THE ROLE OF FOREIGN AID

IN DEVELOPMENT

MAY 1997

The Congress of the United States

Congressional Budget Office
NOTES

All years referred to in the study are fiscal years unless otherwise noted.

All dollar amounts are expressed in 1997 dollars unless otherwise noted.

Numbers in text and tables may not add to totals because of rounding.
W

Preface

hat role does foreign aid play in promoting the economic development and improving the social welfare of countries in Africa, Asia, and Latin America? That question is difficult to answer and has been the subject of much debate among development specialists as well as Members of Congress and the American public.

At the request of Congressman Lee Hamilton, the Ranking Minority Member of the House

Committee on International Relations, and Senator Nancy Kassebaum, then Chairman of the

Subcommittee on African Affairs of the Senate Committee on Foreign Relations, the Congressional Budget Office (CBO) has examined the academic and policy literature for insights into

the relationships between foreign aid and development. This study identifies the economic,

political, and social conditions that appear to favor development. It also highlights the circumstances under which foreign aid promotes or undermines those conditions. In keeping with

CBO’s mandate to provide objective analysis, the study does not make recommendations

about the future of foreign aid.

Eric J. Labs of CBO’s National Security Division prepared the study under the general

supervision of Cindy Williams and R. William Thomas. Sheila Roquitte provided general

assistance and researched the development histories of Botswana and Zambia. R. William

Thomas provided critical assistance in evaluating the empirical studies of foreign aid and

development discussed in Chapter 3. The author would like to thank Anna Cook, Robert

Dennis, Sunita D’Monte, Victoria Greenfield, Ellen Hayes, Kim Kowalewski, Rachel Schmidt,

Marvin Smith, Joseph Whitehill, and Christopher Williams of CBO for their assistance.

Many officials of the Agency for International Development (AID), the World Bank, the InterAmerican Development Bank, the Asian Development Bank, and the Organization for Economic Cooperation and Development also provided information for the study. In particular,

the author would like to thank James Fox, Ellen Peterson, Cheryl Warner, and the staff of

AID’s mission to Honduras. Anne O. Krueger of Stanford University and Nicholas Eberstadt

of the American Enterprise Institute and Harvard University provided many helpful comments

on earlier drafts of the study. The author and CBO, however, bear full responsibility for the

final product.

Sherry Snyder edited the manuscript, and Christian Spoor proofread it. Judith Cromwell

produced drafts of the study. Kathryn Quattrone prepared the report for publication.

June E. O'Neill

Director

May 1997

Contents

SUMMARY xi

ONE INTRODUCTION 1

Significance 1

Scope of the Study 1

Analytic Method 2

Defining Foreign Assistance 3

Limitations of the Study 4

TWO THE FLOW OF FOREIGN AID AND PRIVATE

CAPITAL TO DEVELOPING COUNTRIES 7

What Do Proponents Believe Aid Will Achieve? 7

Why Do Others Criticize Aid Programs? 8

Pattern of U.S. Spending on Foreign Aid Since

World War II 9

Composition of U.S. Spending on Foreign Aid 13

Bilateral Assistance of Other Countries 15

Multilateral Assistance Programs 16

Flow of Private Capital to Developing Countries 17

THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 21

The Influence of Governance on Development 21

The Influence of Domestic Economic Policy 

on Development 24

The Role of Foreign Aid in Development 26

Bilateral Versus Multilateral Assistance 34

FOUR THE CHALLENGE OF DEVELOPMENT: 

ILLUSTRATIONS FROM EIGHT COUNTRIES 39

The Influence of Governance on Development 39

The Influence of Domestic Economic Policy

on Development 45

The Role of Foreign Aid in Development 47

Bilateral Versus Multilateral Assistance 51
vi THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

APPENDIXES

A U.S. Spending on Foreign Aid 59

B Economic and Social Indicators of

Developing Countries 67

BIBLIOGRAPHY 73
CONTENTS vii

TABLES

1. Organizations Disbursing U.S. Economic Aid 2

2. U.S. Regional Aid as a Share of All Bilateral Aid 10

3. U.S. Spending on Foreign Aid by Major Category

and Administering Agency 13

4. Distribution of Foreign Aid by Income Group 17

5. Geographic Distribution of Foreign Aid 18

6. Economic Rates of Return in Education 23

7. Classification of 41 Developing Economies by Trade

Orientation, 1963-1973 and 1973-1985 27

8. Selected Studies Examining the Correlation of Aid with

National Saving, Capital Formation, and Economic Growth 30

9. Rates of Return on Successful Aid Projects Financed

by the World Bank, 1968-1989, by Policy Environment

of Recipient Countries 32

10. Functional Specialties of Major Bilateral Aid Donors 35

11. Indicators of Development for Eight Countries 40

12. Flows of Foreign Aid and International Private Capital

to Eight Countries as a Share of Gross National Product 41

13. Transformation of South Korea’s Economy Between

1954 and 1982 as a Share of Gross National Product 45

14. Standard-of-Living Indicators for the Philippines 46

15. Domestic and Foreign Saving in South Korea, 1958-1974 49

16. Sectoral Emphasis of Donors in Botswana in 1991 55

A-1. Appropriations for Military Aid in 1997 60

A-2. Appropriations for Bilateral Development Assistance in 1997 61

A-3. Appropriations for Other Development-Related Agencies

and Programs in 1997 62

A-4. Appropriations for Humanitarian Aid and Programs in 1997 63
viii THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

A-5. Appropriations for Assistance to Eastern Europe and the

Former Soviet Union in 1997 64

A-6. Appropriations for Multilateral Organizations and

Programs in 1997 65

B-1. Economic Indicators of Developing Countries 68

B-2. Social Indicators of Developing Countries 70
CONTENTS ix

FIGURES

S-1. U.S. Spending on Foreign Aid as a Share of Federal

Outlays, 1946-1997 xii

S-2. Volume of Private Capital and Foreign Aid to All

Developing Countries xiii

1. U.S. Spending on Foreign Aid as a Share of Federal

Outlays, 1946-1997 9

2. Volume of Official Development Finance Provided

by Bilateral and Multilateral Donors 16

3. Volume of Private Capital and Foreign Aid to All

Developing Countries 19

4. Performance of 41 Developing Economies

Grouped by Trade Orientation 28

5. Foreign Aid to South Korea and the Philippines, 1953-1993 48

6. Foreign Aid to Egypt, 1953-1993 52

7. Foreign Aid to Costa Rica and Honduras, 1953-1993 53

BOXES

1. What Is Development? 3

2. Objectives in the Foreign Assistance Act of 1961,

as Amended 12

3. Bilateral and Multilateral Donors 15

A

Summary

fter nearly 50 years of U.S. spending on foreign aid, the purposes and worth of that spending remain issues of debate in the Congress.

Financial assistance may be given for strategic, political, economic, or even cultural reasons. This study focuses on aid that is given to promote economic growth

and improve human welfare in the developing countries

of Asia, Africa, and Latin America.

Determining what role, if any, foreign aid has

played in promoting growth and development is difficult for many reasons. First, the dynamics propelling

material and social progress are extremely complex

historical processes and are influenced by many factors&some possibly remaining unidentified&only one

of which is foreign assistance. Second, a great many

social and economic trends may occur together with the

flow of international aid, which makes determining causality elusive. Third, there is no clear and universally

accepted framework for evaluating the impact of various sorts of aid activities. Finally, the data for a research effort designed to determine the role of foreign

aid or any other factor are problematic; for example,

less than a tenth of the low-income populations of Asia,

Africa, and Latin America live in countries with reasonably complete vital statistics, much less economic

accounts.

A broad review of the literature on development

suggests that foreign aid&in the best of circumstances

&will play only a modest role in promoting economic

development and improving human welfare. Other factors, such as the quality of a developing country’s government and the economic policies it pursues, appear to

be considerably more important in promoting growth

and development than the quantity, quality, or type of

foreign aid the country receives. In fact, how successful

foreign aid is in promoting growth depends crucially on

those $background conditions.# Consequently, this

study first examines the broader development context

and then considers the role of foreign aid within that

context.

Although foreign aid overall appears to have only a

marginal effect, it may promote or hinder development,

depending on the environment in which that aid is used

and the conditions under which it is given. Aid given to

countries that are well governed and have adopted

market-oriented economic policies may provide a boost

to their development. Conversely, aid given to countries that have been governed poorly or have employed

restrictive economic policies is less likely to make a

positive contribution to their development. In addition,

the terms and conditions under which donors give foreign assistance will affect its utility in both of those

circumstances.

The Flow of Foreign Aid and

Private Capital to Developing

Countries

The history of foreign aid spending, particularly U.S.

aid, and the rise of private capital flows provide useful

background to the analysis. Real (inflation-adjusted)

U.S. spending on foreign aid reached a peak of $51 billion (in 1997 dollars) in 1947&the height of postwar

reconstruction, which involved large quantities of aid to
1946 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997

0

5

10

15

20

Percent

a

xii THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

help rebuild Europe. In 1997, foreign aid was around

$14 billion. At less than 1 percent of federal outlays in

that year, U.S. spending on foreign aid was at its lowest

level of the postwar era (see Summary Figure 1).

U.S. aid spending has tended to follow the nation’s

strategic priorities. In the 1940s, Europe received the

most U.S. assistance as war-torn European nations rebuilt their national economies and infrastructure. In the

1950s and 1960s, Asian countries&particularly South

Korea, Taiwan, and South Vietnam&received about

half of U.S. bilateral assistance. In the 1970s, U.S. priorities shifted to the Middle East. The United States

began large security and economic assistance programs

to Israel and Egypt. Since 1979, the year of the Camp

David Accords, countries in the Middle East have received about half of all U.S. bilateral aid.

The foreign aid spending of other bilateral donors

has also tended to follow their political or economic

interests. Japan, for example, devotes the majority of

its aid spending to countries in Asia. France gives most

of its aid to its former colonies, as does Britain. That

pattern appears to be less true, however, for some of the

smaller aid donors; the countries of Scandinavia, for

example, devote their resources to the countries they

perceive to be most needy.

Multilateral institutions such as the World Bank

Group and the regional multilateral development banks

have generally favored the poorest countries in the developing world. In 1991-1992, for example, multilateral donors gave over 45 percent of their concessional

assistance&grants or loans at a low interest rate&to the

least developed countries. By contrast, individual nations gave less than a quarter of their concessional assistance to that same group of countries.

The flow of private capital to developing countries

increased substantially in the early 1990s. Those flows

include direct investment, lending by international

banks, and equity flows (investment in the stock markets of developing countries). They do not include private grants by nongovernment organizations, which

have represented less than 5 percent of all private

flows. During the 1980s, intergovernmental foreign

Summary Figure 1.

U.S. Spending on Foreign Aid as a Share of Federal Outlays, 1946-1997

SOURCE: Congressional Budget Office based on Budget of the United States Government (for data from 1946 to 1961) and Office of Management

and Budget (for data from 1962 to 1996).

NOTE: Data include spending for the International Monetary Fund’s Enhanced Structural Adjustment Facility and the Export-Import Bank.

a. CBO estimate.
1970 1973 1976 1979 1982 1985 1988 1991 1994

0

50

100

150

200

250

Billions of 1994 Dollars

Private Capital

Foreign Aid

a

b

SUMMARY xiii

Summary Figure 2.

Volume of Private Capital and Foreign Aid

to All Developing Countries

SOURCE: Congressional Budget Office based on data from the

Organization for Economic Cooperation and Development and the World Bank.

a. Includes short- and long-term net flows.

b. Represents net official development finance.

aid, which includes both concessional and nonconcessional funds, was usually greater than private flows.

Since 1991, however, foreign aid flows have remained

fairly steady in constant dollars, and private flows to

developing countries have risen sharply (see Summary

Figure 2).

Development and the Role

of Foreign Aid

Many different factors contribute to development.

Unique historical, geographical, or cultural influences

may play an important role in determining whether or

how fast a country develops. Factors such as a climate

that is inhospitable to productive agriculture are often

beyond the control of policymakers in developing countries or their foreign aid donors. Nevertheless, the academic and policy literature on development generally

argues that the political and economic choices developing countries make play an important role in determining how well and how fast they develop.

Governance

Three characteristics of governance seem to be important in the development process. First, countries that

have had a high measure of political stability and social

order are more likely to develop than countries that

have experienced instability and chaos. Second, the

less corrupt and self-serving a developing country’s

government, the more likely it is to achieve long-term

development. Third, successful development usually

depends on developing countries’ having the means to

protect property rights and maintain an efficient economic system. That may mean having institutions such

as a fair and impartial judicial system or a finance ministry and central bank. Investment in elementary education has also been a hallmark of developing countries

that have achieved sustained economic growth. As a

general rule, democracy does not appear to be necessary

for development, though it may be important in some

countries.

Domestic Economic Policy

Sound economic management and an outward-oriented

trade and industrialization strategy are important economic components of successful development. Noninflationary monetary policies and low budget deficits

provide a favorable environment for saving and the accumulation of capital, whereas large deficits, high inflation, and the resulting financial instability work against

them. Uncontrolled fiscal policies have contributed to

the problem of large deficits as have large government

payrolls, inefficient government industries, and various

subsidy programs. Governments may expand the

money supply to pay for those deficits, a step that often

leads to inflation, an overvalued exchange rate, and the

production of goods that are less competitive in world

markets.

The extent of a country’s openness and its integration in the world economy and trading system appear

particularly important to development. The discipline

of world market prices makes it much harder to sustain

distortionary domestic policies that might divert the

economy’s resources to wasteful and inefficient uses.
xiv THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

The more a country keeps tariff and nontariff barriers

low and generally adopts an outward-looking economic

policy, the more likely it is to experience sustained economic growth and improved social welfare.

The Role of Foreign Aid

The average amount of foreign aid transferred to developing countries worldwide is small compared with the

size of their economies&2 percent to 3 percent of their

gross national product. In individual cases, however,

that figure can exceed 60 percent in a given year. But

more assistance is not always more effective. Receiving too much foreign aid may overwhelm a country’s

absorptive capacity and thereby undermine the aid’s

overall effectiveness. Yet even a small quantity can be

useful in achieving results, depending on its purpose

and how it is spent.

Essentially, foreign aid given to developing countries reinforces what is there. If a country has good

government and economic policies, the result is likely

to be more good government and economic policies. If

a country has a highly corrupt political system and has

pursued counterproductive economic policies, the result

is usually more of the same. That is not to say that foreign aid never benefits a country that is pursuing counterproductive economic policies. Child immunization

programs, for example, are likely to benefit a developing country regardless of its economic policies, although a healthier population will almost certainly be

more useful and productive in an economy that is growing briskly than in one that is not.

The way donors give foreign assistance may also

influence its usefulness in promoting economic and social development. Aid may be given to alleviate the

effects of natural disasters, protect the donor nation’s

political and strategic interests, or increase the donor’s

exports. But when aid is given to achieve more than

one objective, it may not be as useful to the recipient’s

growth and development. For example, when aid goes

to an ally to further strategic objectives, as U.S. aid

went to Honduras in the 1980s, it may reinforce poor

economic choices. In addition, other economic or trade

policies sometimes undermine the developmental goals

of a donor’s foreign assistance program. An extreme

example occurred when the United States set quotas on

textile imports from Bangladesh shortly after providing

foreign assistance to its government to expand its textile exports.

Illustrations of Development

To further illustrate the general themes found in the

development literature, the Congressional Budget Office (CBO) examined four pairs of developing countries: South Korea and the Philippines, Costa Rica and

Honduras, Botswana and Zambia, and Tunisia and

Egypt. Those pairs were chosen in part because they

have some similarities in geography, climate, population, or political history. In addition, the first country in

each pair has achieved greater economic and social development than the second.

Allowing for the idiosyncracies of individual countries, the development histories provide strong support

for the themes CBO identified in the scholarly and policy literature. The political and economic policies pursued by South Korea, Costa Rica, and Botswana have

been more conducive to development than those

adopted by the Philippines, Honduras, and Zambia. As

a result, the first three countries have much stronger

economic and social indicators than their regional counterparts.

Tunisia and Egypt represent a somewhat different

pattern. Although Tunisia is richer than Egypt, the two

countries have grown at approximately the same rate.

Tunisia, however, has better literacy and infant mortality rates. They both seem to represent examples of

countries in which sufficient quantities of foreign aid

can generate economic growth, regardless of the economic policy environment. Their ability to sustain that

growth in the absence of fundamental reform, however,

is open to question.
S

Chapter One

Introduction

ince the end of the Second World War, the

United States has spent over $1 trillion on foreign aid (measured in 1997 dollars). Among

the many purposes of that spending is encouraging economic and social development in other countries. Other

purposes have included rebuilding Western Europe after World War II, protecting political and strategic interests, promoting U.S. exports, and providing relief

during humanitarian crises.

The long-term decline of the foreign aid budget and

skepticism in the Congress about the value of foreign

aid in promoting development prompt the central question of this study: What role does foreign assistance

play in promoting economic growth and improving human welfare in developing countries? The Congressional Budget Office (CBO) attempts to answer that

question by summarizing the major findings of the existing scholarly and policy literature on the relationship

between foreign aid and development. In addition, to

provide enrichment and greater detail, CBO uses the

development history of eight countries to illustrate that

relationship.

Significance

It seems an appropriate time for foreign aid donors and

recipients to take stock of the foreign aid experience.

The developing world has changed in the past 40 years.

Some developing countries, particularly in East Asia,

have grown rapidly since the early 1960s. South Korea

and Taiwan, for example, were both aid recipients in

the 1950s and 1960s; now they are aid donors. Other

countries, however, have fallen into extreme poverty,

civil strife, and chaos or have failed to rise above those

conditions. Prominent examples of disintegration or

extreme poverty include Somalia, the former Yugoslavia, Rwanda, Liberia, and Haiti. In some of those

cases, the United States has intervened militarily to provide humanitarian relief and restore order.

