Aid Effectiveness: A missing link

25/09/2007
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Aid Effectiveness: A missing link

"The implementation of these new relevant principles of aid management is underway, though with uneven progress. However, in our opinion, there is a key missing link in the philosophy of enhancement of aid effectiveness," says Hyacinthe Kouassi, AfDB Macroeconomist.

Question: We have noted some progress in international assistance to poor countries over the past few years. What is your opinion on these recent developments?

Answer: Indeed, over the past few years, there has been some progress in economic thought on development aid and its practices. We can point to the Enhanced HIPC Initiative in 1999 and the link between debt relief and poverty reduction; the more holistic approach to development with focus on combating poverty that has been underway since 2000 and, the review of policies relating to conditionalities among certain donors. Then in keeping with MDG 8 on strengthening global development partnership, there has been the will to increase official development assistance following the Monterrey Consensus of 2002.  In 2002, some commitments were made in Johannesburg regarding sustainable development and the increase of access to water. Mention should also be made of progress in resource allocation to low income countries and progress in the clearance of arrears of post-conflict countries.  Note has also been taken of the 2005 Paris Declaration which defined some principles for the efficient management of aid and Multilateral Debt Relief Initiative (MDRI). Mention has also been made of the fragility of certain states. Through this incomplete list, significant progress which was unimaginable twenty years ago has been made. Some of these commitments have been difficult to fulfill.

Question: But you have said nothing about aid effectiveness!

Answer: Yes, I’m coming to that. You see, since it was agreed to increase aid and be flexible in its financing, it has become indispensable to ensure effectiveness of its use. It is within this perspective that we should consider the various meetings leading up to the Paris Declaration in 2005 on improving aid effectiveness through harmonization of policies and procedures, ownership by the countries, participation by stakeholders, alignment of aid on country systems and priorities, management for results which is a cross-cutting principle, and mutual accountability. The implementation of these new relevant principles of aid management is underway, though with uneven progress. However, in our opinion, there is a key missing link in the philosophy of enhancement of aid effectiveness.

Question: And what’s this missing link?

Answer: Answer: Indeed, there’s a missing link. Economic development is a complex phenomenon. There is consensus on the fact that most sub-Saharan African States are not "developing States" as construed by C. Johnson and P. Evans. The World Bank in 1997 produced an excellent report with interesting directions for defining the role of the State and reducing its deficiencies. However, to date, in our opinion, a fundamental issue has been ignored, namely the relevance of structural reforms financed by aid with respect to the objectives of sustained growth and poverty reduction. Inadequate aid effectiveness could be explained in terms of the limited relevance of some of these structural reforms. The fact that this issue was not discussed in the Paris Meeting is, in our opinion, the important missing link in initiatives to enhance aid effectiveness.

Question: Which are the structural reforms you are talking about?

Answer: The standard structural reforms we are talking about are generally grouped under the phrase "Washington Consensus" coined in 1989-1990 by J. Williamson. The consensus contains 10 types of recommendations, which could be summarized as follows: (i) budget discipline; (ii) redirection of public spending toward broad-based provision of key pro-growth and pro-poor public services;  (iii) tax reform to broaden the tax base and adopt moderate marginal tax rates; (iv) financial liberalization to generate interest rates that are market determined and positive (but moderate) in real terms; (v) competitive exchange rates; (vi) trade liberalization; (vii) liberalization of inward foreign direct investment; (viii) privatization of State enterprises; (ix) deregulation, and (x) legal security of property rights. The relevance of some elements of this consensus for sustained economic growth and poverty reduction in sub-Saharan Africa continues to be controversial.

Question: But it has been agreed that governments should assume ownership of these policies in the PRSPs. Does the term "ownership" in the Paris Declaration not address this issue?

Answer: The term "ownership" is ambiguous. In the etymological sense, it means giving ownership, making one’s own, taking what does not belong to you or of which you are not the initial designer. As used in our discussion, it could mean taking intellectual control of development policies and strategies of which these countries are not the initial designers. The term "ownership" in the Paris Declaration means that the partner countries exercise real control over their development policies and strategies, and coordinate action in support of development. The word autonomy seems to better translate the spirit of this definition.

