Faculty of

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Faculty of Management and Organization
Faculty of Economics
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Aid Effectiveness in Africa Requires Good
Policies -But What is Good?Dirk J
Bezemerjoint work with Katrien
WijsmanUniversity of GroningenThe Netherlands
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Growth
Africa experiences steady growth

• Real GDP growth expected to exceed 5 for the
  fifth consecutive year in 2008
• African growth is becoming more broad-based
• 2006 23 countries over 5
• 2007 30 countries over 5
• 2006 15 countries between 3-5
• 2007 12 countries between 3-5

Africa
Total OECD
Source OECD Development Centre / African
Development Bank, 2007
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http//www.undp-povertycentre.org/
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How do Developing CountriesGrow out of Poverty?

• Capital inflows Aid, FDI, Remittances, Private
  Capital
• Primary Exports
• The right domestic policies institutions
• either or all leading to structural change
• We review these options in turn

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Capital inflows are on the rise Aid, FDI,
Remittances, Private Capital
African ODA
Source OECD Development Centre / UNCTAD, World
Bank, IMF, 2008 UNCTAD preliminary estimation
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Commodities
The commodity boom a key driver for Africa
Global commodity prices 2001-2009
Source OECD Development Centre / World Bank, 2008
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But There is a Problem with Africas
Growth(Sub-Saharan Africa w/o South Africa,
1990-2005, per capita basis)

• Income and output have long been depressed but
  recently started to recover
• but productive investments are still down
• gt FDI and commodity exports are not the same as
  sustainable growth through structural change!

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The Trade Conundrum

• We provide evidence that, contrary to popular
  beliefs, increased trade has strongly encouraged
  growth and poverty reduction and has contributed
  to narrowing the gaps between rich and poor
  worldwide.
• David Dollar and Aart Kraay, 2001
• There is no convincing evidence that trade
  liberalization is predictable associated with
  subsequent economic growth.
• Dani Rodrik, 2001

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Capital inflow effects FDI

• FDI is often assumed to be more productive than
  domestic investment.
• The positive impact of foreign direct investment
  on economic growth seems to have recently
  acquired the status of a stylised fact
• But
• This paper finds that in the vast majority of
  developing countries FDI has no impact on
  growth.
• Dierk Herzer, Stephan Klasen, Felicitas
  Nowak-Lehmann D (2008) In search of FDI-led
  growth in developing countries. Economic
  Modelling
• Although theory can identify a range of possible
  spillover channels, robust empirical support for
  positive spillovers is, at best, mixed.
• Görg, Holger Greenaway, David (2004) Much ado
  about nothing? Do domestic firms really benefit
  from Foreign Direct Investment? World Bank
  Research Observer

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Why are there no clear positive FDI effects?

• "What strategies are viable for developing
  countries? The WTO and the shrinking of
  development space." (Wade, 2003)
• FDI is favorable to growth only if appropriate
  conditions exist in the host economy (i.e.,
  mostly not in LDCs)
• FDI may lead to crowding out and unemployment
• Repatriation of profits

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Capital inflows Aid

• Aid Works (Amavilah, 1998, Durbarry et al., 1998,
  Hansen and Tarp, 2000, 2001,Lensink and
  Morrissey, 2000, Lensink and White, 2001,
  Dalgaard and Hansen, 2001 Guillamont and Chauvet,
  2001, Hudson and Mosley, 2001, Lloyd et al.,
  2001, Lu and Ram 2001, Chauvet and Guillamont,
  2002, Dalgaard et al., 2004, Gounder, 2001,
  2002,Mavrotas 2002a, Gomanee et al, 2002a, 2003,
  Ram, 2003, 2004, Economides et al., 2004, Feeny,
  2004, Clemens at al., 2004, Heady et al., 2004,
  Outtara and Strobl, 2004, and Roodman, 2004).
• Aid Does Not Work (Easterly et al 21004 Roodman
  2004). Most studies find support for a negative
  effect of aid on growth after a certain threshold
  level (Durbarry et al.,1998 Dalgaard and Hansen,
  2001 Hansen and Tarp, 2001 Hudson and Mosley,
  2001 Lensink and White, 2001 Islam, 2002 Lu
  and Ram, 2001 Dalgaard et al., 2004).
• Controversies Over The Impact Of Development
  Aid It Works It Doesnt It Can, But That
  Depends Mark Mcgillivray, Simon Feeny, Niels
  Hermes And Robert Lensink Journal of
  International Development J. Int. Dev. 18,
  10311050 (2006)
• Doucouliagos H. and Paldam M. 2005b. The Aid
  Effectiveness Literature the Sad Result of 40
  years Research