The Congress is making large reductions in most

discretionary spending programs, including international affairs. In that starker fiscal environment, getting

the most out of every foreign aid dollar takes on added

importance. So long as economic and social development remains an objective of the U.S. foreign aid program, identifying the conditions that encourage the wise

and efficient use of aid funds may promote that objective.

Scope of the Study

This study focuses on three primary issues. First, why

do some aid recipients develop more quickly than others? At least 90 developing countries have received

substantial U.S. foreign assistance at various times

since 1953. Some have managed to grow and develop

so that they no longer receive such assistance. South

Korea, for example, was a relatively poor country in the

1950s. Today, the World Bank considers it an $uppermiddle-income# country, and it no longer receives economic assistance from the United States. In contrast,

other countries, despite substantial inflows of foreign

aid, have not managed to improve their economic and

social well-being. For example, 13 countries that re-
2 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

ceived at least $10 million in U.S. economic assistance

in 1953 still received at least that much in 1993. Another 26 countries that received that amount in 1973

still received it in 1993.

In addition, are there conditions that must be present before foreign aid can contribute to the development

of a recipient country? The vast majority of the scholars writing on development argue that at least in some

cases, foreign aid can play a useful role in promoting

economic and social progress in developing countries.

But the success of aid depends crucially on numerous

background conditions that relate to the political and

economic policies of the recipient as well as the aid policies of the donor.

Finally, is bilateral or multilateral aid more useful

in promoting economic growth and social development

Table 1.

Organizations Disbursing U.S. Economic Aid

1997

Appropriation

(Millions

Organization of dollars)

Agency for International Development 7,723 a

Other U.S. Aid Organizations 251 b

World Bank Group 742

Regional Multilateral Development Banks 245 c

United Nations and 

Other International Organizations 272

Export-Import Bank 715

SOURCE: Congressional Budget Office.

NOTE: Data exclude military assistance.

a. Includes the Economic Support Fund and humanitarian assistance.

b. The Peace Corps, the Inter-American Foundation, and the African

Development Foundation.

c. The Asian Development Bank, the Inter-American Development

Bank, the African Development Bank, the European Bank for

Reconstruction and Development, and the North American Development Bank.

in developing countries? Currently, the United States

divides its total foreign assistance funding between the

Agency for International Development (AID) and various other organizations (see Table 1). Some development experts argue that multilateral agencies should

administer most foreign assistance because they are less

influenced by parochial concerns. In addition, concentrating aid in one organization would reduce the need to

coordinate in one country the programs of many separate donors. Some experts counter, however, that national agencies do a better job of administering foreign

aid than do multilateral organizations because the former have a strong in-country presence and thus ensure

that their money is spent properly and for the intended

objectives.

Analytic Method

CBO sought answers to those questions by relying on

the existing academic and policy literature on the relationship between development and foreign aid. By describing the policies and interactions of foreign aid donors and recipients that influence economic growth and

improve human welfare in developing countries, this

study specifies some catalysts of development and potential causes of underdevelopment. (See Box 1 for a

discussion of different definitions of development.)

This study highlights those policies and interactions in

greater detail by comparing four pairs of developing

countries: South Korea and the Philippines, Costa Rica

and Honduras, Botswana and Zambia, and Tunisia and

Egypt. Those comparisons, however, are more illustrative than analytic. Generally, they cover a 40-year

period&1953 to 1993. In examining each country,

CBO uses five economic and social indicators to compare them: gross national product per capita, population

growth, literacy, infant mortality, and daily calorie consumption per capita. The development history of the

eight countries is used in Chapter 4 to provide concrete

examples of the themes found in the general literature.

CBO will publish a more thorough analysis of three

pairs of those countries as separate background papers

in late summer.

The eight countries used as illustrations were selected for several reasons. The first country in each pair

has achieved relatively greater economic and social development than the second. All eight have received
CHAPTER ONE INTRODUCTION 3

Box 1.

What Is Development?

Development means change. Most development specialists would agree on that point. But defining development more precisely than that is problematic. Development is sometimes confused with other terms that are

closely related to it but do not mean the same thing.

For the purposes of this study, a country whose

economy is growing&that is, its gross national product

(GNP) is rising&may not be developing. The rising

GNP may simply reflect the increased production and

sale of a natural resource such as oil or minerals. Economic development is a term that is often used interchangeably with development but implies the transformation of a country’s economy from agriculture to industrialization, along with rising per capita income.

Development, however, describes the process of economic and social transformation within a country&both

economic growth and economic development as well as

improvements in human welfare, such as rising education levels, improvements in health care and life expectancy, and increases in household food consumption. It

usually includes a concept of equity (the income level of

the median household increases along with economic

growth) and may include sustainability (a process of

development that does not make future generations

worse off through environmental damage). However,

what constitutes $sustainability# remains a hotly disputed issue within the development field.

For example, the World Bank, in its annual World

Development Report, ranks developing countries on the

basis of per capita GNP, though it stresses that other

indicators representing education levels, health care,

and food production are also important. The United

Nations Development Programme, in its annual Human

Development Report, builds a composite $human development indicator# (HDI), which assigns a value to a

country based on its GNP per capita, life expectancy,

adult illiteracy, and mean years of schooling. Thus, for

some countries, such as Angola or Saudi Arabia, the

GNP per capita rank is higher than the HDI rank, indicating that they have the potential to translate more of

their income into improved well-being for their people.

For other countries, such as China or Costa Rica, the

HDI rank is far ahead of their per capita GNP rank, indicating that they have made judicious use of their income to improve the lot of their population.1

The Congressional Budget Office (CBO) also uses

a broad definition of development. In this study, development encompasses a long-term trend of growth in

GNP per capita, rising education levels, improving

health conditions, low to moderate population growth,

sustainable use of natural resources and the environment, and secure access to adequate amounts of food.

In examining individual countries, CBO also puts some

emphasis on whether a country is industrializing and

whether the broader population is participating in economic growth. Thus, a country that has strong economic and social indicators as well as a vigorous industrial sector and declining poverty rates represents a

higher stage of development than a country that has the

same economic and social indicators but lacks industrialization.

1. Gerald M. Meier, Leading Issues in Economic Development,

6th ed. (New York: Oxford University Press, 1995), pp. 10-11.

U.S. and other aid for an extended period. The countries in each pair generally share some similar background conditions such as geographic proximity, population size, climate, land size, and natural resources.

They may have other features in common as well, such

as similar political histories. Of course, no two countries are exactly alike, but they provide useful comparative illustrations.

Defining Foreign Assistance

A common means of defining and measuring foreign

aid is official development assistance, which is used by

the Development Assistance Committee of the Organization for Economic Cooperation and Development
4 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

(OECD). Official development assistance consists of

grants or loans that one government or multilateral organization gives to a developing country to promote

economic development and welfare. That assistance

must be granted on concessional terms, which in the

case of a loan means that at least 25 percent of it must

be in the form of a grant. Data on official development

assistance also include technical cooperation, such as

teaching farmers new techniques or providing advice on

making economic reforms; they exclude military assistance, political development programs, export credits,

and debt forgiveness for military loans.

The OECD also uses a broader concept called official development finance, which combines official development assistance with other official flows&that is,

the financial flows from government organizations in

developed countries and multilateral organizations to

developing countries. Other official flows usually include loans at or near market rates. Where comparisons

between flows of bilateral and multilateral aid are necessary, CBO has used the OECD’s official development finance (which shows the total aid picture) and

official development assistance (which represents concessional flows only).

For the most part, however, this study uses a broad

definition of foreign assistance. It includes all money

that would be classified as official development assistance, and it incorporates military assistance, political

development programs, export promotion, debt forgiveness, and nonconcessional lending by all bilateral and

multilateral organizations. Any money that benefits a

developing country&grants, concessional loans, or nonconcessional loans&from a governmental or quasigovernmental organization is considered foreign aid.

The only exception is the use of credit from the International Monetary Fund, which is excluded unless otherwise noted.

Aid given for different purposes, of course, will

probably have different effects on development. Assistance designed to foster economic reforms or improve

production methods is likely to have a greater impact

on development than military assistance, which aims to

build stronger armed forces in the recipient country.

But all such resources may influence the development

process. For example, military aid, which is not normally considered to be development assistance, may

enable a country to devote a greater percentage of its

resources to development programs than if it did not

receive military assistance. More likely, however, military assistance simply enables a country to build stronger armed forces than would have been possible in the

absence of such aid. Thus, although the primary focus

of this study is the role of economic assistance in development, other forms of assistance are addressed when

appropriate.

Furthermore, both gross and net aid flows have

advantages and disadvantages in analyses of the effect

of foreign assistance on development. Gross aid flows

capture all the resources a developing country receives

in loans and grants from donor organizations and countries. Net flows represent the same resources but exclude loan repayments. Gross flows more accurately

demonstrate how large a presence foreign aid has had in

a particular country, but by excluding loan repayments

they present a distorted picture of the actual resources a

country receives in a given year. For example, gross

aid flows may be more useful in understanding how aid

can contribute to policy dialogue and reform in a developing country, because gross aid flows do a better job

of illustrating the leverage a donor may have than do

net flows. However, if the objective is to calculate the

macroeconomic effect of aid flows, then net figures are

more appropriate. This study uses data on both measures of aid.

Limitations of the Study

CBO explores the effects of foreign assistance in general terms. Attributing specific economic or social improvements in a country to a particular source of foreign aid is beyond the scope of this study. The reasons

for that qualification are varied and complex. First, the

dynamics propelling material and social progress are

extremely complex historical processes and are influenced by many factors&some possibly remaining unidentified&of which foreign assistance is only one.

Second, a great many social and economic trends may

happen to move in sequence with international aid

flows, which makes determining the impact of any one

factor elusive. And third, no clear and universally accepted framework exists for evaluating aid activities.

In addition, although the country comparisons provide a more in-depth view of the development process,
CHAPTER ONE INTRODUCTION 5

this study does not discuss countries that have managed

to develop with little or no aid. For example, compared

with other countries in Latin America such as Bolivia

or El Salvador, Chile has received very little aid. Yet

Chile achieved an average annual growth rate of 3.6

percent in per capita gross national product between

1980 and 1993&better than most of its neighbors, who

had negative annual growth rates during the 1980s.

CBO does not attempt to evaluate the various bilateral and multilateral institutions through which foreign

aid is administered. This is not a study of AID, the

World Bank Group, or any other organization that provides assistance to developing countries. Such a detailed analysis of the programs of individual aid-giving

organizations is beyond the scope of this analysis and

the resources available. Thus, although the study refers

to specific organizations&AID, after all, has been at the

heart of the aid-giving experience for the past 30 years

&it does not assess their effectiveness.

The World Bank Group, the Organization for Economic Cooperation and Development, the Agency for

International Development, and other agencies provided

most of the statistical data on developing countries for

this study. But the data are not always complete or accurate. In other instances, statistics relating to economic or human welfare may have been manufactured

by a developing country to satisfy the various rules of

organizations dispensing foreign assistance. Such information, therefore, should be used with caution.

Nonetheless, sufficient data are available to conduct a

broad assessment of the conditions that promote development.

F

Chapter Two

The Flow of Foreign Aid and Private

Capital to Developing Countries

oreign aid is the subject of intense debate

within academia as well as among Members of

Congress and the American people. All parties

to that debate marshall strong arguments in favor of

their respective position. Yet to understand the role of

foreign aid in promoting development, one must first

understand the history and objectives of U.S. foreign

aid as well as those of other bilateral and multilateral

donors. The aid resources of bilateral donors, including

the United States, tend to follow the donor’s political

and strategic priorities, not those of the countries that

have the greatest need from a development perspective.

Though much smaller than the amount of aid given by

bilateral donors, the money given by multilateral institutions tends to go mostly to the poorest countries. At

the same time, the flow of international private capital

to developing countries is taking on an increasing importance in the development context, having surpassed

flows of foreign aid in total volume since the early

1990s.

What Do Proponents Believe

Aid Will Achieve?

Proponents of continued or greater funding for U.S.

foreign aid programs employ a variety of political, humanitarian, and economic rationales to make their case.

As one might expect, those rationales extend beyond

the issue of promoting economic and social development in other countries.

Aid Has Often Been Effective

Foreign assistance has often been effective in meeting

its goals. Aid was effective in helping to rebuild Europe after World War II. With respect to development,

aid helped eradicate polio, greatly reduce the incidence

of small pox, increase life expectancy, and reduce fertility rates around the world. Although the United States

cannot expect aid to solve all problems, many of the

efforts the country has attempted with its foreign aid

program have been effective.1

The United States Should Provide 

Humanitarian Assistance

The United States has been very generous when humanitarian disasters have occurred in various parts of the

world. Such crises may be caused by natural disasters,

political instability, or civil conflict&all of which may

create large flows of refugees. Foreign aid can do little

to prevent earthquakes, but it can lessen the severity of

droughts and famine by encouraging better farming

methods and developing and employing drought-resistant strains of crops. Similarly, foreign aid may be able

to reduce the incidence of civil conflict by helping to

create more economic opportunity in developing countries.

1. David Gordon, Catherine Gwin, and Steven W. Sinding, What Future

for Aid? Occasional Paper 2 (Overseas Development Council, November 1996), pp. 11-13.
8 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Development in Other Countries 

Enhances U.S. Security

A potential threat facing the United States after the

Cold War may be the spread of weapons of mass destruction, especially if combined with political instability. An internal conflict in a developing country that

became a regional conflict would have dire consequences for U.S. allies if it involved use of nuclear,

chemical, or biological weapons¬ to mention the

potential impact on the regional and global environment. In 1994, $a brief survey of the world’s trouble

spots show[ed] a fairly striking correlation between

economic malaise on the one hand and domestic unrest

and political instability on the other.# If the United 2

States can address those problems by using its foreign

aid to help to create economic opportunities and invest

in human capital, then the chance of conflict may be

reduced.

Foreign Aid Helps Provide Public

Goods in Developing Countries

Many developing countries do not have sufficient funds

to provide public goods such as education or transportation systems or clean water and waste disposal facilities. Although such goods are essential for development, their economic rate of return is so uncertain that

private investors are unwilling to provide them on a

large scale. Foreign aid can substitute for private capital in those instances, providing the funds for investment in public goods that the international capital market will not supply to those developing countries or

would supply at a high interest rate.

Why Do Others Criticize

Aid Programs?

Critics of foreign aid use a variety of political, strategic,

and economic rationales to make their case.

Aid Is Often Ineffective

One argument is that foreign aid does not contribute

significantly to economic progress in developing countries. Aid that is intended to foster development may

enable some regimes to divert money to other, nonproductive activities. Aid is wasted in countries that do not

have the technical or administrative ability to absorb

and use it properly. Furthermore, the recipients of aid

may use it to fund projects that are poorly conceived

and planned. Examples of roads being built and going

unmaintained and unused, or other large projects destroying more productive resources than they create, are

not uncommon. It follows, critics argue, that development should be left to market forces. The private sector

in developing countries would be much more efficient

in promoting economic growth than development specialists, they say.

Aid Often Harms Developing Countries

Peter Bauer has argued that aid has serious, distorting

consequences in the political life of recipient countries.

Aid is generally transferred to the government of those

countries, which tends to increase the government’s

power, resources, and patronage relative to the rest of

society and, consequently, the stakes in any struggle for

control of that power. People will spend relatively

more of their time focused on the outcome of political

and administrative decisions, thereby diverting attention, energy, and resources from more productive economic activities. That may encourage tension and disturbances that can lead to the outbreak of civil armed

conflict.3

In many cases, foreign aid has sustained governments in their pursuit of economically counterproductive political and economic policies. Such policies include the persecution of particular groups, restrictions

on private trade and the inflow of private capital and

enterprises, confiscation of property, price policies that

discourage agricultural production, and the expropriation of foreign capital and enterprises. To add insult to

2. Congressional Budget Office, Enhancing U.S. Security Through Foreign Aid (April 1994), p. 5.

3. Peter Bauer, $Foreign Aid: Mend It or End It?# in Peter Bauer,

Savenaca Siwatibau, and Wolfgang Kasper, Aid and Development in

the South Pacific (Australia: Center for Independent Studies, 1991),

p. 9.
1946 1949 1952 1955 1958 1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997

0

5

10

15

20

Percent

a

CHAPTER TWO THE FLOW OF FOREIGN AID AND PRIVATE CAPITAL TO DEVELOPING COUNTRIES 9

Figure 1.

U.S. Spending on Foreign Aid as a Share of Federal Outlays, 1946-1997

SOURCE: Congressional Budget Office based on Budget of the United States Government (for data from 1946 to 1961) and Office of Management

and Budget (for data from 1962 to 1996).

NOTE: Data include spending for the International Monetary Fund’s Enhanced Structural Adjustment Facility and the Export-Import Bank.

a. CBO estimate.

injury, when the pursuit of such policies worsens the

economic performance of an aid recipient, the country

may qualify for still more aid because its situation is

deteriorating.4

Economic Growth in Developing 

Countries May Not Be Beneficial 

for the United States

One might argue that even if U.S. foreign aid does the

job of promoting economic growth overseas, it will

have adverse consequences for the United States. Economic growth among developing countries means that

they have become competitors in the global market.

Cheaper wages in developing countries allow foreign

competitors to charge prices that are lower than those

for comparable U.S. goods in world and domestic markets, critics would claim, thus causing the United States

to lose jobs.

Aid Should Support Only 

U.S. National Interests

Another argument is that the United States should target its foreign aid dollars toward countries and policies

that directly support U.S. national interests. Helping all

the poor people of the world, though laudable, is impractical. The United States should, therefore, enable

countries to defend themselves, reward its friends, and

reinforce success where it is occurring. When viewed in

that light, helping the poorest of the poor may be an

ineffective use of U.S. aid dollars.

Pattern of U.S. Spending

on Foreign Aid Since 

World War II

Historical spending on foreign aid suggests that since

4. Ibid., pp. 9-10. the 1950s, such aid has not been a particularly high
10 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

priority of U.S. policymakers. Another, perhaps more

important, point is that foreign aid has been used primarily as a foreign policy tool. Political and security

interests have dominated the allocation of U.S. foreign

assistance in the 50 years since the end of World War

II. That ap-proach is reflected in changes in geographic

emphasis in the allocation of U.S. aid over time. Promoting economic development and human welfare has

been an objective of U.S. foreign aid but, overall, a secondary one.

