The radical rethinking of aid policy towards the world´s poorest countries is largely misguided, concludes UNCTAD in its Least Developed Countries 2000 Report (1), released today.
This rethinking is prompted by mounting evidence of the mixed outcome of globalization and liberalization, and by the failure of previous debt-aid systems to make good on their promises. The number of people living in poor countries is increasing in many regions of the world, the poorest countries are failing to catch up with developed and other developing countries, and some are getting stuck in economic stagnation and regress. And almost two thirds of the least developed countries (LDCs) - a group of 48 developing countries which the United Nations has identified as such, owing to their poverty, weak human resources and low level of economic diversification - have an external debt burden which is unsustainable according to international criteria.
At the same time, however, the LDCs and their official creditor-donors are "wed in an aid-and-debt trap" in which high debt levels impede effective aid, and ineffective aid prevents a solution to the debt problem, according to the report. It is this vicious circle that has led multilateral and bilateral aid agencies to overhaul their aid policies over the past five years. Both the World Bank and the IMF are re-engineering the way they do business in poor countries by linking the process of structural adjustment, debt relief and concessional lending to the formulation of "nationally owned", participatory poverty reduction strategies. Many bilateral aid agencies have also been reformulating their aid policies through the application of the principles of partnership and policy coherence.
UNCTAD´s Least Developed Countries 2000 Report provides an assessment of these changes in the context of the LDCs, the most marginalized nations in the world economy (see TAD/INF/2863). It argues that the attempts to disable the debt-trap of poor countries through the HIPC Initiative are important and that the associated changes are substantial. But while the new development policies are not business as usual, they also are not a constructive new beginning.
"Debt-tail Wags Aid-dog"
For most LDCs, the overwhelming proportion of the debt is owed to official creditors, and throughout the 1990s, the "debt-tail has been wagging the aid-dog", the report contends. Levels of aid inflows to individual countries have been animated by the desire to maintain positive net transfers to the LDCs, to ensure continued debt service of old loans and to avoid embarrassing arrears and development failure. This explains the fact that the more debt service payments an LDC has to make, the more official finance it receives.
This "absurd" situation, in which official creditor-donors have in effect been taking away with one hand what they have been giving with the other, has reduced the developmental impact of aid within the more indebted LDCs and diverted aid away from the less indebted ones. The burden of the debt service payments reduces the effectiveness of aid by subtracting from the scarce resources urgently needed to increase investments in the economic and social infrastructure, including health and education.
On the debtor side, the system has acted as a disincentive to effective resolution of the debt problem because the better a country performs in terms of reducing its external debt, the less concessional finance it is likely to receive. And it has created a moral hazard as official creditors are insulated from the full effect of their lending mistakes. On the creditor side, the system has led to substantial frustration and aid fatigue, since it did not deliver on its promises. In addition, the debt-aid system associated with frequent negotiations between creditors and donors over the repayment of debt introduced considerable financial uncertainty and economic instability. It also generated immense transaction costs, tying up the resources and time of key officials.
HIPC Initiative Insufficient, Claims UNCTAD
The HIPC Initiative is important as it widens the coverage of the types of official debts eligible for relief to include multilateral debt, and this can potentially end the need to pump in aid to ensure debt service payments. But current expectations as to the benefits of the Initiative, even in its enhanced form, are "unrealistic", maintains UNCTAD in its new report.
The relief being provided is not just coming too late and too slow - a criticism that is being actively addressed by rushing as many countries as humanly possible to decision point by the end of this year. Rather, the problem is that the magnitude of assistance is quite simply too little. It is too little for a durable exit from the debt problem for the indebted countries, for a transition to greater aid effectiveness for official creditor-donors, and for significant poverty reduction.
The magnitude of debt relief appears large if the opportunity costs of the loans are included in the calculation, but it is rather small if the actual annual savings on debt service payments are used as a yardstick. In Mauritania, for example, debt service payments due in 1997-1998 were 184% of total social expenditure, and the payments due in 2000-2002 are projected to constitute 75% of social expenditure, according to IMF data.
The UNCTAD report argues that, to the extent that the Initiative succeeds in reducing debt burdens, aid flows are likely to decline. All observers agree that this will undermine the effectiveness of the Initiative. But even if this does not happen, a fundamental weakness of the HIPC Initiative as it relates to the LDCs is that the medium-term forecasts of a durable exit from the debt problem are over-optimistic. They are based on high rates of economic and export growth sustained over a long period - often over and above the rates achieved in the 1990s - and slower import growth. If the export growth rate is just 10% less than projected, major financing gaps will open by 2005.
The shortcomings of the HIPC Initiative are largely based on a misdiagnosis of past policies.
Elements of the Misdiagnosis
- The myth: "Aid is less necessary now as, with the globalization of production and finance, countries can secure development finance from private sources".
- The facts: Current limits on domestic resource mobilization in the LDCs and on those countries´ attractiveness to private capital inflows mean that aid remains essential to these countries´ development.
The report shows that when per capita income increases in LDCs there is a strong domestic savings effort. But with many people living from hand to mouth, and with few businesses in place nationally, domestic savings are necessarily low. Many LDCs are caught in a trap in which slow growth and low incomes limit domestic savings and loanable funds, which in turn, limit increases in investments and economic growth. The only way to escape the trap of low economic development is through external finance. But recent trends are not favourable.