Things are not so clear on the field. Indeed, in practice, as noted by the World Bank and IMF in 2002 after a survey, the PRSP preparation seems to be greatly influenced by what the countries feel the donors are ready to accept. A detailed review of macro-economic and structural adjustment measures in PRSPs was conducted by UNCTAD in 2003 and reached the following conclusions: (1) that the key elements of the first generation of economic reforms in the 80s and 90s, based on "getting prices right", are still there, in particular elements (iv) to (x) of the Washington Consensus; (2) that new elements underscoring the importance of good institutions and the strengthening of good governance were introduced and; (3) greater autonomy in designing social safety nets and programs for targeted spending has been granted to countries. This is surprising, especially as Article 18 of the GATT Agreement, adopted by the WTO, recognizes special and different treatment for developing countries and that G8 did ask, in June 2005 at Gleneagles, for these countries to have greater economic policy autonomy.

Question: Could you clarify the problem areas of these economic prescriptions?

Answer: It could be said, without any risk of error, that there is consensus among theoreticians and practitioners of development economy on the possible contributions of prescriptions (i), (ii), and (iii) to sustained growth and poverty reduction. The 7 others remain controversial, and this was recognized by Williamson himself in 2000. These controversies came to a peak during the Asian and Russian crisis in 1997-1998; they continue to be fuelled by former African leaders such as the former President of Mozambique, Joachim Chissano, alter-globalists, economics historians and renowned Economists including  J. Stiglitz, Nobel Prize Winner of Economics in 2001, former Chief Economist of the World Bank and Professor at Columbia University, Mr. Yunus, Nobel Peace Prize Winner in 2006, and even liberal authors such as J. Bhagwati of Columbia University and J. Sachs and other pragmatic authors such as D. Rodrik of Harvard University.

Question: What are the bases for these criticisms?

Answer: Two bases could be established: one is theoretical, and the other empirical. At the theoretical level, serious criticisms have come from the Information Economy paradigm led nowadays by J. Stigliz. This paradigm, which is based on assumptions different from those of the welfare economy model of Arrow-Debreu, makes a key contribution to the understanding of the functioning of market economies. Other major critical theories could also be cited, in particular those of late industrialization developed by A. Amsden, Professor of Economics at MIT, and comparative institutional analysis developed by Mr. Aoki, Professor of Economics at Stanford University.

At the empirical level, as noted above, a survey was conducted by the World Bank and IMF in 2002, showing that PRSP preparation seems to be influenced by what countries think the donors are ready to accept. There is therefore a problem of conviction. Furthermore, comparative studies conducted by J. Stigliz, A. Amsden, R. Wade, D. Rodrik and other authors, have indicated that most industrialized countries, including the recent ones of Asia as well as China, did not follow the standard prescriptions of the Washington Consensus. Lastly, increasingly many voices are being raised to point out that the Tunisian and Mauritius development models, often cited as examples, diverge from these standard prescriptions on several points. Lastly, UNCTAD in 2005 recommended that the foreign direct investment policies in Africa should be reviewed. According to the organization, these policies which were intended to replace industrialization policies since the 80s, have promoted external integration of economies instead of internal integration, which is more conducive to internal priorities and structural changes required for poverty reduction. There is consensus on the fact that trade can promote development, but the recent failure of the Doha negotiations known as "poor countries development cycle" has led to the proliferation of bilateral trade agreements and, to some extent, has undermined the virtues of multilateralism. There is also the rebellion against orthodoxy in Latin America, Asia and Africa, though we should not forget the counter-offensive led by the supporters of orthodoxy.

Question: What is the rebellion in Latin America and Asia all about?