Real (inflation-adjusted) U.S. spending on foreign

aid has fluctuated from year to year but has been on a

downward path since the 1960s, both in dollar terms

and as a share of all federal outlays. It reached a high

of $51 billion (in 1997 dollars) during postwar relief

and reconstruction in 1947. By 1997, funding for foreign aid had fallen to around $14 billion.

As a percentage of federal outlays, U.S. spending

on foreign aid reached its lowest level in the post-World

War II era in 1997, falling to less than 1 percent (see

Figure 1 on page 9). That share compares, for example, with almost 16 percent for defense, almost 21 percent for Social Security, and 15 percent for interest on

the national debt. Although many major categories of

federal spending have increased substantially over the

past 10 years, foreign aid outlays fell by 32 percent between 1985 and 1995. Overall federal spending rose

by almost 15 percent during that period.

Geographic Distribution of 

Aid Since 1945

With the onset of the Cold War in the late 1940s, a critical priority of Washington was to rebuild the war-torn

economies of Western Europe. The United States created the Marshall Plan&named after Secretary of State

George Marshall, who proposed it&which provided

billions of dollars in aid to various European countries.

The Marshall Plan, along with the military and economic aid programs to Greece and Turkey, constituted

the bulk of U.S. bilateral aid between 1946 and 1952.

Europe received 82 percent of U.S. bilateral assistance

&nearly $267 billion&during that period.

In the 1950s and 1960s, the focus of U.S. spending

on foreign aid shifted from Europe to Asia, especially

South Korea, Taiwan, and later South Vietnam. Between 1953 and 1975, that region received about half

of all U.S. bilateral assistance. Bilateral military assistance, like the Lend-Lease program before the United

States entered World War II, was designed to support

strategic and politically important U.S. allies around the

globe. It both signaled a U.S. political commitment to

recipient countries and helped them build stronger military capabilities. In that sense, the objective of U.S.

military assistance given to countries today does not

differ materially from that of 40 years ago.

In the 1970s, U.S. funding priorities shifted from

Asia to the Middle East. The level of aid given to Asian

countries declined dramatically after North Vietnam

conquered South Vietnam in 1975 and the United

States withdrew all foreign assistance to that country

(see Table 2). In addition, U.S. aid programs to South

Korea and Taiwan had been winding down since the

early 1970s. However, the 1979 Camp David peace

accords between Israel and Egypt inaugurated large

bilateral security and economic assistance programs to

both of those countries. Other recipients in the region

have included Jordan, Tunisia, and Morocco. Since

1979, the Middle East has received about half of U.S.

bilateral assistance.

Table 2.

U.S. Regional Aid as a Share of All Bilateral Aid

(In percent)

Region 1955 1965 1975 1985 1995

Africa 1 5 6 11 12

Asia 54 52 51 14 6

Europe/NIS 36 13 5 14 18

Latin America 3 20 11 15 9

Middle East and 

North Africa 6 10 27 45 55 a

SOURCE: Congressional Budget Office based on data from the

Agency for International Development.

NOTE: NIS = newly independent states (of the former Soviet Union).

a. The Agency for International Development reports these data under a category called Near East.
CHAPTER TWO THE FLOW OF FOREIGN AID AND PRIVATE CAPITAL TO DEVELOPING COUNTRIES 11

With the exception of the early 1960s and the mid1980s, Latin America has never received large amounts

of U.S. bilateral aid. Its share of U.S. foreign aid

spending never exceeded 25 percent of the bilateral aid

budget. President Kennedy’s Alliance for Progress program briefly boosted aid to the region, and the effort to

thwart the spread of communism in Central America in

the 1980s benefited El Salvador, Honduras, and Costa

Rica. Since 1979, Latin American countries have received about 13 percent of U.S. bilateral assistance.

Finally, Africa has been a relatively low priority in

the U.S. foreign aid program. It has received about 10

percent of U.S. bilateral assistance in the 1990s.

Historical Objectives of Aid

During World War II, the U.S. view of foreign aid as a

foreign policy tool changed dramatically. Before the

war, with the notable exception of the Lend-Lease program, the United States devoted few resources to foreign aid and international institutions. After the war, the

United States emerged as the world’s strongest economic power. Its gross national product exceeded that

of the six next largest powers. The war had devastated 5

large parts of Europe and Asia. In response, U.S.

policymakers began to fund programs that could be

broadly defined as foreign aid. Nevertheless, U.S. strategic interests have determined where most U.S. foreign

aid has been spent.

Europe was an immediate concern. Postwar aid to

Europe had two major functional and political objectives. First, part of the program provided immediate

disaster relief to countries devastated by the war. That

meant supplying them with food, clothing, and medicine&the basic necessities to prevent starvation and

disease. Second, the Marshall Plan assisted Western

European countries, including the western part of Germany, in rebuilding their economies and thereby restoring and ultimately elevating their standard of living.

Politically, the program was intended to reduce or eliminate the wretched economic and social conditions that

some U.S. policymakers believed might cause the peoples of Western Europe to turn to communism for a

solution. The Italian and French communist parties in 6

particular were quite strong in the late 1940s. In addition, restoring the prosperity of Western European

countries would make them better able to contribute to

their own military defense against what appeared to be

an increasingly menacing Soviet Union.

In the 1950s, the United States also inaugurated

development and food assistance programs for developing countries. The original political and functional objective of those programs, as outlined by President Truman in the Point IV program of 1949, was to give other

countries access to the skills and knowledge that generate widespread affluence. That approach differed from

the Marshall Plan in that the countries of Western Europe required, for the most part, help in reconstructing a

fully developed industrial economy: the technical skill

and high levels of human capital already existed there.

Those conditions, however, were not likely to be found

in the countries receiving aid under Point IV. But by

1960, more and more of U.S. development assistance

went to countries that were friendly to the United

States.7

By 1961, President Kennedy was arguing that development assistance was security assistance, that subversion and revolt around the world fed on social injustice and economic chaos. Consequently, he signed the

Foreign Assistance Act of 1961, which set up the

Agency for International Development. The mission 8

of that agency was to supervise and administer the U.S.

development assistance program. The legislation ensured that most of that assistance would go to countries

that were politically important to the United States.

The act and its subsequent amendments also included

numerous specific functional and political objectives.

Today, the Foreign Assistance Act, as amended,

instructs the executive branch to pursue at least 32 separate goals. They include reducing infant mortality,

controlling population growth, reducing illiteracy, preserving biological diversity, supporting human rights,

encouraging private U.S. investment, and strengthening

5. Paul Kennedy, The Rise and Fall of the Great Powers: Economic

Change and Military Conflict from 1500 to 2000 (New York: Random House, 1987), p. 369.

6. Vernon W. Ruttan, United States Development Assistance Policy:

The Domestic Politics of Foreign Economic Aid (Baltimore: Johns

Hopkins University Press, 1996), pp. 38-41, 50.

7. Nicholas Eberstadt, Foreign Aid and American Purpose (Washington, D.C.: American Enterprise Institute, 1988), pp. 25-31.

8. Ibid., p. 33.
12 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Box 2.

Objectives in the Foreign Assistance Act of 1961, as Amended

1. Alleviating the worst physical manifestations of poverty among the world’s poor majority.

2. Promoting conditions that enable developing countries to achieve self-sustaining economic growth with

equitable distribution of benefits.

3. Integrating developing countries into an open and

equitable international economic system.

4. Increasing the opportunity and capability for the poor

to participate in the development process.

5. Reducing infant mortality.

6. Controlling population growth. 

7. Increasing agricultural productivity per unit of land

through small-farm, labor-intensive agriculture.

8. Contributing to improvements in the health of the

greatest number of poor people in developing countries.

9. Reducing illiteracy, extending basic education, and

increasing manpower training in skills related to development.

10. Helping developing countries to develop, produce,

and effectively use energy.

11. Assisting the development of the private sector in

developing countries.

12. Integrating women into national economies to enhance their status and to further the development process.

13. Supporting human rights by not providing assistance

to countries that engage in a consistent pattern of

gross violations of these rights.

14. Reducing environmental degradation and promoting

natural resources management.

15. Encouraging conservation and sustainable management of tropical forests.

16. Preserving biological diversity.

17. Using, whenever feasible, private and voluntary organizations to implement development activities.

18. Strengthening the development and use of cooperatives.

19. Eliminating illicit narcotics production.

20. Establishing and upgrading the institutional capacities in developing countries.

21. Demonstrating American ideas and practices in education and medicine to citizens of other countries

through U.S. schools, libraries, and hospitals abroad.

22. Assisting developing countries in marshalling resources for low-cost shelter.

23. Encouraging democratic institutions in developing

countries.

24. Encouraging the development capacities of U.S. educational institutions.

25. Educating the U.S. public concerning developing

countries.

26. Providing international disaster assistance.

27. Emphasizing the use of smaller, cost-saving, laborusing technologies.

28. Encouraging U.S. private investment in U.S.-

sponsored economic and social development programs.

29. Encouraging regional cooperation among developing

countries.

30. Promoting policy reforms in developing countries to

achieve economic growth with equity.

31. Assisting developing countries to increase their

national food security.

32. Addressing the shelter and urbanization needs of developing countries, such as municipal management

and finance, water and sanitation, and infrastructure.

SOURCE: General Accounting Office, Foreign Assistance: AID Strategic Direction and Continued Management Improvements Needed, NSIAD93-106 (June 1993), pp. 66-67.
CHAPTER TWO THE FLOW OF FOREIGN AID AND PRIVATE CAPITAL TO DEVELOPING COUNTRIES 13

Table 3.

U.S. Spending on Foreign Aid by Major Category and Administering Agency

1997 Appropriation

Category Administering Agency (Millions of dollars) a

Military Assistance Department of Defense 3,400

Bilateral Development Assistance Agency for International Development 2,500b

Economic Support Fund Agency for International Development 2,300

Humanitarian Assistance Agency for International Development 1,700

Aid to Eastern Europe and 

the Former Soviet Union Agency for International Development 1,400c

Multilateral Assistance Department of the Treasury 1,300

SOURCE: Congressional Budget Office.

a. Many different organizations may play a role in determining who receives assistance, not just the administering agency.

b. Does not include funding for development-related agencies such as the Export-Import Bank or the Overseas Private Investment Corporation.

c. Includes funding for the Cooperative Threat Reduction program, which is administered through the Department of Defense.

the development and use of cooperatives. (For a complete list of all specified goals of the U.S. development

assistance program, see Box 2.)

Overall, the end of the Cold War has brought few

changes in the objectives of U.S. foreign aid. Egypt

and Israel remain the largest recipients of U.S. bilateral

assistance. However, other countries that had received

hundreds of millions of dollars in U.S. assistance, in

part because they were allies during the Cold War (including Pakistan and some Central American states),

have found their funding cut.

Composition of U.S. Spending

on Foreign Aid

In 1997, U.S. spending on foreign aid totals nearly $14

billion. The foreign aid budget can be roughly divided 9

into six categories: military assistance, bilateral development assistance, the Economic Support Fund, humanitarian assistance, aid to Eastern Europe and the

republics of the former Soviet Union, and multilateral

assistance (see Table 3). Three agencies oversee that

spending, but numerous other agencies participate in

allocating and distributing that aid.

Military Assistance

Most U.S. military assistance is from the Foreign Military Financing (FMF) program, which is administered

by the Department of Defense. It provides grants and

loans that enable foreign governments to purchase military equipment from the United States. Lately, FMF

has focused on grants for a few, mostly Middle Eastern,

recipients. In 1997, assistance to Egypt and Israel consumed 94 percent of the program’s appropriation of

almost $3.3 billion.

Another important, albeit far less expensive, program is International Military Education and Training,

which cost about $40 million in 1997. That program

provides grants to countries for training foreign military

officers and personnel. Funding for military-to-military

contact programs and some peacekeeping operations

9. Foreign aid falls within budget function 150 (international affairs).

That function also includes spending for the conduct of foreign affairs

and for information and exchange programs&two activities that in

1997 accounted for nearly $5.1 billion.
14 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

also belongs in this category. (For a complete breakdown of spending for military assistance, see Table

A-1.)

Bilateral Development Assistance

In 1997, the United States allocated about $2.5 billion

for bilateral development assistance. Such assistance is

intended to encourage equitable and sustainable economic growth in many developing countries. The programs and projects vary widely across many different

sectors, including agriculture, health, private enterprise,

education, population, the environment, and economic

reform. In 1973, the Congress amended the Foreign

Assistance Act of 1961 to require U.S. development

assistance programs to emphasize helping the poorest

segments in developing countries. Other programs

such as the Trade and Development Agency, the

Export-Import Bank, and narcotics control programs

have purposes that overlap those of the bilateral development assistance programs but are funded separately

&approximately $1.2 billion in 1997 (see Tables A-2

and A-3).

Economic Support Fund

The Economic Support Fund (ESF), administered

through AID, explicitly directs economic aid to countries that are deemed to be politically or strategically

vital to the security of the United States. But the form

ESF moneys take is often similar to development assistance. It may also include cash transfers into a country’s bank account. Recently, a high proportion of this

aid has gone to countries in the Middle East, with Israel

and Egypt receiving 85 percent of the $2.3 billion program in 1997.

Humanitarian Assistance

The United States provides money to alleviate humanitarian crises around the globe. About half of the $1.7

billion the United States spends on humanitarian assistance funds emergency food programs in developing

countries. The remainder is provided to assist refugees

and help alleviate natural disasters or man-made problems such as civil war. That money is not intended or

expected to promote development. It is usually distributed by private and multilateral organizations acting on

behalf of AID. Recent recipients have included Somalia and Rwanda (see Table A-4).

Aid to Eastern Europe and the 

Former Soviet Union

With the end of the Cold War, new programs in foreign

aid have been created to assist countries of the former

Soviet bloc in their transition to democracy and freemarket economies. Aid to Eastern European countries

is funded through the Support for East European Democracy Act, and aid to the former Soviet republics

through the Freedom Support Act. In addition, a separate program funded through the Department of Defense&the Cooperative Threat Reduction program (also

known as Nunn-Lugar)&provides money and technical

expertise to assist the states of the former Soviet Union

in dismantling nuclear weapons. In 1997, foreign assistance to Eastern Europe and the former Soviet Union

totaled about $1.4 billion (see Table A-5).

Multilateral Assistance

The United States also contributes substantial funding

to various multilateral institutions that provide economic assistance to developing countries. The most

prominent are the World Bank Group, the International

Monetary Fund (IMF), and some agencies affiliated

with the United Nations, such as the United Nations

Children’s Fund and the United Nations Development

Programme. Technically, both the World Bank Group

and the IMF are $specialized agencies# of the United

Nations, though they are not subordinate administratively to that organization. The World Bank and the

regional multilateral development banks have programs

that lend money at both concessional and nonconcessional rates. The concessional loans are intended for

low-income countries, and the nonconcessional loans

for middle-income countries. In 1997, the United

States allocated $1.3 billion to multilateral assistance

(see Table A-6).
CHAPTER TWO THE FLOW OF FOREIGN AID AND PRIVATE CAPITAL TO DEVELOPING COUNTRIES 15

Box 3.

Bilateral and Multilateral Donors

Many countries and organizations provide foreign assistance to other countries. This box lists all bilateral and major

multilateral donors.

Bilateral Donors

Australia Iceland Portugal

Austria India Spain 1

Belgium Ireland Saudi Arabia

Canada Italy Sweden

China Japan Switzerland 1

Czech Republic South Korea Taiwan

Denmark Kuwait Turkey

Finland Luxembourg United Arab Emirates

France Netherlands United Kingdom

Germany New Zealand United States

Greece Norway

Multilateral Donors

African Development Bank United Nations

African Development Fund Food and Agriculture Organization

Arab agencies United Nations Development Programme

Asian Development Bank United Nations Fund for Population Activities

Asian Development Fund United Nations Children’s Fund

Caribbean Development Bank United Nations Programme of Technical Assistance

Commission of the European Communities United Nations High Commissioner for Refugees

European Bank for Reconstruction World Food Programme

and Development Other United Nations programs

Inter-American Development Bank World Bank Group

Inter-American Investment Corporation International Bank for Reconstruction

Fund for Special Operations and Development

Enterprise for the Americas Multilateral International Development Association

Investment Fund International Finance Corporation

International Fund for Agricultural Development Multilateral Investment Guarantee Agency

International Monetary Fund Global Environment Facility

SOURCE: Congressional Budget Office based on information from the Organization for Economic Cooperation and Development and the World

Bank.

1. India and China receive large amounts of foreign assistance, but they have also contributed a modest amount of aid to a few developing countries.

Bilateral Assistance of

Other Countries

As other countries recovered from the devastation

caused by the Second World War, they began to devote

more money to foreign aid. The United States was the

primary donor of foreign assistance in the first 20

years after the war, when it was also the dominant economic power. Since that time, however, other countries

have grown in importance as foreign donors.

In 1960, the major Western nations decided to formalize and cooperate in the aid-giving process. They

set up the Organization for Economic Cooperation and

Development to promote economic development and

trade among member and nonmember nations. One of
1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994

0

20

40

60

80

Billions of 1994 Dollars

Bilateral

Multilateral

16 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

the special committees of the OECD is the Development Assistance Committee. Its members have agreed

to make more money available to developing countries,

help coordinate their aid programs, and make more resources available to multilateral donors. In 1994, developing countries and multilateral organizations received $59 billion in official development assistance;

17 percent of that amount was from the United States.

(For a list of all bilateral and multilateral aid donors,

see Box 3 on page 15.)

The foreign aid spending of other bilateral donors,

however, has also tended to follow their political or

economic interests. Japan, for example, devotes the

majority of its aid to countries in Asia with whom it has

strong economic ties. France gives most of its aid to its

former colonies, as does Britain. In contrast, some of

the smaller aid donors, such as the countries of Scandinavia, tend to devote their resources to countries that

they perceive as being the most needy.