Net official development assistance (ODA) from OECD-DAC countries to LDCs is estimated to have been US$12.1 billion in 1998, down by US$4.5 billion since 1995. In real per capita terms, net ODA to LDCs has dropped by 45% since 1990 and is now back to the levels of the early 1970s. Private capital inflows, however, increased in 29 out of 45 countries in the 1990s. But private capital inflows could generally not offset declining aid, since they are concentrated in only a few LDC economies. Furthermore, the share of long-term private capital inflows to LDCs has dropped by at least 30% since 1990. Today LDCs benefit from only 4% of long-term capital flows to developing countries, and in the 1990s they attracted only 1.4% of the foreign direct investment (FDI) going to the developing countries as a whole.
- The myth: "Aid will work if the national policy environment is right. Thus aid effectiveness can be increased by greater selectivity, targeting aid at countries where the right policies are in place".
- The facts: It is correct to argue that it is necessary to have the right national policies for aid to work, says the UNCTAD report. But aid will not work merely by getting the national policy environment right. It is also necessary to change the nature of the aid delivery system and to ensure that the international trade regime, debt relief policies and measures to promote private capital inflows support, rather than undermine, aid effectiveness.
During the heyday of structural adjustment, donors articulated similar demands for strict policy reforms in the developing countries, but they were unable to coordinate their aid projects and programmes in individual countries. The lack of coordination and integration has led to fragmentation of the aid-delivery system, which in turn undermined the sustainability of aid projects and negatively affected resource allocation and growth. Uncoordinated aid flows - which have been more volatile than current government revenues and even more volatile than export earnings in the LDCs - substantially contributed to financial uncertainty and hindered stable macroeconomic development in the LDCs.
Furthermore, aid has distorted the government finances of many LDCs, as they have been subject to the double squeeze of uncoordinated and non-integrated project aid on the one hand, and policy conditionalities to reduce the budget deficit, excluding grants, on the other. The result is that capital expenditures as a percentage of total government expenditure have been rising whilst current government expenditure has been falling.
- The myth: "National policy will be most effective if donors are not in the driving seat and if there is national ownership of policy. Ownership in this context means that government, through a participatory process, takes the lead in the preparation of the strategic programme document which will guide the economic reform process and whose implementation will later be monitored as a condition for aid and debt relief".
- The facts: Donors are correct to stress the importance of national ownership. But weak ownership is not simply a problem of donors bringing inappropriate "off-the-shelf" blueprints which are then imposed by the sticks and carrots of policy conditionality, UNCTAD asserts.
More seriously, the aid system has eroded state capacities. This has occurred through the fiscal squeeze of policy conditionality and through a domestic brain drain from the government sector to donor projects, which was motivated by substantial differences in wages. Foreign aid projects, though nominally administered by local authorities, have effectively been managed by donors, at least until their completion or exit date.
- The myth: "The relatively weak response to policy reforms is the result of poor implementation".
- The facts: The economic liberalization process accelerated during the 1990s in many LDCs. In fact, 33 of them have undertaken policy reforms under the IMF-financed Structural Adjustment Facility or Enhanced Structural Adjustment Facility programmes since 1988. These reforms have gone further than in many other developing countries. The LDCs have kept up with other developing countries in all areas of the structural reform process except the financial sector and public enterprises. And they have outpaced others in the area of pricing and marketing reform.
IMF data show that trade liberalization has also advanced further in the LDCs than in other developing countries. Of 43 LDCs for which data are available, 37% had average import tariff rates of below 20%, coupled with no or minor non-tariff barriers, and 60% had average tariff rates below 20%, coupled with only moderate non-tariff barriers. Trade liberalization was complemented by financial sector reforms. Of 45 LDCs for which data are available on the late 1990s, 27 adopted a free regime, guaranteeing capital transfers. Nine others maintained a relatively free regime with moderate controls, and another nine had strict controls on the remittances of dividends and profits and capital repatriation.
- The myth: "The fundamental elements of the right national policy environment are present when Governments: (a) pursue macroeconomic stability by controlling
inflation and reducing fiscal deficits; (b) open their economies to the rest of the world; and (c) liberalize domestic product and factor markets through privatization and deregulation. However, insufficient attention was paid to social policies, which now have to be integrated with macroeconomic policies and structural reforms".
- The facts: The shortcomings of existing policies go beyond the insufficient attention they pay to social issues and poverty reduction, according to the authors of the Least Developed Countries 2000 Report. Policy reforms have had serious design weaknesses in relation to LDC-type economies because they neglected the impact of structural constraints, lack of social and economic infrastructure, weakness of market development, thinness of the entrepreneurial class, and low private-sector production capabilities. As a result, the new policy environment does not deliver high growth rates.
The UNCTAD report argues the need for a "New Deal" for the LDCs. This should be based on the understanding that more aid is a precondition for effective aid, and that effective aid is necessary for economic growth, poverty reduction and sustainable development. It should also be recognized that the conditions for effective aid lie not only at the national level. They also depend on the nature of the international relationships between LDCs and their development partners. The synergies between aid policy, debt relief, the international trade regime and measures to promote private capital inflows are crucial as well.