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Capital inflows Aid
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That didnt work, so lets try it again

• At the 2005 G8 Summit in Gleneagles, Scotland,
  leaders focused on Africa and climate change.
  They agreed to double aid to Africa
• Pledge to double aid for poor is renewed
• By Andrew Grice, The Independent
• Wednesday, 9 July 2008
• G8 leaders have bowed to pressure to renew their
  pledge to double aid to the world's poorest
  countries to 50bn (25bn) a year by 2010. A
  draft communiqué for their meeting in Japan
  angered aid campaigners by omitting the keynote
  promise made at Gleneagles three years ago. Some
  countries questioned the need for the aid boost
  at a time when they were feeling the strain of
  the global credit crunch
• But campaigners warned the G8 nations were behind
  on their Gleneagles promises, saying that only
  3bn of the 25bn promised for Africa had been
  delivered.

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The right policies option I

• Dollar Burnside (2000)
• - fiscal prudence budget balance low debt
• - Openness to trade FDI
• (gt In these conditions, aid could work)
• problems
• Not based on proven development models (Chang
  2002)
• no solid empirical evidence (Easterly et al 2005)

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The right policies option II

• Not Trade, Aid, FDI but Developmental States
• Consensus states need to create an enabling
  environment for markets to develop build and
  support institutions like
• a political governance system
• a functioning monetary system
• commercial codes
• Chambers of Commerce
• property rights legislation
• law and order
• transport and communications infrastructure
• Education
• and so on

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The right policies option II

• But states also need to also initiate markets
  themselves, which did not exist before (as in the
  above coordination problem) and they actively
  meddle in existing market.
• including price controls, import barriers and
  export subsidies, state ownership in enterprises,
  credit controls and targeted credit allocation,
  exchange rate depreciation
• getting prices wrong, as Amsden (1990)
• Outcome Structural Transformation

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Developmental States Policies Motivation

• All LDCs that experienced over four percent a
  year growth over 1965-1990 share the presence of
  developmental state policies (Leftwich 1995)
• developmental state policies have always been
  applied to achieve the first phase of
  development, which is a transformation from an
  agrarian to an industrializing or
  service-oriented economy (including all OECD and
  Miracle economies - Chang, 2002 Adelman and
  Morris, 1984)

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Developmental State Policies Key Components

• state strength and credibility
• promotion of targeted sectors (industrial
  policies)
• allocation of credit
• stable and depreciated exchange rates
• Investments in education
• and these must first and foremost focus on
  agriculture

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Why focus on agriculture?theory

• agricultures contribution to growth is
  significantly larger than its output share would
  suggest
• This is due to a number of externalities. Rising
  agricultural productivity stimulates structural
  change and growth via
• rising farm incomes gt rising domestic demand
  higher savings
• Supply of labour and raw material to industry
• Low food prices gt competitiveness
• Exports
• Especially strong multipliers in poor countries
  where agricultural labour shares and food budget
  shares are high
• Especially effective in poverty reduction

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Why focus on agriculture? Historical Evidence

• in the 19th Century the strong agricultural
  performers among the now advanced, Western
  countries subsequently developed most rapidly
  (Adelman and Morris, 1988)
• A Green Revolution occurred before or
  contemporaneously to the Industrial Revolution in
  Europe, its offshoots, and Japan (Rostow, 1960
  Ohkawa Rosovsky, 1964 Bairoch, 1973 Lipton,
  1977 Crafts, 1985 Allen, 1994 Overton, 1996)
• The importance of pre-war agricultural growth to
  their post-war industrialization in Asias
  miracle economies (on Taiwan and South Korea
  Wade, 1990 Kang Ramachandran, 1999)