Multilateral Assistance

Programs

In addition to its direct aid program, the United States

helped organize and fund a number of multilateral organizations at the end of World War II, including the International Monetary Fund, the World Bank, and the

United Nations. The functional and political objectives

of those institutions were closely related. The financial

institutions&the IMF and World Bank&were to help

regulate the international economy, promote trade, promote economic growth, and create a mechanism for

exchanging and converting the currencies of member

countries. Those institutions, their creators hoped,

would help prevent a repetition of the Great Depression

and the high tariffs that it inspired. The political institution&the United Nations&organized the world’s nations into a collective body. Members hoped that it

would provide a means whereby states could resolve

disputes among themselves or, if necessary, punish aggressors who chose to make war on other states.

Assistance from multilateral institutions has grown

faster than that from bilateral donors since 1961 (see

Figure 2). In the 1960s, the members of the OECD

agreed to try to give more money to multilateral institutions that dispense foreign assistance. That commitment was made in part because the OECD countries,

who fund the multilaterals, believed that they needed an

instrument for giving foreign aid that would be relatively free of the domestic political and foreign policy

concerns of individual donor countries.

Since the early 1980s, multilateral donors have

given relatively more of their concessional assistance to

the least-developed countries than have bilateral donors. According to data from the Development Assistance Committee, 45 percent of the official development assistance (ODA) from multilateral organizations

went to the least-developed countries in the 1991-1992

period, down from 51 percent in the 1981-1982 period.

In contrast, bilateral donors allocated only a quarter of

their resources to the same group of nations in the early

1980s. Bilateral ODA was fairly evenly distributed

among most developing nations in the early 1980s,

though by the 1990s most of it was again going to the

poorer countries. That trend is also occurring with respect to all foreign assistance provided to developing

Figure 2.

Volume of Official Development Finance Provided

by Bilateral and Multilateral Donors

SOURCE: Congressional Budget Office based on data from the

Organization for Economic Cooperation and Development.

NOTE: Official development finance includes grants and concessional loans as well as nonconcessional loans or credits

from individual countries and multilateral organizations.
CHAPTER TWO THE FLOW OF FOREIGN AID AND PRIVATE CAPITAL TO DEVELOPING COUNTRIES 17

Table 4.

Distribution of Foreign Aid by Income Group (In percent)

Bilateral Multilateral

Income Group 1981-1982 1991-1992 1981-1982 1991-1992

Official Development Finance

Least-Developed Countries 20 18 27 22 a

Low-Income Countries 22 41 20 40

Lower-Middle-Income Countries 16 23 20 22

Upper-Middle-Income Countries 42 13 33 17

High-Income Countries n.a. 5 n.a. 0

Total 100 100 100 100

Official Development Assistance

Least-Developed Countries 25 23 51 45 a

Low-Income Countries 25 47 28 39

Lower-Middle-Income Countries 17 21 13 11

Upper-Middle-Income Countries 32684

High-Income Countries n.a. 4 n.a. 0

Total 100 100 100 100

SOURCE: Congressional Budget Office based on data from the Organization for Economic Cooperation and Development.

NOTES: Official development finance includes official development assistance (grants and concessional loans) as well as nonconcessional loans

or credits from individual countries and multilateral organizations. Data reflect gross flows.

n.a. = not available.

a. Includes China and India.

countries. In the early 1980s, some 42 percent of bilateral and 33 percent of multilateral official development

finance (ODA plus the nonconcessional flows) went to

upper-middle-income countries. By the 1990s, those

figures were 13 percent and 17 percent (see Table 4).

Geographically, bilateral donors distribute the vast

majority of their official development assistance across

the major regions of the developing world. Multilateral

donors, however, have tended to concentrate their ODA

in Africa and Asia, where most of the world’s poorest

people live (see Table 5).

Flow of Private Capital to

Developing Countries

The amount of private capital going to developing

countries increased substantially in the early 1990s.

Private capital includes direct investment, international

bank lending, stock market investment, and, to a much

smaller degree, assistance from private organizations

such as the International Red Cross. During the 1980s,

the amount of official development finance was usually

greater than private capital flows (excluding aid from

private organizations). Since 1991, however, private

flows to developing countries have risen sharply, and

foreign aid flows have remained fairly steady (see Figure 3). Unlike foreign assistance, private capital has

tended to go to developing countries that appear likely

to provide the greatest economic return.

Foreign direct investment (FDI) represents the largest component of private capital going to developing

countries&around 50 percent, or $80 billion, in 1994.

According to the World Bank, most FDI goes to countries in Latin America and Asia. Countries in subSaharan Africa attracted only $3 billion in 1994. In

fact, seven countries&Brazil, Argentina, Malaysia,

Mexico, Indonesia, Thailand, and especially China&
18 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table 5.

Geographic Distribution of Foreign Aid (In percent)

Official Official

Development Finance Development Assistance

Region Bilateral Multilateral Bilateral Multilateral

Sub-Saharan Africa 26 25 29 45

Middle East and North Africa 22 11 24 8

Asia 27 34 28 35

Latin America 19 25 12 9

Oceania 3131 a

Europe 4 5 4 2

Total 100 100 100 100

SOURCE: Congressional Budget Office based on data from the Organization for Economic Cooperation and Development.

NOTE: Official development finance includes official development assistance (grants and concessional loans) as well as nonconcessional loans or

credits from individual countries and multilateral organizations. Data reflect gross flows expressed as a four-year average, 1989-1992.

a. Pacific island states.

receive more than half of all FDI to the developing

world. Most of those countries had vigorous economic

growth rates between 1990 and 1994, and all except

China are middle-income or upper-middle-income

countries. According to the OECD, the increase in FDI

to developing countries since the mid-1980s reflects the

progress that those countries have made in liberalizing

trade regimes and large-scale privatization of statesupported industries.

Other private capital includes long- and short-term

loans by commercial banks, bonds, and equity flows

(investment in the stock markets of developing countries). Compared with FDI, equity flows have tended to

be more volatile, rising or falling with conditions on the

international market. For example, the Mexican peso

crisis in 1994 led to a substantial drop in money being

invested in the stock markets of developing countries,

but FDI still grew by more than $10 billion in that year.

Lending by commercial banks decreased in 1993 but

turned positive again in 1994 and 1995. Investment in

bonds issued by developing countries, however, held

steady between 1993 and 1995.

An important question that has arisen in the literature is whether foreign assistance serves as a catalyst

for private capital flows. Theoretically, it might, because foreign economic assistance, particularly that

from multilateral institutions, would indicate which

countries have economic policies conducive to growth

or are implementing such policies. Alternatively, aid

might assist developing countries in achieving policy

reform and a higher income status. Thus, private capital would know where investment was likely to be the

most profitable. In practice, however, the data supporting such a relationship are inconclusive. One study, for

example, found a positive relationship between bilateral

aid and private capital flows and a negative but insignificant one between multilateral aid and private capital. That analysis has been criticized for failing to 10

distinguish between multilateral lending directed toward public goods, which may have a positive association, and multilateral lending for emergencies, which

may discourage private capital flows.11

10. Dani Rodrik, $Why Is There Multilateral Lending?# in Michael Bruno

and Boris Pleskovic, eds., Annual World Bank Conference on Development Economics 1995 (Washington, D.C.: World Bank, 1996), pp.

167-193.

11. Guillermo A. Caluo, $Comment on ‘Why Is There Multilateral Lending?’ by Dani Rodrik,# in Michael Bruno and Boris Pleskovic, eds.,

Annual World Bank Conference on Development Economics 1995

(Washington, D.C.: World Bank, 1996), pp. 194-196.
1970 1973 1976 1979 1982 1985 1988 1991 1994

0

50

100

150

200

250

Billions of 1994 Dollars

Private Capital

Foreign Aid

a

b

CHAPTER TWO THE FLOW OF FOREIGN AID AND PRIVATE CAPITAL TO DEVELOPING COUNTRIES 19

Figure 3.

Volume of Private Capital and Foreign Aid

to All Developing Countries

SOURCE: Congressional Budget Office based on data from the

Organization for Economic Cooperation and Development and the World Bank.

a. Includes short- and long-term net flows.

b. Represents net official development finance.

The prospects for the continued long-term growth of

private capital to developing countries are promising,

although short-term volatility in the amount of investment will probably continue. Developing countries

seem to realize in increasing numbers that the more

they liberalize trade, privatize state industry, and adopt

open, market-oriented economic policies that encourage

integration in the world economy, the more likely they

are to see sustained economic growth. Such conditions

tend to attract private capital, particularly FDI and investment in stock markets.

S

Chapter Three

Development and the Role

of Foreign Aid

uccessful long-term development is a complex

process that depends on many factors. The

Congressional Budget Office’s review of the

development literature identified two themes that seem

particularly important: the quality of governance in a

country will heavily influence its development; and

adopting economic policies that promote growth will

contribute significantly to development.

Compared with those two factors, foreign aid is

much less important in determining whether a country

will achieve long-term economic growth and development. However, foreign aid is likely to be the most

helpful when it is given to countries that maintain

stable, honest governments and have adopted marketoriented, outward-looking economic policies. Foreign

aid can encourage countries to adopt positive political

and economic policies if that is its principal objective.

But it may undermine development if it is given to

countries that are unlikely or unwilling to make necessary political and economic reforms.

The Influence of Governance

on Development

CBO’s review of the development literature suggests

that the way a country is governed will affect its rate of

development. Three characteristics seem key:

o Countries that have enjoyed a high measure of political stability and social order are more likely to

develop than countries that have experienced instability and chaos.

o The less self-serving the officials of a developing

country’s government, the more likely that country

is to achieve long-term development.

o Successful development usually depends on the

existence of functioning governmental institutions

that can support a growing economy.

Political Stability

Political instability, not surprisingly, is likely to hinder

development. Studies have shown that countries in

which political authority has broken down&perhaps

even to the point where civil war erupts&are less likely

to achieve economic growth and improvements in human welfare. Instability, especially civil war, may 1

cause widespread destruction of private and public

property. It is likely to impede productive activities by

raising the economic risk that potential investors face.

Countries such as Ethiopia, Rwanda, Somalia, and

1. See N. Gregory Mankiw, $The Growth of Nations,# Brookings Papers

on Economic Activity, no. 1 (1995). See also Pierre-Richard Agenor

and Peter J. Montiel, Development Macroeconomics (Princeton:

Princeton University Press, 1996), pp. 30-32.
22 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Liberia&all of whom have experienced lengthy or intense civil wars&were unable to achieve any lasting

economic development while those conflicts raged. In

contrast, countries that have smoothly functioning and

stable political systems tend to be more capable of pursuing a program of development.

Honest and Capable Administration

Honest and capable government appears to be an important component of development. In its absence,

government officials may pursue policies that damage

the economy simply because those policies benefit them

and others with political and economic power. When

governments require permits, licenses, and quotas that

effectively create private monopolies throughout the

economy, they essentially lower economic output and

raise prices. Governments can also increase waste

through uncompetitive contracting that favors the politically well connected rather than the most innovative or

efficient. The government may charge explicitly for the

monopoly or contracting privileges it grants. Moreover, government officials may take bribes and kickbacks or even misappropriate funds to their own accounts. In either case, the resource represented by the

labor of a government employee is not contributing to

the economy’s productive capacity; even worse, it is

creating inefficiency elsewhere in the economy.2

Governmental Institutions 

and Public Goods

Some experts argue that governmental institutions that

can support economic activity are important to development. Those institutions can be classified as two different types: the laws, regulations, and other rules that

foster economic activity; and formal organizations such

as a central bank.

The first type of institution usually includes mechanisms that protect property rights, make and enforce

contracts, organize a system of national currency, create

a system of tax collection, or provide the regulatory

framework for things like a banking system or stock

exchange. They are the $rules of the game#&the institutions that make the economic system less arbitrary,

lower the economic risk in investing in productive activities, and facilitate economic interaction. Assuming

they are properly constructed, they reduce the transaction costs of economic activity.3

The second type are the institutions most people

usually think of&formal organizations. Some of them

implement the system of laws discussed above, such as

a police force and an independent judicial system. In

countries that lack an impartial judicial system, potential entrepreneurs&foreign or domestic&are likely to be

discouraged from starting businesses or expanding existing ones. Such institutions also include financial

organizations&a central bank, for example. Most de- 4

veloping countries have such organizations today, but

as late as the 1970s, not all did. Even a uniform language is an innovation that may promote development

by making it easier for people to engage in commerce,

although some multilingual countries, such as Switzerland, have achieved impressive levels of economic

prosperity.

An important function of those organizations is the

provision of public goods. Such goods are used by

most or all members of a society but are unlikely to be

provided by any one individual, because everyone

would reap the benefit of that good but the individual

would have assumed all of its cost. They may also be

goods that are simply too expensive for one person or

group to provide and then expect a reasonable rate of

return. Ports, roads, communication systems, and irrigation systems are examples of such public goods.5

That kind of physical infrastructure is crucial to a country’s long-term development.

Providing a system of education through at least the

elementary school level is perhaps the most important

public investment a government can make to improve

human resources. A basic level of education is neces2. See, for example, World Bank, World Development Report 1987

(New York: Oxford University Press, 1987), pp. 74-77.

3. A country may, of course, have written its laws on banking or property

rights so badly that they inhibit economic growth more than if those

laws did not exist at all.

4. For a general discussion of the importance of institutions, see World

Bank, World Development Report 1991: The Challenge of Development (New York: Oxford University Press, 1991), pp. 134-136.

5. A judicial system and a finance ministry are also public goods, but

they in turn provide additional public goods that are discussed here.
CHAPTER THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 23

Table 6.

Economic Rates of Return in Education 

(In percent)

Rate of Return by

Average Level of Education

Country Group Primary Secondary Higher

Industrial Market 

Economies 15 11 11 a

Developing Country 

Exporters of 

Manufactured Goods 15 13 9 b

Other Developing 

Countries 28 17 14 c

SOURCE: World Bank, World Development Report 1987 (New

York: Oxford University Press, 1987), Table 4.1.

NOTE: The economic rates of return (referred to as social rates of

return in the literature on the economics of education) on

which the averages are based are from studies that for the

most part refer to the 1970s and early 1980s. For comparison, economic rates of return to investment in physical capital averaged 13 percent for developing countries and 11 percent for industrial market economies.

a. The lack of a control group of illiterates in the industrial market

economies prevents a direct computation. The estimates are

based on the return for developing countries that export manufactured goods.

b. India, Israel, Singapore, and Yugoslavia.

c. Twenty-six countries.

sary to have a productive labor force. For example,

many countries in East Asia invested heavily in education and achieved above-average economic growth rates

over the past 20 years. In addition, investment in education (and health) spread the benefits of that economic

growth across those countries&the rich became richer,

but the poor became richer as well. According to a

study by the World Bank, the economic rate of return

for primary education in developing countries is almost

double that in industrial market economies (see Table

6).6

Does Democracy Matter?

Experts on development cannot agree on whether democracy promotes development. Some aid-giving organizations, such as the Agency for International Development, argue that promoting democracy in recipient

countries will reduce corruption and foster development. For example, AID’s annual report states that

$democracy is not only an end in itself, but it makes a

vital contribution to sustainable development.# De- 7

mocracy, in that view, enhances the protection of human rights, increases public accountability, frees individual initiative, and facilitates informed participation

of the citizenry in the process of government and development.

No firm empirical link exists, however, between

democracy and the rate of economic growth. Different

regions seem to yield different results. In the Far East,

many countries that have been less than democratic

have experienced exceptional economic performance.

In Africa, many authoritarian states have performed

much worse than Botswana, a democracy since gaining

its independence in 1966. Certainly among the developed countries, democracies have outshone dictatorships in terms of growth and development.8

To help sort out the issue, Jagdish Bhagwati created four categories of governance and market orientation into which most countries fall: 

o Democracies with markets have had good economic

performance and strong social indicators. Most

Western countries are in this category.

o Democracies without markets have had poor economic performance and weak social indicators.

India has been the classic example.

o Authoritarian governments without markets have

failed in terms of economic growth and social indicators. The former socialist countries of the Soviet

bloc are obvious illustrations.

6. World Bank, World Development Report 1987. Just as the rate of

return on traditional investment measures the economic benefits of that

investment relative to its cost, the rate of return on education measures

the gains in income realized by those who attain particular levels of

education.

7. Agency for International Development, Annual Report on Program

Performance 1994 (March 1995), p. 19.

8. For a balanced discussion of this issue, see World Bank, World Development Report 1991, pp. 132-134.
24 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

o Authoritarian governments with markets have

made rapid gains in prosperity. Examples include

China, the fast-growing countries of East Asia, and

Chile under General Pinochet.

Bhagwati's categorization suggests that market liberalization has been a very strong determinant of growth

and that democracy may facilitate growth; without

strong markets, however, democracy will not be able to

sustain growth.9

The Influence of Domestic 

Economic Policy on 

Development

The development literature argues that the economic

policy environment is crucial to long-term development.

At the most basic level, of course, countries need to

have a market-oriented economy dominated by a private sector. Beyond that, sound economic management

of that economy and an outward-oriented trade and industrialization strategy are essential components of successful long-term development.

Monetary and Fiscal Policy

Experts generally agree that a country’s economic policies play an extremely important role in its development. In the long run, economic growth depends on the

growth of physical and human capital and their productivity. Physical capital is largely a country’s infrastructure&roads, bridges, canals, irrigation systems,

communication networks, and the like. Human capital

is the health and education of a country’s population.

