overall development, the country’s capital budget to the tune of 70 percent is foreign aid".

This means that already of every dollar spent on highways only a fraction comes from government revenues. Given Ethiopia's terrain, road building can cost up to $2 million a mile so - under MDG levels of support there will be so much money around that accountability will no longer matter at all to native auditors - who knows how high the prices may go?

This does not necessarily imply graft either, although that will necessarily occur. If there are billions being spent where 'only' tens of millions where once at issue prices will rise several fold. Increase salaries? It is a certainty that the prices for every staple such as grain or eggs will jump up even more. Regulations will only make matters worse as is always the case.

There will be severe shockwaves felt in the society with so much money in the pipeline and at hand - donors will have little control over what happens. Government will either become powerless to control the flow or all but certifiable saints will exploit it for personal gain. The inflationary boom will probably render the national economy and psychology totally dependent on foreign largesse and little able to do much more that crash down when it inevitably ends.

Even assuming something like this happens in a democracy the results would be bad. After World War II Argentina had a living standard superior to Canada. By electing the Perons and their successively more destructive 'populist' heirs the country effectively thought it was voting for itself an earthly paradise of eternal government benefits - without thought of who would have to pay for it all in the end.

how vital have current levels of aid been anyway?

Argentina is still trying to recover from that mess that even led to periods of dictatorship. The Argentines destroyed their own institutions using only locally mispent funds. Now imagine enough aid to dwarf an entire ecomony with little to no accountability. Actually, even current levels of aid are not necessarily helpful. Ato Nega's interview continues

Q: Do you think it [aid] has had a negative effect on the economy?
A: No. There are specific kinds of foreign aid that have helped, like emergency relief has saved lives. But if one is looking at the long-term development of this country, and trying to pick up the degree to which foreign aid has contributed, unfortunately I must say the foreign aid contribution to long-term economic development of this country has not been positive.

Is it negative? We can say a number of things of what foreign aid has done in terms of social psychology of the country, in terms of the operational attitude of governments in this country. In that sense I must say there has been, if not deliberate on the part of the donors, it has created an attitude of dependence that in the long run has contributed negatively towards both the potential for our development and our self-respect and attitude towards ourselves, which I think is an important part of the overall development process.
Q: What would Ethiopia look like without foreign aid?
A: I sometimes wonder what a country like Ethiopia would look like if there were no foreign aid. For sure, one of the things I think would happen is that government would be much more responsive to its own citizens than is currently the case. I presume that would be the case in many African countries. The link between state and society is seriously severed in countries like Ethiopia because of donors.

That is one of the unfortunate, maybe collateral, damage of foreign aid. That is why I think, while donors should continue their support to societies such as ours, the modalities of this contribution, as much as possible it should not be in such a way that it would affect the organic development of a society - the relationship between state and citizens and people’s self respect and attitude towards themselves.

I don’t have a formula on how to do that, but it has affected us negatively, because it has made our governments accountable to foreigners [rather] than to their own citizens.
There are specific projects such as relief for victims of famine, digging wells or the building of roads that are important but the overall effect on Ethiopian society is thought to be of dubious value.

what can be done locally using existing resources and more efficient use of aid? REFORM!

The Adam Smith Institute Blog looks at the Economic Freedom of the World: 2004 Report and notes that economic freedom is the best predictor of foreign investment and of
Prosperity is as possible in Asia and Africa as it is anywhere else in the world. It is not related to natural resources or to climate or to population density but only to better or worse governance.
Crispus in 'How Regulation Fuels African Poverty' quotes the Economist about the World Bank Report 'Doing Business in 2005' - "To register [a business] in Ethiopia, a would-be entrepreneur must deposit the equivalent of 18 years’ average income in a bank account, which is then frozen."

The Heritage Foundation Index of Economic Freedom 2004 places Ethiopia in the 'mostly unfree' category and says that
Ethiopia’s cumbersome bureaucracy deters investment. Much of the economy remains under state control, and the evidence suggests that businesses also must contend with political favoritism.
Ethiomedia reports from a U.N. Economic Commission for Africa Report that 'Ethiopia one four countries ranked last for good governance' adding of Kenya, Ethiopia, Chad, Zimbabwe and Malawi that "there are doubts about the commitment of government agencies to respect and implement the rule of law."

Well spent money in the right setting can achieve wonders. AdamSmithee quotes a World Bank report
"in countries suffering from poor governance, the positive effects of increased spending on education is reduced, and those of higher health spending can be completely negated
and from this IMF working paper
An increase in education spending of 1 percentage point of GDP is associated with 3 more years of schooling on average and a total increase in growth of 1.4 percentage points in 15 years.

Similarly, an increase in health spending of 1 percentage point of GDP is associated with an increase of 0.6 percentage points in the under-5 child survival rate and a rise of 0.5 percentage point in annual per capita GDP growth."Even better, "there are substantial differences in the effects of social spending on social indicators and growth among different country groups. The positive effects are the highest in low-income countries and sub-Saharan Africa.
Even small projects such as building local bridges can have profound economic impact with very small investments.

development can't be separated from the right institutions, including political ones, no matter how much money is spent

There are particularly negative consequences to the survival and development of accountable and democratic economic and political relations between the rulers and the ruled. For example, government policy is responsible for recurrent starvation but as long as foreigners will feed the people and the victims have no political power, what does it matter to unrepresentative rulers what happens?

In the absence of basic policy changes such as private ownership of land instead of the current status of serfdom on state land suffered by all Ethiopians it is clear that the cycle of famine will continue indefinitely. The aid dependent economy will continue to underperform in other areas as well, including the growth that is dependent on government spending.

Essentially, current levels of aid in the absence of democratic or even traditional accountability has allowed the country's rulers to be entirely divorced from the consequences of their policies.

What is needed to make Africa and Ethiopia survive and then prosper are native institutions whose potential is untapped and that remain so because of ill considerd aid. It is a tragic that bad government and aid donors have made themselves partners.

Actually, one can wonder if the aid donors could do better even if they wanted to because the country's own rulers have goals often entirely seperate from the interests of the population. Development is not all about money and an African Marshall Plan might indeed be a final catastrophe.

There are no substitutes for Doing the Right Thing. After that, MDG or near-MDG levels of aid, properly applied, may do more good than harm.

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