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Why focus on agriculture? Contemporary evidence

• all cross-country studies we reviewed show that
  agricultures multiplier effects on economic
  growth are larger than those of any other sector
• (Huppi Ravallion, 1991 Datt Ravallion, 1996
  Gallup, et al., 1997 Bourguignon Morrison,
  1998 Ravallion Datt, 2002 Timmer, 2002 Warr,
  2002a Warr, 2002b Thirtle, et al., 2003
  Ravallion Chen, 2004)
• Bravo-Ortega, C. Lederman, D. (2005).
  Agriculture and National Welfare around the
  World Causality and International Heterogeneity
  since 1960. World Bank Policy Research Working
  Paper No. 3499. Washington DC The World Bank.
• Tiffin, R. Irz, X. (2005). Is Agriculture the
  Engine of Growth? Agricultural Economics, 35 (1),
  79-89.

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The Role of the Public Sector

• Public investment are a sine qua non for
  agricultural development (land reform,
  irrigation, roads, credit fertilizer, marketing)
• Theoretical
• pervasive market failures (land, credit,
  insurance)
• Externalities
• Empirical agricultural development has implied
  extensive state involvement

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Three Decades of Policy Neglect?
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In summary

• Africas current growth spurt is driven by
  private capital flows and the commodities boom
• but it has not achieved structural change and
  poverty reduction.
• Policies emphasizing openness to trade and FDI
  have historically failed to durably generate
  growth and reduce poverty.
• Instead developmental states policies,
  especially focused on agriculture, have
  historically been more successful.

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Empirical analysis

• We construct a developmental state index
• DSindexit a1 credibility
• a2 authority
• a3 subsidy
• a4 reserves ratio
• a5 savings rate
• a6 volatility of the exchange rate
• a7 Gini Coefficient
• a8 educational investment

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Empirical analysis

• We regress growth in LDCs and African countries
  1980-2005 on this index on aid flows.
• We take acount of endogeneity by long lags (4
  year)
• We look into the role of agriculture in mediating
  the DS effects.

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Both developmental state policies and aid
supported growth in Africa (1962-2001)- but NOT
their combination
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A Question

• Why do developmental state policies fail to
  generate growth in African countries that receive
  higher levels of aid?
• General answer because of aid conditionalities
  precluding price controls, import barriers and
  export subsidies, state ownership in enterprises,
  credit controls and targeted credit allocation,
  exchange rate depreciation, and so on (Wade
  1990)
• Specific answer because of a bias against
  agriculture in aid allocation
• gt this should be especially relevant to African
  economies which are largely agrarian.
• We now probe these answers empirically.

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Developmental policies mostly support
agricultural productivity growth in Africa - aid
or lagged does not
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Developmental policies that support agriculture
in Africa are good for growth
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Aid in Africa does not support growth via
agriculture
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Conclusions (1)

• Africas current growth spurt is driven by
  private capital flows and the commodities boom
• but it has not achieved structural change and
  poverty reduction.
• Policies emphasizing openness to trade and FDI
  have historically failed to durably generate
  growth and reduce poverty.
• Instead developmental states policies,
  especially focused on agriculture, have
  historically been more successful.

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Conclusions (2)

• In empirical analysis we find that
• Both aid and developmental policies support
  growth in Africa.
• Developmental policies combined with aid DO NOT
  support growth in Africa
• This is probably because of aid conditionalities
  and the aid bias against agriculture
• Indeed developmental policies mostly support
  agricultural productivity growth in Africa - aid
  does not
• Those developmental policies that do support
  agriculture in Africa are good for growth
• but aid in Africa does not support growth via
  agriculture
• (caveat confidence intervals!)

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Policy Implications?

• There are working alternatives to Washington
  Consensus type of policies
• even in Africa.
• Agriculture should be central in such development
  efforts.
• The role of aid is doubtful.
• gt but are we expecting too much of African
  states?