The growth of a country’s human capital is largely

determined by the growth of its population and skills

base, and that of its physical capital by the country’s

rate of net saving. Noninflationary monetary policies

and low budget deficits provide a favorable environment for saving and for accumulating capital, whereas

large deficits, high inflation, and the resulting financial

instability work against them. The factors that determine productivity are not well understood, but other

aspects of economic policy can affect the ability of an

economy to deploy resources productively. Policies

that create uncertainty or that otherwise harm the incentives for saving and investing and for accumulating

physical and human capital will inhibit development

and economic growth.10

Uncontrolled fiscal policies, according to development economists, have been at the center of the economic problems of many developing countries in which

an ill-disciplined public sector has diverted resources

from the private economy. Spending on large government payrolls, government industries that are inefficiently run, and various subsidy programs (for the population as a whole, for specific economic sectors, or for

individual industries) have created large fiscal deficits

in many developing countries. For example, before the

economic reform program under President Carlos

Menem, Argentina had high government budget deficits

that were caused in part by large annual losses in more

than 300 state-owned enterprises.11

A common means of financing the resulting government deficits has been to expand the money supply.

But doing so has led in turn to inflation and ultimately&if the country has fixed nominal exchange

rates and an overvalued currency in inflation-adjusted

terms&to shortages in foreign exchange. Foreign investors may be reluctant to lend to such an economy,

and the foreign currency reserves required to maintain a

fixed exchange rate may run out.

Many governments have tried to regulate and control the operation of private markets in ways that have

further distorted the incentives for private economic

production and investment. Setting price controls,

granting monopolies, and subsidizing particular producers are all ways in which governments have wasted

resources by overriding the functioning of the market.

Controls on interest rates and capital flows and the rationing of foreign exchange become necessary when a

government tries to isolate its domestic economy from

the powerful market forces of the world economy. As

9. Jagdish Bhagwati, $New Thinking on Development,# Journal of Democracy, vol. 6 (October 1995), pp. 61-62.

10. World Bank, World Development Report 1991, pp. 109-127.

11. Anne O. Krueger, Constantine Michalopoulos, and Vernon W. Ruttan,

eds., Aid and Development (Baltimore: Johns Hopkins University

Press, 1989), p. 56.
CHAPTER THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 25

markets are controlled and suppressed, prices become

distorted, inhibiting the effective and efficient use of

society’s resources. Some analysts have found that the

greater the restrictions on interest rates, the lower the

economic growth. Other common distortions include

having minimum-wage laws, placing limits on laying

off workers, and setting public-sector wages above

those of the private sector for comparable jobs.12

Trade and Industrialization Policy

The extent of a country's openness and integration in

the world economy and trading system is also important

to development. The discipline of world market prices

makes it much harder to sustain distortionary domestic

policies that might divert the economy's resources to

wasteful and inefficient uses. Substantial evidence indicates that the more a country adopts a generally outward-looking economic policy, the more likely it is to

experience sustained economic growth and improved

social welfare.

Two primary strategies for becoming industrialized

directly involve trade policies: inward-looking import

substitution and outward-looking export-led growth.

This discussion relies on the following factors to distinguish between those two strategies:13

o Degree of trade protection. The lower the actual

protection for domestic markets, the more trade

policy is export-oriented. Policies that contribute

to the effective rate of protection include tariffs and

nontariff barriers as well as taxes and subsidies for

inputs, such as energy or steel, that are used to

make particular products.

o Use of direct controls such as quotas and import

licensing. The less a country relies on direct controls on imports, the more outward-oriented the

economy.

o Use of export incentives. The greater the use of

broad-based export subsidies and incentives, the

more export-led and outward-oriented the economy.

o Degree of overvaluation of the exchange rate.

Outward orientation generally reflects an appropriately valued exchange rate.

Import Substitution. When policymakers pursue an

import-substitution strategy, they adopt policies to encourage the domestic production of as many industrial

goods as possible. They may place high tariffs on imports and grant credits or exemptions from import taxes

to producers of particular goods. Such policies protect

industries from international competition and encourage

the production of items at home that would otherwise

have been imported in the absence of subsidies and

trade restrictions.

The motivation for this strategy is understandable.

Many developing countries recognize that the path to

greater prosperity is through industrialization. But new

industries in developing countries find it very difficult

to compete with established producers from the more

advanced economies unless they have some sort of protection or subsidy. Indeed, the United States and Germany used the strategy of protecting new industries in

the late 1800s to develop their industrial sector in the

face of competition from more established and advanced companies in Great Britain, the first nation to

industrialize.

This strategy initially may spur industrialization

and economic growth, but unless the trade tariffs and

subsidies are gradually removed, the protected industries are likely to become increasingly less efficient over

time because they have little competition. Productivity,

competitiveness, and growth in export earnings slow

down or decline, possibly creating or exacerbating fiscal deficits and other economic problems.

The practice of import substitution has led many

developing countries to set up government-run enterprises or to nationalize industry so that they can produce goods directly. They may also use autonomous

institutions to regulate and supervise an entire industrial sector. Those organizations or enterprises may be

poorly run and highly susceptible to corruption. The

government may strangle domestic competition through

12. Ibid., pp. 58-59.

13. World Bank, World Development Report 1987, p. 82.
26 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

overregulation or by restricting access to credit. In addition, the government-run enterprises and autonomous

institutions may create new interest groups that demand

government support and protection from external competitors.

The consequences of such inward-looking economic policies are considerable. Protection removes

much of the incentive for companies to produce more

efficiently and competitively, which tends to result in

goods of inferior quality produced at high costs.

Policymakers often maintain a policy of fixed exchange

rates; as domestic prices increase faster than international prices, the currency becomes overvalued. That

result in turn may lead to more protection in an attempt

to promote growth at home and to restrict domestic demand for imports. Public spending to stimulate development, which can occur simultaneously, also increases

demand for imports and, thus, the pressure for more

protection. Even industries that should be competitive

in world markets may become uncompetitive because

protection eliminates or reduces the incentive for efficiency.

Export-Led Growth. The second strategy is outwardoriented, export-led growth, which usually involves

specializing in a more limited range of products. Exchange rate policy is neutral with respect to exports,

and the government may use broad-based tax rebates or

access to credit to promote exports. This strategy also

encourages domestic companies to produce efficiently

by forcing them to compete with one another for international markets.

Many countries in East and South Asia have generally followed an outward-oriented strategy and have

experienced high rates of economic growth. Countries

such as South Korea, Taiwan, and Singapore as well as

Thailand, Malaysia, and even Indonesia protected domestic producers for a short time and then gradually

allowed more imports to subject the home-grown industries to competitive pressures. They also encouraged

saving, invested in education, and maintained conservative fiscal policies.

Studies have shown that countries that adopt an

outward-oriented trade and economic strategy as well as

policies that have a minimal distorting effect on the

economy achieve higher growth rates than inward-looking countries. Jeffrey Sachs and Andrew Warner found

that developing countries with open economies grew at

an average annual rate of 4.5 percent between 1970 and

1989 compared with only 0.7 percent for those with

closed economies.14

The World Bank came to a similar conclusion in its

1987 World Development Report. It classified 41 developing countries into four categories: strongly

outward-oriented; moderately outward-oriented; moderately inward-oriented; and strongly inward-oriented

(see Table 7). The bank found that an outward orientation was positively related to higher growth rates for

real gross domestic product (GDP), higher real gross

national product per capita, more productive investment

as represented by the incremental ratio of capital to output, and higher rates of growth in manufactured exports

(see Figure 4). The bank concluded that $the economic

performance of the outward-oriented economies has

been broadly superior to that of the inward-oriented

economies in almost all respects.#15

The Role of Foreign Aid

in Development

The literature that has evaluated the role of foreign aid

in development falls into two broad categories. A substantial empirical literature attempts to analyze the effects of foreign aid on economic growth using statistical

models and aggregate data on economic and foreign aid

for large numbers of countries. A second body of literature attempts to understand the role of foreign aid in

development in a more qualitative fashion, relying on

in-depth research or case studies of particular foreign

aid programs. The empirical literature thus far is inconclusive. The qualitative literature generally argues

that foreign aid can help development if the policy environment is favorable to growth.

14. Jeffrey D. Sachs and Andrew Warner, $Economic Reform and the

Process of Global Integration,# Brookings Papers on Economic Activity, no. 1 (1995), p. 36.

15. World Bank, World Development Report 1987, p. 85.
CHAPTER THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 27

Table 7.

Classification of 41 Developing Economies by Trade Orientation, 1963-1973 and 1973-1985

Strongly Moderately Moderately Strongly

Period Outward-Oriented Outward-Oriented Inward-Oriented Inward-Oriented

1963-1973 Hong Kong Brazil Bolivia Argentina

South Korea Cameroon El Salvador Bangladesh

Singapore Colombia Honduras Burundi

Costa Rica Kenya Chile

Côte d’Ivoire Madagascar Dominican Republic

Guatemala Mexico Ethiopia

Indonesia Nicaragua Ghana

Israel Nigeria India

Malaysia Philippines Pakistan

Thailand Senegal Peru

Tunisia Sri Lanka

Yugoslavia Sudan

Tanzania

Turkey

Uruguay

Zambia

1973-1985 Hong Kong Brazil Cameroon Argentina

South Korea Chile Colombia Bangladesh

Singapore Israel Costa Rica Bolivia

Malaysia Côte d’Ivoire Burundi

Thailand El Salvador Dominican Republic

Tunisia Guatemala Ethiopia

Turkey Honduras Ghana

Uruguay Indonesia India

Kenya Madagascar

Mexico Nigeria

Nicaragua Peru

Pakistan Sudan

Philippines Tanzania

Senegal Zambia

Sri Lanka

Yugoslavia

SOURCE: Congressional Budget Office using data from World Bank, World Development Report 1987 (New York: Oxford University Press, 1987).

NOTES: Strongly Outward-Oriented: Trade controls are nonexistent or very low; disincentives to export resulting from import barriers are more or

less counterbalanced by incentives to export. There is little or no use of direct controls and licensing agreements, and the exchange rate

is maintained such that the effective exchange rates for imports and exports are roughly equal.

Moderately Outward-Oriented: The overall incentive structure is biased toward production for domestic rather than export markets. But

the average rate of effective protection for the home markets is relatively low, and the range of effective protection rates is relatively narrow.

The use of direct controls and licensing arrangements is limited, and although some direct incentives to export may be provided, they do

not offset protection against imports. The effective exchange rate is higher for imports than for exports, but only slightly.

Moderately Inward-Oriented: The overall incentive structure distinctly favors production for the domestic market. The average rate of

effective protection for home markets is relatively high, and the range of effective protection rates is relatively wide. The use of direct

controls on imports and licensing is extensive. Although some direct incentives to export may be provided, there is a distinct bias against

exports, and the exchange rate is clearly overvalued.

Strongly Inward-Oriented: The overall incentive structure favors production for the domestic market. The average rate of effective

protection for home markets is high, and the range of effective protection rates is relatively wide. The use of direct controls on imports and

licensing disincentives to the traditional export sector is pervasive, positive incentives to nontraditional exports are few or nonexistent, and

the exchange rate is significantly overvalued.
0

2

4

6

8

10 Average Annual Growth (Percent)

Real Gross Domestic Product

-2

0

2

4

6

8

10 Average Annual Growth (Percent)

Real Gross National Product per Capita

0

2

4

6

8

10 Average Annual Ratio

Incremental Ratio of Capital to Output

0

5

10

15

20

a Manufactured Exports

Average Annual Growth (Percent)

Strongly

OutwardOriented

Moderately

OutwardOriented

Moderately

InwardOriented

Strongly

InwardOriented

Strongly

OutwardOriented

Moderately

OutwardOriented

Moderately

InwardOriented

Strongly

InwardOriented

Strongly

OutwardOriented

Moderately

OutwardOriented

Moderately

InwardOriented

Strongly

InwardOriented

Strongly

OutwardOriented

Moderately

OutwardOriented

Moderately

InwardOriented

Strongly

InwardOriented

1963-1973 1973-1985 1963-1973 1973-1985

1963-1973 1973-1985 1963-1973 1973-1985

28 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Figure 4.

Performance of 41 Developing Economies Grouped by Trade Orientation

SOURCE: Congressional Budget Office based on data from World Bank, World Development Report 1987 (New York: Oxford University Press,

1987).

NOTE: Averages are weighted by each country’s share in the group total for each indicator. See Table 7 for a list of the economies in each of the

trade groups.

a. For the incremental ratio of capital to output, the lowest value indicates the most productive investment.
CHAPTER THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 29

Evidence from Statistical Studies

Ever since the pathbreaking analysis by Hollis Chenery

and Alan Strout, there has been considerable interest in

what might be called the econometrics of foreign aid.

Those authors developed the $two-gap# model of development. According to that model, to achieve a given 16

growth rate, a developing country must have adequate

savings for investment and sufficient foreign exchange

to buy the capital goods necessary for development

from the international market. If a country is deficient

in either area, then foreign aid can fill the gap either by

providing foreign saving to supplement inadequate domestic saving or by providing the necessary foreign

exchange to buy the goods and services in the international market that the country requires for development

but cannot produce on its own. Thus, by specifying a

particular growth rate and holding productivity constant, one can determine the amount of aid needed to

achieve that growth by subtracting the domestic saving

rate from the growth rate or subtracting export earnings

from import requirements. The larger of the two gaps

is the amount of foreign aid the country needs to

achieve the given growth rate. Foreign aid will $fill two

gaps at once# because foreign aid provided as foreign

exchange can be used to buy imported capital goods

and can supplement domestic saving directly.

Chenery and Strout analyzed data for 50 developing nations. For each country, they measured the

growth rate of GNP, the rate of investment, the rate of

domestic saving, and the propensity to export and import. Using those values, they identified countries that

were likely to benefit from an infusion of external resources because their own saving were inadequate, as

well as others for which greater aid might be of limited

value. But Chenery and Strout assumed that foreign

assistance would be productive if inadequate saving or

foreign exchange was the constraint on growth.

A number of other economists have attempted to

measure statistically the extent to which foreign aid

encourages economic development. Two separate,

though related, issues are of interest to analysts and

policymakers: Do the projects funded through foreign

assistance programs yield a positive economic return,

and do the projects achieve the objective set for them?

To explore the first issue, the multilateral lending agencies, for example, regularly assess the returns on the

projects funded by their loans and periodically compile

them into an overall assessment of effectiveness. According to their analyses, foreign aid projects, as a

whole, appear to yield favorable rates of return. A

1995 study by the World Bank found an average rate of

return of 17 percent on projects completed between

1990 and 1994. Assessments by the Asian Development Bank and the Inter-American Development Bank

have yielded similar results. To determine whether projects achieve their objectives&for example, the construction of a road or hospital&a team of researchers

reviewed project evaluations from the early 1980s.

They concluded that projects, on average, produce satisfactory results. As evidence, they cited the findings of

eight major agencies that had evaluated a large number

of their projects. Their evaluations indicated that twothirds to three-quarters of the projects broadly achieved

their objectives.17

Not all analysts would accept project results as definitive proof of the effectiveness of aid. Project evaluations, though useful in judging the performance of lending institutions and their staffs, do not capture the overall economic effects of aid, whether positive or negative. Proponents of aid might argue that the transfer of

technology and knowledge that accompanies many major aid efforts could have important spillover benefits

that the agencies' assessments do not capture. For instance, a major construction project may equip workers

with skills that they will retain and continue to use after

that particular project is completed. Conversely, the

construction of a dam to generate hydroelectric power

may succeed in the sense that electricity is produced,

but it may have disastrous environmental consequences

for the neighboring villages, wildlife, and other natural

resources.

Critics of foreign assistance argue, however, that

the receipt of such aid discourages domestic saving.

They believe that projects that represent good investment opportunities will be financed in any event using

private foreign or domestic funding. The receipt of foreign assistance may simply divert those funds into con16. H.B. Chenery and A.M. Strout, "Foreign Assistance and Economic

Development," American Economic Review, vol. 56 (September

1966), pp. 679-733.

17. Robert Cassen and others, Does Aid Work? Report to an Intergovernmental Task Force (Oxford: Clarendon Press, 1986), p. 307.
30 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

sumption, for no net gain in total domestic investment

activity.

For those reasons&and also because aggregate national data are more accessible to the academic scholar

than are project data&most empirical studies of development have attempted to determine whether receiving

foreign assistance can be shown to be positively related

to higher rates of national saving, capital formation, or

economic growth. A typical study would gather aggregate national statistics for those variables for some 50

to 100 developing countries. Data would be in the form

of annual averages for growth rates, saving rates, and

inflows of aid and foreign investment. Data are expressed as a percentage of GDP to avoid weighting the

larger nations more heavily in the results.

The results of such studies are far less definitive

than were analyses of large numbers of project evaluations. If aid does not add significantly to total national

saving, it is not likely to promote growth. Early studies, confirmed by more recent investigations, found that

foreign assistance contributed little, if any, impetus to

saving and instead increased domestic consumption.

Table 8.

Selected Studies Examining the Correlation of Aid with National Saving, 

Capital Formation, and Economic Growth

Study Conclusions

Griffin and Enos (1970) Aid receipts appear to reduce domestic saving; thus, they do not add to investment. a

Weisskopf (1972) The inflow of foreign capital has a significantly negative impact on domestic saving. b

Papanek (1972) Omitted factors that produce below-average saving rates will produce above-aver- c

age foreign inflows. That biases the relationship between aid and saving.

Heller (1975) A positive and significant relationship exists between foreign aid and investment. d

Mosley (1987) No significant correlation exists between aid and growth once other factors such as e

private capital flows and domestic saving are taken into account.

Boone (1996) No significant correlation exists between aid and growth. Virtually all aid goes to f

consumption.

