Throughout the last five decades, hundreds of billions of dollars have been paid to governments around the world as “development” aid. Much of it has been wasted in overhead and corruption… Worse, a lot of it went to dictators such as Mobutu, who depended on foreign aid from his Western patrons both to buy support from his clients to shore up his regime and to enrich himself. The picture in much of the rest of sub-Saharan Africa was similar. Humanitarian aid given for temporary relief in times of crises, for example, most recently in Haiti and Pakistan, has certainly been more useful, even though its delivery, too, has been marred in similar problems.
Despite this unflattering track record of “development” aid, foreign aid is one of the most popular policies that Western governments, international organizations such as the United Nations, and NGOs of different ilk recommend as a way of combating poverty around the world. And of course, the cycle of the failure of foreign aid repeats itself over and over again. The idea that rich Western countries should provide large amounts of “developmental aid” in order to solve the problem of poverty in sub-Saharan Africa, the Caribbean, Central America, and South Asia is based on an incorrect understanding of what causes poverty.
Countries such as Afghanistan are poor because of their extractive institutions—which result in lack of property rights, law and order, or well-functioning legal systems and the stifling dominance of national and, more often, local elites over political and economic life. The same institutional problems mean that foreign aid will be ineffective, as it will be plundered and is unlikely to be delivered where it is supposed to go. In the worst-case scenario, it will prop up the regimes that are at the very root of the problems of these societies.
If sustained economic growth depends on inclusive institutions, giving aid to regimes presiding over extractive institutions cannot be the solution. This is not to deny that, even beyond humanitarian aid, considerable good comes out of specific aid programs that build schools in areas where none existed before and that pay teachers who would otherwise go unpaid. While much of the aid community that poured into Kabul did little to improve life for ordinary Afghans, there have also been notable successes in building schools, particularly for girls, who were entirely excluded from education under the Taliban and even before.
One solution—which has recently become more popular, partly based on the recognition that institutions have something to do with prosperity and even the delivery of aid —is to make aid “conditional.” According to this view, continued foreign aid should depend on recipient governments meeting certain conditions—for example, liberalizing markets or moving toward democracy. The George W. Bush administration undertook the biggest step toward this type of conditional aid by starting the Millennium Challenge Accounts, which made future aid payments dependent on quantitative improvements in several dimensions of economic and political development. But the effectiveness of conditional aid appears no better than the unconditional kind. Countries failing to meet these conditions typically receive as much aid as those that do. There is a simple reason: they have a greater need for aid of either the developmental or humanitarian kind. And quite predictably, conditional aid seems to have little effect on a nation’s institutions. After all, it would have been quite surprising for somebody such as Siaka Stevens in Sierra Leone or Mobutu in the Congo suddenly to start dismantling the extractive institutions on which he depended just for a little more foreign aid. Even in sub-Saharan Africa, where foreign aid is a significant fraction of many governments’ total budget, and even after the Millennium Challenge Accounts, which increased the extent of conditionality, the amount of additional foreign aid that a dictator can obtain by undermining his own power is both small and not worth the risk either to his continued dominance over the country or to his life…
There are two important lessons here. First, foreign aid is not a very effective means of dealing with the failure of nations around the world today. Far from it. Countries need inclusive economic and political institutions to break out of the cycle of poverty. Foreign aid can typically do little in this respect, and certainly not with the way that it is currently organized. Recognizing the roots of world inequality and poverty is important precisely so that we do not pin our hopes on false promises. As those roots lie in institutions, foreign aid, within the framework of given institutions in recipient nations, will do little to spur sustained growth.
Second, since the development of inclusive economic and political institutions is key, using the existing flows of foreign aid at least in part to facilitate such development would be useful. As we saw, conditionality is not the answer here, as it requires existing rulers to make concessions. Instead, perhaps structuring foreign aid so that its use and administration bring groups and leaders otherwise excluded from power into the decision-making process and empowering a broad segment of population might be a better prospect.