Answer: It is a recent rebellion by some major Latin American countries, grouped around President H. Chavez of Venezuela, who repaid their debt to our sister institutions of the Bretton Woods, and planned to set up a regional development bank in 2008 known as the "Bank of the South", and a regional institution that would play the role of the IMF. This is closely linked to the significant increase in oil revenues in some of these countries. Furthermore, in May 2005, on the initiative of the President of the Asian Development Bank which was the promoter of the Japanese project for an Asian Development Fund presented in 1997, China, Japan, South Korea and 10 ASEAN members met and agreed to extend their currency exchange network, therefore creating the first Asian Monetary Fund which is competing with the IMF. They have decided to increase disbursable emergency reserves from 10% to 20% without the authorization of the IMF. 

Question: And where is the rebellion in Africa?

Answer: Regarding Africa, Angola, in early 2007, cancelled planned consultations with the IMF. The Minister of Finance, who is a former Executive Director himself, said that an IMF program would not help the country maintain its economic and social stability, adding that the country would like to continue applying its own macroeconomic policies capable of producing results without the country being subjected to restrictive conditionalities. This policy is possible thanks to the country’s immense oil reserves and the aid these reserves have made it possible for the country to obtain from China. But Angola’s decision is an important precedent and it is probably the first time an African government is in a position to turn down reciprocal commitment with the IMF. Given that the IMF plays a leading role in reform programs, what will the Bank do in countries that are disconnecting from the IMF? 

Question: Are you talking of an orthodox counter-offensive? 

Answer: Indeed, some economists express reservations, and rightly so in most cases, on the ability of the leaders of some developing countries to manage activist structural reform policies.  For example, A. Winter of the World Bank Development Research Group recognizes hundreds of cases where immediate State intervention would be beneficial, but he rejects the use of these "second choice" interventions to address market failures because, according to him, the leaders of developing countries are not competent enough to determine the said interventions and effectively implement them. Here, the argument for the adoption of standard reform policies is not based on the fact that the policies are optimal in the accepted sense, but rather that any more complicated development strategy would go beyond the capacities of leaders of developing countries.

Question: What, in your opinion, should the Bank do?

Answer: The President of the Bank and the Chief Economist have, on several occasions, insisted on the importance of innovation and being proactive. It is clear that if aid is used in financing structural reforms, some of which are not relevant in terms of the objectives of growth and poverty reduction, and that PRSP preparation is influenced by what the countries feel the donors are ready to accept, aid will continue to have limited effectiveness, even if progress is made with respect to the above-mentioned aid management principles. The Bank’s 2008 Economic Conference could be dedicated to this issue and held in Tunis. The conference could lead to a definition of a New Consensus on structural reforms in African countries which could be called the "Tunis Consensus".  The objective of the conference will be to assess all controversial structural reforms and to reach a consensus on the future direction. Ownership and autonomy will therefore be synonymous and the discussion on conditionalities will focus on their effectiveness, the volume and the timing of their implementation.

Question: What are the risks of inaction for the Bank?

Answer: The Bretton Woods Institution (BWI) will react definitely to adjust to the new environment. The Bank has to be pragmatic. The risk of inaction is the loss of political and financial viability of the Bank in the long term. South-South cooperation, driven by China, India and some Latin American countries, currently has a trade and financial content non conventional in some extent. In the event of economic and social success of these emerging countries, and enhancement of their political influence at the international level, the Chinese model and the revolt against orthodoxy in Latin America, Asia and in Angola could spread to other African countries, particularly to those producing oil, and the number of oil producing countries is on the rise as well as those that have benefited from debt relief under the Multilateral Debt Relief Initiative (MDRI).This trade and financial cooperation could, in a few years, be coupled with the emergence of other development models, the importation of alternative economic development models by African countries, financed by Banks of the South. This could have a negative impact on the political and financial viability of the Bank. The Bank should act now, and take the lead in renewing structural reforms thinking in Africa. The political impact will be positive regardless of the results of such an initiative.

Question: To which school of thought do you belong?

Answer: I am rather of the Pragmatic School of Thought. Finally, I wish to thank you for giving me the opportunity to discuss these key issues.


Speaker

Name: Hyacinthe Kouassi Title: AfDB Macroeconomist