SOURCE: Congressional Budget Office using sources listed below.

a. Keith L. Griffin and J.L. Enos, $Foreign Assistance: Objectives and Consequences,# Economic Development and Cultural Change, vol. 18 (April

1970), pp. 313-337, as cited in Anne O. Krueger, Constantine Michalopoulos, and Vernon W. Ruttan, eds., Aid and Development (Baltimore:

Johns Hopkins University Press, 1989), Chapter 7.

b. Thomas E. Weisskopf, $The Impact of Foreign Capital Inflow on Domestic Savings in Underdeveloped Countries,# Journal of International

Economics, vol. 2 (February 1972), pp. 25-38.

c. Gustav F. Papanek, $The Effect of Aid and Other Resource Transfers on Savings and Growth in Less Developed Countries,# Economic Journal,

vol. 82 (September 1972), pp. 934-950, as cited in Anne O. Krueger, Constantine Michalopoulos, and Vernon W. Ruttan, eds., Aid and Development (Baltimore: Johns Hopkins University Press, 1989), p. 120.

d. Peter S. Heller, $A Model of Public Fiscal Behavior in Developing Countries: Aid, Investment, and Taxation,# American Economic Review, vol. 65

(June 1975), pp. 429-445. The analysis employed a multiequation model.

e. Paul Mosley, Overseas Aid: Its Defence and Reform (Brighton, England: Wheatsheaf Books, 1987), Chapter 5.

f. Peter Boone, $Politics and the Effectiveness of Foreign Aid,# European Economic Review, vol. 40 (1996), pp. 289-329.
CHAPTER THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 31

One reason could be that for most countries, aid flows

are simply too small to make a difference in overall national saving rates (see Table 8 for a summary of major

studies since 1970).

Such a conclusion is not inconsistent with the

broader aims of foreign assistance programs&improving the health and welfare of the population, promoting

democracy, and so forth. But it is inconsistent with the

narrower proposition that receipt of aid promotes economic growth. Although the majority of studies have

failed to find a link between aid and economic growth,

some analysts have obtained more positive results. In

particular, a positive correlation between aid, saving,

and growth has been established for the group of developing countries in Asia. The overall negative findings

can be attributed mainly to the failure of aid to countries in Africa to improve their economies.

Gustav Papanek attributes the negative results of

studies of foreign aid to statistical biases. In particular,

the fact that aid is targeted toward the poorer nations

might bias downward the measured correlation between

saving or growth rates and the amount of aid received.

Using more complex models, some analysts found a

positive and significant relationship between the formation of capital and public and private investment flows.

In a recent article, N. Gregory Mankiw of Harvard

University, after examining empirical models of nations’ growth, suggested that the roughly 100 nations

for which data on economic performance over recent

decades are available offer too few observations to allow scholars to discriminate among the many factors

said to contribute to growth, notably including foreign

aid. According to Mankiw, the empirical evidence 18

from this body of research is simply too limited to enable analysts to reach strong conclusions.

Evidence from Qualitative Studies

CBO found that the qualitative literature on foreign aid

and development strongly suggests that the usefulness

of development assistance varies with the quality of a

country’s governance and the economic policies it pursues. In countries whose policy environment is highly

unfavorable to growth, aid is less likely to be productive and contribute to long-term development. According to one group of scholars, $in terms of growth prospects and performance, no amount of foreign assistance

can substitute for a developing country’s internal policies and incentives for increasing output and improving

the efficiency of resource allocation.# Development 19

assistance has enabled some countries whose policy

environment was not quite as severe to achieve temporarily higher rates of growth than if they had not received aid at all. Although foreign aid may allow developing countries to postpone correcting their economic

policies, it may also encourage them to adopt needed

economic reforms. Finally, foreign assistance can help

strengthen development in countries whose policies do

not distort the allocation of resources in the economy.20

Studies by the World Bank have tended to confirm

those broad conclusions. In its 1991 World Development Report, the bank found decreasing rates of return

for its aid projects as the overall policy environment

deteriorated along various economic indicators (see

Table 9). And the World Bank’s Wapenhans Report

&an extensive inquiry into the effective implementation

of aid projects¬ed that its $findings support the

need for linking strategy, especially in social sectors,

even at the project level, to the overall framework of

policies at the country level. Even very well designed

projects cannot succeed in a poor policy or regulatory

environment.#21

Policy Dialogue and Conditionality. In light of the

crucial importance of governance and economic policies, foreign aid may be able to help developing countries make appropriate political and economic reforms.

Donors can encourage policy reform through two primary means: policy dialogue (donors give aid to create

opportunities for policy discussions and interactions

with the recipient on key issues such as macroeconomic

policy) and conditionality (donors release the aid only if

recipients meet certain economic criteria, such as reducing fiscal deficits below certain levels or reducing tar18. Mankiw, $The Growth of Nations.#

19. Krueger, Michalopoulos, and Ruttan, Aid and Development, p. 89.

20. Ibid., pp. 60-62. 

21. Portfolio Management Task Force, Effective Implementation: Key to

Development Impact (Washington, D.C.: World Bank, September

1992), p. 7.
32 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

iffs by a particular percentage within a specified time

frame).

In practice, policy dialogue and conditionality are

often two sides of the same coin. In the background of

even the most benign policy dialogue is the mutual understanding between donor and recipient that aid can be

terminated at any time, even if that is unlikely. Yet

conditionality in the absence of dialogue is unlikely to

occur and is probably too blunt an instrument for

achieving the desired objectives of reform. Thus, many

aid relationships involve some element of both policy

dialogue and conditionality&if policy reform and development are the objectives of the aid&but the balance

between the two varies from country to country and

donor to donor.

The record on the effectiveness of policy dialogue

and conditionality is mixed. In the 1950s and 1960s,

Table 9.

Rates of Return on Successful Aid Projects

Financed by the World Bank, 1968-1989, by Policy

Environment of Recipient Countries (In percent)

Policy and Level of Distortion Rates of

in Recipient Countries Return

Trade Restrictiveness

High 13.2

Moderate 15.0

Low 19.0

Foreign Exchange Premium

High (200 percent or more) 8.2

Moderate (20 percent to 200 percent) 14.4

Low (Less than 20 percent) 17.7

Real Interest Rate

Negative 15.0

Positive 17.3

Fiscal Deficit as a Percentage 

of Gross Domestic Product

High (8 percent or more) 13.4

Moderate (4 percent to 8 percent) 14.8

Low (Less than 4 percent) 17.8

SOURCE: Congressional Budget Office based on data from the

World Bank, World Development Report 1991: The

Challenge of Development (New York: Oxford University

Press, 1991), p. 82.

for example, U.S. aid to some Asian countries involved

both policy dialogue and elements of conditionality.

That approach yielded some positive results in South

Korea and Taiwan but was much less successful in

India.

More recently, multilateral institutions, particularly

the World Bank, have used both tools to encourage recipients to make macroeconomic reforms, and those

efforts have also had mixed results. The main mechanism they use is known as structural adjustment lending, a process by which donors make loans to recipients

in successive tranches as policy reforms are carried out.

Those reforms are usually negotiated between donors

and recipients. How successful those efforts have been,

however, is not clear.

Policy dialogue and conditionality have perhaps

been most effective when recipients knew they had to

make reforms and wanted to make them but needed

some extra political cover to do so. Such economic

reforms as cutting government spending, reducing subsidies, and lifting trade barriers are inherently unpopular because they take benefits away from some groups

&and in some cases, politically powerful ones. Under

those circumstances, foreign aid may lend credibility to

a reform effort and soften the negative consequences

such reforms may have. More specifically, officials in

the recipient country may have realized that such reforms are necessary&either through a dialogue with

donors or on their own&but would like the presence of

$conditions# so that the onus of making such unpopular

changes is shifted to a foreign entity, thereby reducing

the political pressure on themselves. According to

some scholars, cases of such $phantom# leverage are

quite common.22

Increasing Resources for Investment. The main

macroeconomic mechanism by which aid can promote

growth is to enlarge the pool of capital available for

investment and growth. Even in a favorable policy environment, however, foreign aid may permit domestic

resources to be diverted from investment to consumption, with no net effect on growth. Empirical studies of

this issue, as was indicated earlier, have yielded inconclusive results. Studies of individual countries are

22. Krueger, Michalopoulos, and Ruttan, Aid and Development, p. 91.
CHAPTER THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 33

equally inconclusive: aid seems to contribute to saving

in some cases but not in others.23

Providing Public Goods. Foreign aid might help raise

the level of investment in the economy by easing the

constraints on public funds available for necessary public investments&that is, goods that are important for

production and for which the returns cannot be captured

and used to repay borrowing; public investments may

include infrastructure such as rural roads. Foreign aid

might also limit the strains on the domestic tax base

and prevent costly distortions. For example, the recipient might levy tariffs to fund those public investments if it does not receive aid.

According to the Agency for International Development, the success of foreign aid in supporting public

investment also varies widely. The Inter-American

Highway in Central America was funded largely

through foreign aid (though it was not called that at the

time), and it has contributed enormously to improving

the prospects of growth for Central American countries.

But such projects have also failed. Many aid-financed

projects languished after their completion, because the

recipient government was unwilling or unable to provide adequate maintenance.

Increasing Human Capital. Foreign aid might be

able to help a country develop its human capital&for

example, by supporting elementary education or basic

health care. Investment in human capital in developing

countries is often more difficult to finance than are

physical capital projects. Even in relatively rich countries, private investors are wary of lending for skills and

education without a government guarantee for a return

on investment. Foreign aid, however, may be able to

provide targeted funds for enhancing human capital and

thereby raise the economy’s stock of skills and, perhaps, stimulate growth.

Foreign aid can claim some credit in this area. Aid

resources have helped strengthen agricultural production by funding new crop varieties, irrigation programs,

and extension practices. They have also played a role

in sponsoring research, education, and immunization

programs that have led to the control of various diseases such as smallpox, polio, diphtheria, and measles.

But simply investing more in physical or human

capital will not necessarily lead to fast economic

growth. Many countries have invested heavily over

long periods but have not grown quickly. Productive 24

investment in human&as well as physical&capital still

depends on the policy environment. In the words of the

1995 World Development Report, $Greater investment

in human capital can neither compensate for nor overcome an environment inimical to economic growth.#25

In addition, the particular investment choices also

matter. For example, the World Bank argues that excessive spending on education bureaucracy and school

infrastructure, rather than on teaching staff and supplies, undermines the quality and quantity of schooling.

So may investing too much in higher education relative

to basic literacy or elementary education. The skills

being taught should match the needs and economic opportunities of the country.26

Facilitating the Transfer of Technology. Another

channel through which aid might foster growth is technical assistance and technology transfer. That type of

aid promotes growth not by accumulating greater resources but by making existing resources more efficient

and effective. Technical assistance programs may also

include educating and training government officials

who play a large role in creating the policy environment

and using foreign aid. Helping developing countries to

organize institutions that protect property and minority

rights is another example. As in other cases, the success

of such programs will probably depend on the political

and economic environment in which they operate. For

example, according to some analysts, $assistance to

encourage agricultural production had a substantially

higher payoff in the presence of realistic exchange rate

and trade policies.#27

23. Cassen and others, Does Aid Work? p. 24.

24. World Bank, World Development Report 1995: Workers in an Integrating World (New York: Oxford University Press, 1995), pp. 20-21.

25. Ibid., p. 37.

26. Ibid.

27. Krueger, Michalopoulos, and Ruttan, Aid and Development, p. 63.
34 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Bilateral Versus Multilateral

Assistance

As discussed in Chapter 2, aid is channeled to recipients through both bilateral and multilateral donors.

Individual countries give aid through their own bilateral

aid programs. Multilateral donors are the international

financial institutions, such as the World Bank Group or

the regional multilateral development banks, that receive their money from individual countries and capital

markets and then lend it to developing countries. Both

types of assistance programs have advantages and disadvantages in providing aid to developing countries.

Strengths and Weaknesses of 

Bilateral Aid Programs

From a developmental perspective, the strengths of bilateral aid programs include an ability to render effective technical assistance, build institutions, and develop

close relationships with recipients. Donor policies that

may hinder the usefulness of aid include giving aid for

political reasons, tying aid to the purchase of the donor’s goods and services, and adopting other economic

policies&such as import quotas&that undermine the

objectives of an aid program. Those policies may have

important objectives in their own right, but they may

come at a cost to development.

Close Relationships. Some nations tend to concentrate

their aid on a few recipients. Consequently, bilateral

donors may develop close, long-standing relationships

with those recipients and thereby improve the effectiveness of aid. Cultural or linguistic similarities help create the skills needed for effective communication across

national political boundaries. For example, the aid programs of France are directed toward many of its former

colonies with whom it maintains a close relationship.

Such relationships make it easier for the donor to render

technical assistance and better understand what kind of

aid programs might achieve the best results for the recipient.28

Institution Building. Bilateral donors appear to have

more practical experience in helping developing countries build various institutions that foster development,

such as a judicial system, than do multilateral organizations. Thus, they are likely to be better placed to help

aid recipients build such institutions on their own, particularly if the donor and recipient share a common language and, to some degree, a political heritage.

Functional Specialties. Bilateral donors have developed particular areas of expertise, such as strengthening public institutions (see Table 10). Having that expertise, however, does not necessarily mean that they

will be successful or effective in applying it. In addition, major bilateral donors usually have a significant

in-country presence that enables them to monitor their

assistance and ensure that the amount of aid that is

wasted or diverted is minimal.

Multiple Purposes of Foreign Aid. The reasons for

which bilateral aid is given may affect its usefulness in

promoting development. For example, the aid may be

politically motivated; that is, developing countries are

the recipients of donors’ largesse because they are politically or strategically important, not because they are

the ones most in need or most capable of making effective use of the aid. Aid may also be given to alleviate

the effects of natural disasters or increase the donor’s

exports as well as to promote the economic and social

development of the recipient. Whatever the motivation

of the donor, foreign assistance will probably influence

the development process of the recipient.

Nevertheless, foreign aid may not be as useful in

encouraging economic growth when the donor shapes

its program with another goal in mind. The recipient

may know that it is considered strategically important

and may therefore be unwilling to adopt policies that

would promote long-term development, particularly if

the policies are painful in the short run. Rather than

adopt needed reforms, recipient countries may use the

aid to compensate for inefficient economic policies.29

Some prominent examples include U.S. assistance to

Honduras and Egypt in the 1980s. From the recipient’s

point of view, however, the political winds in the donor

28. Cassen and others, Does Aid Work? p. 209.

29. See, for example, the testimony of Nicolas Van de Walle, The Future

of Aid to Africa, before the Subcommittee on African Affairs of the

Senate Committee on Foreign Relations, May 1, 1996, pp. 4-5.
CHAPTER THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 35

Table 10.

Functional Specialties of Major Bilateral Aid Donors

Country Functional Specialty

United States Covering a broad geographic area because of the size, breadth, and history of the U.S. aid

program. Maintaining large in-country missions aiding country-specific analysis and longterm relationships with governments. Using U.S. institutions for public education and for

mobilizing resources. Conducting research and training in agriculture.

Japan Strengthening and investing in electrification and public utilities. Focuses aid on Asian countries.

France Strengthening public and private institutions. Promoting the development of export crops.

Focuses aid on former colonies.

United Kingdom Strengthening public and private institutions. Promoting the development of export crops.

Focuses aid on former colonies.

Germany Strengthening and investing in public utilities.

Scandinavia Promoting alleviation of poverty, especially in countries that other donors would not or could a

not work in for political reasons.

SOURCE: Congressional Budget Office based on John W. Mellor and William A. Masters, $The Changing Roles of Multilateral and Bilateral Foreign

Assistance,# in Uma Lele and Ijaz Nabi, eds., Transitions in Development: The Role of Aid and Commercial Flows (San Francisco: ICS

Press, 1991), pp. 352-353.

a. Sweden, Norway, Denmark, Finland.

country may change suddenly, resulting in a dramatic

cutoff of aid, which could hurt development.

According to the Organization for Economic Cooperation and Development, however, the end of the Cold

War has reduced much of that behavior. Donor states

are becoming more selective and careful with respect to

giving aid. Countries that seem unwilling to make reforms or take steps to help themselves are finding it

increasingly difficult to attract economic assistance.30

Contradictory Policies. The economic or trade policies of a single donor may contradict and undermine its

foreign assistance program. For example, a donor may

give aid to a developing country to improve its industry

and promote exports; at the same time, the donor raises

trade barriers to the importation of the recipient country’s products that the assistance was intended to promote. As one observer wrote:

In Bangladesh, for example, U.S. authorities

actively urged the government to promote manufactured exports of labor-intensive goods.

Policies changed as a result, and some clothing

exports soared in response. Soon after the

boom, U.S. trade officials confronted Bangladeshi authorities eager to negotiate quotas that

would restrict apparel exports to the United

States! Such restrictions have been in place

since 1986.31

Tied Aid. A donor may require a recipient to spend

some or all of its foreign aid on goods and services pro30. Organization for Economic Cooperation and Development, Development Assistance Committee, Development Cooperation 1994: Efforts

and Policies of the Members of the Development Assistance Committee (Paris: OECD, 1995), p. 89.

31. Anne O. Krueger, Economic Policies at Cross-Purposes: The United

States and Developing Countries (Washington, D.C.: Brookings Institution, 1993), p. 63.
36 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

duced in the donor’s country, a practice known as tying

aid. In a newer form of tied aid, the donor offers aid as

subsidized credit for the purchase of its exports. Donor

governments then justify aid budgets by arguing that

they promote their commercial objectives and exports.

The degree to which OECD countries tie their aid

varies considerably and changes from year to year. In

1992, Spain tied nearly 86 percent of its official development assistance, compared with Norway at only 20

percent. The United States tied approximately 50 percent&nearly $6 billion&of its official development assistance. In 1993, however, those figures fell to 33 percent for Spain, 29 percent for the United States, and 11

percent for Norway.

The tying of funds may have hidden costs for the

recipient. The Development Cooperation 1994 report,

put out by the OECD’s Development Assistance Committee, cites the following:

o The aid may be given with the best interests of the

donor in mind, not those of the recipient country.

o The subsidy involved in concessional aid may benefit the exporter rather than the recipient. 

o Linkages between the development projects and the

local economies are not formed. Thus, the local

economy derives little long-term benefit from the

projects.

No consensus exists, however, as to whether tying

aid undermines its effectiveness. On the one hand, recipient countries sometimes manage to evade the tying

effect of aid when it is imposed. On the other hand,

studies of individual countries have found that tying aid

increases the costs of goods purchased with foreign

assistance by as little as 12 percent or by as much as 80

percent. The Development Cooperation 1994 report 32

argues, however, that the tying of aid matters less than

the degree of competition in the procurement process

for aid contracts. Competition in awarding aid contracts, even if they must be awarded to the companies

of the donor country, may provide better value than

untied aid contracts that are not subject to a bidding

process. Most U.S. aid contracts are subject to com- 33

petition, and only U.S. companies may compete for

them. That would suggest that the prices for goods and

services needed by U.S. aid-administering organizations are competitive, at least in the U.S. market.

Strengths and Weaknesses 

of Multilateral Donors

Multilateral donors such as the World Bank or the regional multilateral development banks do not have

some of the disadvantages of bilateral donors. Their

aid is less politically motivated; they tend to give aid to

the poorest countries. Nor do multilateral donors tie

their aid. As some analysts have put it, multilaterals

$can establish systems of international competitive bidding to purchase goods and services at the lowest possible cost and maximize the real value of aid flows.#34

Another advantage is that they will not undermine the

objective of an aid program through other economic

policies such as import quotas. They also have been

able&more so than bilateral donors&to make longerterm and more stable commitments for aid geared to the

resource needs of the recipient.

The central functional specialty of the multilateral

organizations is promoting and supporting the economic reforms necessary for creating a policy environment that is conducive to economic growth. Those activities include opening trade regimes, minimizing restrictions on the private sector, and building economic

infrastructure.35

The disadvantages of multilateral aid center around

the relationship those donors have with recipients. The

multilateral institutions provide most of their assistance

32. Krueger, Michalopoulos, and Ruttan, Aid and Development, p. 81.

33. Organization for Economic Cooperation and Development, Development Cooperation 1994, pp. 28-29.

34. John W. Mellor and William A. Masters, $The Changing Roles of

Multilateral and Bilateral Foreign Assistance,# in Uma Lele and Ijaz

Nabi, eds., Transitions in Development: The Role of Aid and Commercial Flows (San Francisco: ICS Press, 1991), p. 361.

35. Ibid., p. 360.
CHAPTER THREE DEVELOPMENT AND THE ROLE OF FOREIGN AID 37

to the governments of recipient countries. That prac- 36

tice may tend to increase the relative power of government in the economy and in promoting development in

recipient countries. Bilateral donors, such as the

Agency for International Development, may be more

adept at helping to build the civil societies&labor unions, citizens groups, and watchdog organizations&in

developing countries that serve as a check on the

growth of government power and influence. Furthermore, the multilateral institutions may not have the expertise or experience in building institutions, such as an

independent judiciary, that are so important in protecting property rights, enforcing contracts, and maintaining the rule of law.

Coordination Between Bilateral 

and Multilateral Donors

Development assistance received from multiple sources

may create problems of administration and coordination

in a recipient country and thereby undermine the effectiveness of aid. When donors approach a government

with a proposed development project, the recipient

country may agree to the project without integrating it

into a comprehensive development framework. The

lowest-income countries may not even have such a

framework or may be so desperate for foreign assistance that they seldom refuse aid or challenge a donor's

approach. That makes it possible for different donors

to start contradictory programs or for multiple donors

to duplicate projects, reducing the overall effectiveness

of the assistance.

At the very least, an uncoordinated investment program from many donors may strain the capacity of a

recipient to implement, monitor, and maintain those

projects. For example, in the early 1980s, Kenya had

approximately 600 active projects financed by 60 donors. Other African countries had similar experiences. In contrast, other evidence suggests that the 37

more the government of a recipient country is involved

in leading and coordinating aid programs, the more effective and integrated those programs will be in promoting long-term development.38

The problem of coordinating donors has increased

with the proliferation of bilateral and, especially, multilateral donors. In 1960, seven different multilateral aid

agencies gave assistance to developing countries; by

1975, there were 15.

Formally, donors try to reduce these problems

through two primary mechanisms: the World Bank

consultative groups and the U.N. roundtables. Both

donors and recipients attend those meetings to discuss

the programs that will be undertaken in the coming

years and to pledge support. If bilateral and multilateral donors wish to make greater use of their respective

advantages and specialties, then close coordination may

be necessary. For example, if a group of donors intend

to encourage policy reform in a developing country, all

donors must agree on the terms and conditions of granting the assistance, $otherwise, the more lenient lenders

will undercut the rest, and the quality of development

will suffer.#39

However, some development experts believe that

the presence of multiple aid donors in one country is

not necessarily a bad thing. Competition among do- 40

nors may solve developmental problems and get results

sooner. For example, if a donor has a good idea for a

project to solve a particular problem, waiting for the

next coordination meeting could create unnecessary and

counterproductive delays.

The Nature of Aid Flows

The quantity and type of the development assistance

affect the usefulness of aid in promoting economic and

social development. Quantity appears less important

than quality, and quality is determined in part by the

type of assistance that countries receive. Program assistance and technical assistance are generally consid- 36. Indeed, the multilateral institutions are required to get the approval of

the recipient government and its guarantee for loans. The only exceptions are the private windows of the banks. For example, the World

Bank created the International Finance Corporation in 1956 precisely

so that the private sector in developing countries could benefit from its

largesse. Most of the other banks have similar operations. However,

they represent a very small percentage of the overall operations of each

multilateral development bank.

37. Krueger, Michalopoulos, and Ruttan, Aid and Development, p. 104.

38. Van de Walle, The Future of Aid to Africa, p. 5.

39. Cassen and others, Does Aid Work? p. 217.

40. Ibid.
38 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

ered to be the best types of aid to promote policy reform in recipient countries.

Quantity. The amount of foreign aid given to developing countries worldwide is small compared with the size

of their economies&2 percent to 3 percent of their

gross national product. In a few countries, that figure

can exceed 60 percent in a given year, but in many developing countries, the figure is less than 10 percent

(see Appendix B).

Nevertheless, more assistance is not always more

effective. Too much foreign aid given to one recipient

may overwhelm its ability to use the aid effectively and

productively. Yet even a small quantity of aid can be

useful in achieving results, depending on its purpose

and how it is spent. If a small amount of aid can help

convince a developing country to adopt market-oriented

economic policies, it will probably do more good than a

vast investment program in a hostile economic environment. That helps explain why there is no agreement on

what amount of aid, if any, is needed to promote development.

Type. Development assistance is generally classified

into three categories: project assistance, program assistance, and technical assistance. Project assistance refers to a specific investment in the recipient country,

such as the building of a road or a dam. Program assistance is usually a cash transfer as general support for a

country’s overall development objectives. Technical

assistance represents the transfer of knowledge from

the donor to the recipient, either by bringing members

of the recipient country to the donor to study or by

sending experts from the donor country to the recipient

to guide, teach, and ultimately transfer skills and technology. 

No consensus emerges from the development literature as to which type of assistance is most effective.

All three types have had successes and failures. Generally, if a developing country maintains political and

economic policies that are favorable to long-term development, then each type of assistance is likely to be

more productive over the long term. In the absence of

such policies or a willingness to create them, all three

types will probably be unproductive. Determining

which type of assistance is the most useful for helping

countries reform their economic policies is difficult.

If aid donors choose to help a developing country

carry out policy reforms, then some degree of technical

assistance is likely to be important in that effort. Many

developing countries do not have the same depth of expertise and experience as developed countries, particularly in managing an economy. Thus, technical assistance will be highly useful either in training economists

or in using economists as advisers to policymakers in

developing countries.

For encouraging the actual reform effort, program

assistance is generally a more useful and more flexible

instrument than project assistance. Once begun, project

assistance can be ended only at the risk of undermining

the entire project; thus, its use as a tool of leverage is

comparatively weak. But program assistance, because

it is largely a cash transfer, can be turned on and off at

will and disbursed quickly or slowly or in tranches as

the recipient proceeds along a program of reform,

thereby encouraging the right reforms or discouraging

backpedaling or failure to reform. Thus far, donors,

including the multilateral institutions, allocate most of

their resources to project assistance. However, program assistance is growing in importance as donors

increasingly recognize that the overall economic policy

framework plays an extremely important role in determining whether a recipient will continue developing

over the long term.
T

Chapter Four

The Challenge of Development:

Illustrations from Eight Countries

o illustrate the themes presented in Chapter 3,

the Congressional Budget Office reviewed the

development experience of four pairs of countries: South Korea and the Philippines, Costa Rica and

Honduras, Botswana and Zambia, and Tunisia and

Egypt. The first country in each pair has achieved a

greater degree of economic and social development than

the second. In each comparison, except Botswana and

Zambia, who achieved independence in the 1960s,

CBO examined the 40 years from 1953 to 1993. CBO

also looked at five important indicators of development

in each of the eight countries (see Table 11). For most

of those countries, foreign aid has represented a relatively higher portion of gross national product than

have external flows of private capital (see Table 12).

This chapter discusses examples from one or more

of the countries that seem to illustrate a theme or that

run particularly counter to it. Thus, readers will not

find a discussion of every point with respect to all eight

countries.

The Influence of Governance

on Development

The three elements of governance that seem to matter

most in the development process are political stability,

honest and competent government officials, and institutions. As the country examples reveal, however, the

connection between governance and development is a

matter of degree. None of CBO’s successful development cases were completely stable or totally free of

corruption. Nevertheless, more stable, less corrupt, and

more capable countries seemed to achieve greater development than their less stable counterparts.

Political Stability

No country among the eight suffered from the kind of

political instability and turmoil that one associates with

Rwanda or Somalia in the 1990s. Excluding countries

that had experienced such chaos was a deliberate analytic choice. It seemed self-evident that a country engulfed in a devastating, long-term civil war would be

unlikely to develop. Nevertheless, the degree of political stability in the eight countries mattered with respect

to development. But because some of the countries

with weaker growth are also relatively stable, political

stability appears to be a necessary but not sufficient

condition for successful long-term development. Thus,

with respect to this particular theme, each country is

discussed both to emphasize the point that political stability alone will not lead to development and to provide

brief political histories as background to the other

points that will be illustrated in succeeding pages.

South Korea. Between 1953 and 1988, South Korea’s

government was stable and authoritarian. Syngman

Rhee governed Korea as president until 1960 when he

was driven from power by large-scale student demonstrations. Power was shifted to Prime Minister Chang

Myon in a brief era of democratic, parliamentary government. However, nine months later, in the spring of

1961, a coup put the military in power, ending residual

political instability from the upheaval of 1960. General

Park, the leader of the 1961 coup, assumed the presi-
40 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table 11.

Indicators of Development for Eight Countries

Calories

Literacy Infant Consumed b

GNP Population (Percent) Mortality Daily c

per Capita (Thousands) 1970- 1985- (Percent) per Capita a

Country 1960 1991 1960 1994 1975 1990 1967 1992 1961 1992

South Korea 800 9,790 25,003 44,563 88 96 58 11 2,187 3,285

Philippines 911 2,893 27,560 66,188 83 90 72 44 1,708 2,255

Costa Rica 1,963 5,002 1,236 3,304 88 93 68 14 2,168 2,886

Honduras 733 1,583 1,894 5,493 57 73 119 43 1,960 2,306

Botswana 964 3,123 480 1,443 41 72 105 43 2,054 2,264 d

Zambia 879 685 3,141 9,196 n.a. 73 115 104 2,140 1,931

Tunisia 1,067 3,571 4,221 8,815 38 65 138 43 2,069 3,332 e

Egypt 330 2,781 27,840 57,556 n.a. 48 170 67 2,281 3,335 e

SOURCE: Congressional Budget Office based on data from the World Bank, the Agency for International Development, and the University of

Pennsylvania.

NOTE: n.a. = not available.

a. Gross national product (GNP) is in 1994 dollars and is calculated using estimates of purchasing power parity.

b. Literacy is the percentage of literate people in the population over the age of 15. (The data represent a survey made at some point during the fiveyear period.)

c. Infant mortality represents deaths per 1,000 live births.

d. Value is for 1989.

e. Value is for 1961.

dency and launched Korea on its successful path of development. The Revolutionary Committee, headed by

Park, later wrote a new constitution, held elections, and

restored the appearance of a democracy. Park served as

president until his assassination in 1979.

After another brief period of constitutional government, a faction of the military reasserted direct control,

extending martial law and installing General Chung

Doo Hwan as president in 1980. In 1987, however,

South Korea moved to a more democratic system and

held fair elections that were won by the ruling party.

Despite the political upheaval in 1979 and 1980 and the

changes in government, Korea’s approach to development has been fairly consistent and stable for the past

35 years.

The Philippines. The Philippines was a democracy in

the 1950s and 1960s, though in practice a landed oligarchy dominated the political system. Ferdinand

Marcos, who was not a member of the oligarchy, was

elected president in 1966. He was reelected in 1969,

but in 1972, in the wake of domestic disorder, he staged

a coup whereby he dissolved the legislature, shut down

the media, and arrested hundreds of individuals in the

name of restoring domestic political order. He ruled by

decree and wrote a new constitution&actions that have

been called $constitutional authoritarianism.# He ruled 1

1. Robert S. Dohner and Ponciano Intal, Jr., $The Marcos Legacy: Economic Policy and Foreign Debt in the Philippines,# in Jeffrey D. Sachs

and Susan M. Collins, Developing Country Debt and Economic Performance, vol. 3, Country Studies&Indonesia, Korea, Philippines,

Turkey (Chicago: University of Chicago Press, 1989), p. 386.
CHAPTER FOUR THE CHALLENGE OF DEVELOPMENT: ILLUSTRATIONS FROM EIGHT COUNTRIES 41

until driven from power by a $people’s power# revolution in 1986.

Around the time of Marcos’s coup, a Muslim-led

insurgency broke out in the southern part of the country. The Philippines is overwhelmingly Christian, and

the Muslim forces sought greater autonomy. Although

that conflict was a seemingly intractable problem that

took more than 20 years to end, it was confined and did

not impinge much on the normal business of most of

the country. Marcos also had to deal with the Marxistoriented New People’s Army in the northern part of the

country. Few experts on the Philippines attribute a major portion of its underdevelopment to those problems,

however. Other factors, such as corruption, seemed to

matter more.

Costa Rica. Political stability in Costa Rica was provided through a democratic system of government and

was an important element of its long-term development

Table 12.

Flows of Foreign Aid and International Private Capital to Eight Countries 

as a Share of Gross National Product (In percent)

Country 1970-1974 1975-1979 1980-1984 1985-1989 1990-1993

South Koreaa

Aid flows 8.6 3.8 1.8 0.6 0.2

Private flows 2.9 3.7 -3.2 -1.1 2.1

Philippines

Aid flows 4.2 3.9 3.5 5.1 6.9

Private flows 0.6 3.8 2.3 0.9 1.9

Costa Rica

Aid flows 3.4 3.8 6.7 9.3 7.0

Private flows 5.0 5.7 3.9 2.6 2.4

Honduras

Aid flows 3.0 4.5 8.7 8.8 7.4

Private flows 1.3 2.1 1.5 1.4 1.0

Botswana

Aid flows 36.6 18.2 13.0 11.8 4.3

Private flows 0.3 7.5 6.9 3.9 -1.4

Zambia

Aid flows 5.1 7.8 10.4 20.2 31.1

Private flows 0.4 2.9 2.1 7.9 1.4

Tunisia

Aid flows 7.7 7.3 7.6 7.9 7.2

Private flows 1.2 5.6 3.9 1.4 1.5

Egypt

Aid flows 5.6 21.1 12.0 10.9 16.0

Private flows 0.1 4.3 5.7 5.2 -1.2

SOURCE: Congressional Budget Office based on data from the Agency for International Development, the Organization for Economic Cooperation

and Development, and the World Bank.

NOTE: Data reflect averages for the period shown.

a. South Korea received a substantial amount of foreign aid in the 1950s and 1960s&amounts far in excess of anything received since 1970.

However, data for private capital flows before 1970 were unavailable.
42 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

success. Costa Rica is the oldest continuously functioning democracy in Latin America. It is governed by

a parliament and an executive, and in most elections

since 1950, the presidency has alternated between the

two major political parties: a social democratic party

known as the Partido Liberación Nacional (PLN), and a

loose coalition of forces opposed to the PLN.

That political stability played an important role in

promoting Costa Rica’s economic growth because it

favored investment and the strengthening of institutions. In 1948, after a two-month civil war, the army

was disbanded and was never reestablished. Costa Rica

avoided the political upheaval that much of Central and

South America has experienced over the past 40 years,

and that stability fostered sustained foreign investment.

Costa Rica’s political culture was and is oriented toward political stability, peaceful resolution of conflicts,

and a willingness to evolve without abrupt changes.

Unlike many of its neighbors, it was spared from a

guerrilla war during the 1970s and 1980s.

Honduras. In contrast, Honduras has not had such

political stability. Honduran politics have been highly

contentious, and the military has not hesitated to intervene directly in the political process. Unlike Costa

Rica, which dissolved its army in 1948, the Honduran

military transformed itself in the 1950s into a modern

professional organization. Of the 12 changes in the

executive between 1953 and 1993, five were coups.

The military became an independent, and one of the

most powerful, interest groups within Honduran government and politics.2

Although some reformist military governments

have taken positive steps to promote Honduras’s development, overall the pervasive influence of the military

appears to have contributed to the country’s underdevelopment. During the 1980s, the military claimed

20 percent to 30 percent of the government budget.

Another problem was that the coups disrupted the political stability of the country and sometimes brought to

an end reformist liberal governments. Finally, according to Kent Norsworthy and Tom Barry, Honduras suffers from a deep fear of its neighbors. The powerful 3

influence of the military in Honduran society appears to

have done little to alleviate that fear.

Botswana. Political stability was not an issue in the

two countries of sub-Saharan Africa that CBO examined. Botswana combines some attributes of both

South Korea and Costa Rica. Since its independence in

1966, Botswana has been a stable democracy. Yet the

same party&the Botswana Democratic Party&has been

in power since independence, guiding Botswana’s development. The opposition party, the Botswana National Front, has gained almost one-third of the seats in

parliament and won most of the local elections in larger

cities and towns.

Zambia. Zambia, too, has enjoyed a fair degree of political stability since independence in 1964. Until 1991,

Zambia was governed by a one-party political system.

President Kenneth Kaunda, leader of the United National Independence Party, ruled Zambia free of major

political unrest or civil war. In 1991, partly as a result

of popular disenchantment with the state of the economy, President Kaunda promised to hold free and fair

elections. As a result, an opposition group came to

power peacefully.

Tunisia. Tunisia is one of the more stable and developed countries of North Africa and the Middle East.

Governed by the Destourian Socialist Party since independence in 1957, Tunisia's administration has been

flexible and pragmatic in implementing development

policy. In the 1970s, for example, international confidence in Tunisia’s political stability helped strengthen

its economy. In 1975, Habib Bourguiba, president

since 1957, became $president for life.# He was ousted

in 1987 by Zine el-Abidine Ben Ali, who is pushing

Tunisia toward a market economy if not a democratic

course. The Destourian Socialist Party was renamed

the Constitutional Democratic Party in 1988 but remains the ruling party.

Egypt. Egypt has also had relative political stability,

though somewhat less so than Tunisia. Only three

presidential administrations have governed Egypt since

1952&those of Gamel Abdul Nasser, Anwar Sadat,

and Hosni Mubarak. Nasser came to power in a coup

that overthrew the monarchy. Sadat was Nasser’s vice

president and succeeded him in 1970 on Nasser’s death.

Mubarak was Sadat’s vice president and became president on Sadat’s assassination in 1981.

2. James A. Morris, Honduras: Caudillo Politics and Military Rulers

(Boulder, Colo.: Westview Press, 1984), pp. 35-37.

3. Kent Norsworthy with Tom Barry, Inside Honduras (Albuquerque:

Inter-Hemispheric Education Resource Center, 1993), p. xvii.
CHAPTER FOUR THE CHALLENGE OF DEVELOPMENT: ILLUSTRATIONS FROM EIGHT COUNTRIES 43

Despite its surface of relative calm, Egypt’s stability is often described as delicate. The government has

had to quell occasional riots, such as the food riots of

the 1970s, when Sadat attempted to reduce food subsidies. Since 1952, Egypt had been involved in three

wars with Israel before signing the Camp David Accords in 1979. In addition, Egypt openly sided with the

republican forces in the Yemen War in the mid-1960s,

consuming valuable resources for several years. Finally, extremist religious factions&the same ones that

assassinated President Sadat&seek to remove the government and transform Egypt into an Islamic republic.

This very brief survey of the political histories of

the eight countries substantiates the assertion that political stability may be a necessary but not sufficient condition for successful long-term development. None of

the eight countries experienced severe political turmoil

or civil war during the period that CBO examined, yet

some countries have been more successful in their development than others. Political stability in Zambia,

for example, has not been enough to produce long-term

development. And Costa Rica has probably been the

most stable of the countries; its economy has grown

rapidly over the past 30 years, but not as fast as South

Korea’s. Costa Rica has also been more stable than

Honduras, which has had more difficulty in achieving

long-term development. Clearly, political stability matters up to a point, but it is not enough.

Honest and Competent Government 

Officials

Because the particular countries CBO chose were relatively stable politically (at least compared with countries like Somalia or Bosnia), corruption and the influence of self-serving government officials probably had

a greater impact in shaping the development histories of

the eight countries. The differences between the more

successful and less successful countries on this variable

were probably the most pronounced in the Asian and

African nations, but they mattered in Latin America and

the Middle East as well.

South Korea. Corruption under Rhee and Park was

significant, though hard data on its extent do not exist.

Still, corruption in the 1950s was more detrimental than

that in later years because of the economic policies pursued by the Rhee government.

Corruption under Rhee was in the form of payoffs

from foreign aid funds and bank loans. $Inflation, an

overvalued exchange rate, low interest rates, and elaborate government controls formed an environment in

which such corruption operated profitably for those

involved but to the detriment of sound investments or

national economic development.#4

In contrast, corruption under Park took the form of

payoffs from private investment. But the payoffs took

place in an economic environment more favorable to

growth. Thus, the private capital, $despite pay-offs and

the like&fed an investment boom that followed reasonably accurate market indicators of real benefits and

costs for the country.# Investments approved by the 5

government, even though payoffs were extracted from

them, had been tested and approved through feasibility

studies and were generally consistent with Korea’s economic plan.6

The Philippines. Of all the countries CBO examined,

corruption appears to have posed the greatest problem

in the Philippines. In the 1950s and 1960s, the Filipino

political system was used as a means to enrich members

of the ruling elite. As one member of the Philippine

senate put it: $What are we in power for? We are not

hypocrites. Why should we pretend to be saints when

in reality we are not?#7

Under Marcos, however, the use of the political and

economic system to benefit the president and his friends

expanded on a massive scale. Robert Dohner and

Ponciano Intal have characterized their behavior as

$crony capitalism# and attribute to it a major portion of

the blame for the Philippines’ underdevelopment.

Crony capitalism was conducted through various

means, such as awarding government contracts to the

politically favored, padding expenses, and providing

kickbacks. But $the most important aspect was the creation of monopolies, either through direct intervention

to control an industry or through granting exemptions

4. David C. Cole and Princeton N. Lyman, Korean Development: The

Interplay of Politics and Economics (Cambridge: Harvard University

Press, 1971), p. 252.

5. Ibid.

6. Ibid.

7. Quoted in James K. Boyce, The Philippines: The Political Economy

of Growth and Impoverishment in the Marcos Era (Honolulu: University of Hawaii Press, 1993), p. 8.
44 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

or exclusive privileges to favored individuals.# For 8

example, in the forestry sector, some of the logging licenses went to government ministers and Marcos’s

friends. Even when some land was allocated to others,

Marcos’s allies were allowed to log in those areas under

the pretext of clearing the forest for settlement projects

of the Ministry of Agrarian Reform. Overall, the cost 9

to the Philippine economy of crony capitalism is hard to

measure, but the cost of the monopolies alone was in

the billions of Philippine pesos, not counting all the

investment they may have discouraged and capital

flight they encouraged.10

Moreover, Yoshihara Kunio, in a comparative

study of the Philippines and Thailand, has argued that

corruption has extended to the Philippine police forces

and judiciary. Many police have worked for criminal

syndicates. High-ranking police officials receive a

modest salary yet live luxuriously. The Philippine police, Yoshihara concluded, are $probably the most corrupt government agency in the Philippines.# Some 11

judges were allegedly influenced by money during trials; even before martial law, the rich and powerful in

the Philippines could evade punishment for many

crimes, including murder.12

As martial law corrupted law enforcement and the

economy deteriorated, the crime rate exploded. That

contributed to the flight of domestic capital from the

Philippines during the 1970s and 1980s. Private property of the poorer classes was often confiscated by

wealthy individuals, and the poor could do little about it

except join the rebels. Owners of small firms would

lose their businesses to criminals who used fake titles

or legal gimmicks to claim property they did not own,

and the judges would uphold their tactics.

Botswana and Zambia. Botswana has suffered from

far less corruption than Zambia. The first president of

Botswana, Sir Seretse Khama, established the tradition

of an accountable and transparent government. He

helped set a precedent for an effective government with

a culture of openness, accountability, and little corruption that has been maintained over time. Corruption in

Zambia has been far greater. Government leaders have

spent millions of dollars on personal perquisites. Zambia’s government has also wasted resources by employing large numbers of people for political reasons rather

than for providing services.

Governmental Institutions

Certain governmental institutions seem important to the

development process. For example, having the means

to secure and protect property rights generally means

having an independent and fair judiciary to enforce the

relevant laws. Similarly, governments appear to need

the ability to regulate the monetary system, such as exchange rate policy, and thus may require a finance ministry or a central bank. To provide some essential services, governments must have the means to collect

taxes.

In practice, these issues are more ambiguous in the

countries CBO examined. For example, the judicial

system in Costa Rica is well established and provides a

framework for defining and enforcing contracts.13

Property rights are well defined and protected under the

judicial system. In theory, that should make it easier

for foreign and domestic entrepreneurs to invest and

start businesses, profit from them, and create jobs and

spur economic growth in the process. Political stability

in general has reduced the risks and transaction costs of

operating in the Costa Rican society and economy.14

Similarly, Honduras has also taken important steps

to build institutions. The Galvez administration in the

1950s began to modernize the Honduran government

and, in particular, to establish institutions that would

further national development. Notably, Galvez created

the Central Bank of Honduras to control monetary policy and established an agricultural development bank.

He also created the Ministry of Economy, the National

Council on Economics, the Board of Budget Management, and the Income Tax Board&all of which were

8. Dohner and Intal, $The Marcos Legacy,# p. 399.

9. Boyce, The Philippines, pp. 233-234.

10. Dohner and Intal, $The Marcos Legacy,# pp. 478-479.

11. Yoshihara Kunio, The Nation and Economic Growth: The Philippines and Thailand (New York: Oxford University Press, 1992), p.

193.

12. Ibid., p. 194.

13. Simon Rottenberg, ed., Costa Rica and Uruguay: The Political Economy of Poverty, Equity, and Growth (Washington, D.C.: World

Bank, 1993), pp. 20-21.

14. Ibid., p. 127.
CHAPTER FOUR THE CHALLENGE OF DEVELOPMENT: ILLUSTRATIONS FROM EIGHT COUNTRIES 45

intended to create the means for modern development.15

But the existence of those institutions has not been sufficient to generate economic growth.

The Influence of Domestic 

Economic Policies on 

Development

The literature on development discussed in Chapter 3

stresses that the economic policies a country pursues

will have an important influence on its development.

That observation was borne out in most of the countries

that CBO studied, but perhaps the best comparison is

South Korea and the Philippines.

South Korea

South Korea has used both import-substitution and

export-led industrialization strategies at various times.

In the 1950s under Syngman Rhee, Korea adopted an

inward-looking, import-substitution strategy of industrialization. High tariffs and quotas protected domestic

industry. The exchange rate was both controlled and

overvalued. In 1954, exports accounted for less than 1

percent of GNP; by 1962, that share had risen to only 2

percent. The economy was highly dependent on foreign

aid. Although the economy grew initially as a result of

reconstruction efforts that followed the Korean War,

high inflation was the price.

A military coup in 1961 brought Park Chung Hee

and an authoritarian, technocratic government to power.

During the 1960s, he set about reforming the economy.

The government reformed the exchange rate system and

devalued the currency, promising exporters that it

would protect their rate of return no matter what the

rate of inflation was. It also liberalized trade and lowered tariffs. Interest rates on bank deposits and loans

were doubled to increase private saving and discourage

unproductive use of credit. However, government involvement in the economy under Park was still considerable. For example, the government made institutional

reforms in the financial system and allocated investment credit.

The results transformed South Korea’s economy

between 1962 and 1982. The primary sector of the

economy&agriculture and natural resources&fell from

about 45 percent of GNP in 1962 to about 19 percent

in 1982 (see Table 13). Manufacturing, in contrast,

grew from 9 percent to 34 percent over those 20 years.

Economic growth paralleled the rise of manufacturing

in the economy. Between 1963 and 1976, GNP grew at

the astounding rate of 9.2 percent a year. Per capita

GNP growth was equally impressive at 7.2 percent a

year. Those developments were largely financed by the

dramatic rise in domestic saving that government policies had promoted.

Exports grew in quantity and breadth. Accounting

for only 2 percent of GNP in 1962, exports represented

over 16 percent by 1972 and nearly 32 percent by

1982. The change in the number of countries to which

Table 13.

Transformation of South Korea’s Economy

Between 1954 and 1982 as a Share of 

Gross National Product (In percent)

Sector 1954 1962 1972 1982

Primary Sector 51.1 45.3 29.2 19.2 a

Manufacturing 5.3 9.1 20.9 34.2

Social Overhead 

and Services 43.6 45.6 49.9 46.6

Exports 0.8 2.0 16.4 31.8

Imports 7.2 15.6 23.7 36.5

Domestic Investment 11.9 12.8 21.7 26.2

Domestic Saving 6.6 3.3 15.7 21.5

Foreign Saving 5.3 10.7 5.2 4.8

SOURCE: Congressional Budget Office based on data from Kim

Kwang-suk and Park Joon-kyung, Sources of Economic

Growth in Korea, 1963-1982 (Seoul: Korea Development Institute, 1985), p. 9.

a. Includes agriculture and natural resources. 15. Mark B. Rosenberg and Philip L. Shepherd, eds., Honduras Confronts Its Future (Boulder, Colo.: Lynne Rienner, 1986), p. 99.
46 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table 14.

Standard-of-Living Indicators for the Philippines

Indicator 1962 1966 1970 1974 1978 1982 1986

Wage Ratea

Agricultural 100 93.6 75.9 54.2 87.6 65.0 70.7

Skilled worker 100 89.1 89.5 55.3 54.0 48.8 27.8 b

Unskilled worker 100 96.1 103.3 63.0 57.2 41.1 25.7 b

Total Unemployment (Percent) 21.8 22.0 14.9 10.6 14.7 24.1 22.9 c d

Pricese

Food 20.4 27.6 33.4 74.5 100 162.5 329.1

Nonfood 27.8 29.6 36.1 70.1 100 186.3 387.3

SOURCE: Congressional Budget Office based on data from James K. Boyce, The Philippines: The Political Economy of Growth and Impoverishment in the Marcos Era (Honolulu: University of Hawaii Press, 1993).

a. Daily wage rate index: 1962 = 100.

b. Value shown is for 1983; value for 1982 is not available.

c. Value shown is for 1961; value for 1962 is not available.

d. Value shown is for 1971; value for 1970 is not available.

e. Food price index: 1978 = 100.

Korea exported was particularly astonishing. In 1954,

Korea exported to only five countries. By 1976, it was

exporting to 175 countries. According to one study,

expansion of exports accounted for 31.8 percent of

Korea’s growth in industrial output between 1963 and

1975.16

South Korea’s economy has flourished despite the

existence of a number of public enterprises. Unlike the

enterprises in many developing countries, those in

South Korea generally have been efficiently run and

have contributed substantially to economic growth.

One reason for that achievement may be the willingness

of the government to take action to address problems.

$In Korea, there have been numerous cases of divestiture, most notably in the 1967-1969 period. And if a

Korean public enterprise considered important for development shows signs of becoming moribund, it is

likely to be vigorously kicked back into life by drastic

changes in management and operating procedures.#17

For example, the government asked a private firm to

manage Korean Air Lines when it was not profitable as

a public endeavor.

The Philippines

The Philippines, however, did not fare as well. After

Marcos declared martial law in 1972, he attempted to

stimulate growth through expansionary fiscal policies

and continued import substitution. That program enjoyed only modest success. Between 1973 and 1979,

GNP and per capita GNP grew at an average annual

rate of 4.8 percent and 2.7 percent, respectively.

The average Filipino, however, did not participate

in those economic gains. Real wage rates for agricultural workers declined by 25 percent between 1966 and

1986 (see Table 14). Urban workers, both skilled and

16. Edward S. Mason and others, Economic and Social Modernization of

Korea (Cambridge: Harvard University Press, 1980), pp. 139, 152-

153. 17. Ibid., p. 275.
CHAPTER FOUR THE CHALLENGE OF DEVELOPMENT: ILLUSTRATIONS FROM EIGHT COUNTRIES 47

unskilled, fared even worse: their real wages declined

by 69 percent and 73 percent during the same period.

Thus, although the economic pie was growing larger,

the distribution of that pie was shifting against the

poorest segments of the population. Between 1970 and

1985, the percentage of the population living in poverty

increased dramatically:18

Percentage

of Population

 Year in Poverty 

1965 41.0

1971 43.8

1975 51.5

1985 58.9

The consequences of Marcos’s economic policies,

however, caught up with the economy, which was unable to weather the oil shock of 1980. Between 1980

and 1986, GNP hardly grew at all, per capita GNP

dropped an average of 2.8 percent a year, and export

earnings declined. The government tried to alleviate

those conditions by increasing government expenditures and foreign borrowing. The external debt nearly

doubled in four years. But foreign and domestic investors were not confident that the economic problems

were short term. Net foreign investment declined to

almost nothing, and the amount of capital leaving the

country may have reached 5 percent of GNP in 1981

and 1982. By the time Marcos was overthrown in

1986, the Philippine economy was in dire straits. Economic reforms introduced by his successors appear to

be putting the Philippines back on a growth track, but

the economy may take decades to recover fully.

Botswana

Botswana provides one of the best illustrations of

sound fiscal policies. Its economy has benefited tremendously from the discovery of diamonds in the

period immediately after independence. Diamonds represent approximately 80 percent of Botswana’s exports. But unlike other developing countries that sometimes squander such windfalls on consumption, Botswana has used its resources wisely and managed its

economy well. Since it achieved independence in 1966,

the government’s development strategy has included

high levels of investment, a conservative fiscal policy,

and an appropriately valued exchange rate. Because

much of the national revenue comes from nonrenewable

mineral resources, the government has avoided using

earnings from those resources for recurrent expenses

and has instead invested them in infrastructure.

One indicator of that strategy, other than GNP

growth, is that in the early 1990s, Botswana’s external

debt represented less than 20 percent of GNP. In addition, as of 1993, Botswana had foreign exchange reserves equal to approximately 30 months’ worth of imports. Botswana’s per capita GNP grew at an average

annual rate of 7 percent in real terms between 1965 and

1994.

Zambia

In contrast, Zambia pursued different economic policies, to its detriment. At independence, Zambia had

extensive reserves of copper and was enjoying high

copper prices. Shortly after independence, however, the

government used the revenues from the country’s primary export to expand the role of government. Between 1963-1964 and 1967, the number of civil servants more than doubled. The government nationalized

many of the natural resources and industry, and social

welfare spending rose dramatically. During the 1970s

and 1980s, the government subsidized agriculture, instituted price controls, maintained a fixed exchange rate

that became overvalued, and restricted trade. The new

government-run industries became increasingly inefficient. High copper prices in the 1970s&and thus high

export revenues&hid the first signs of those problems,

but by the 1980s, copper prices had fallen, and the inefficiencies that had been built into the economy caused a

period of long-term decline. Between 1965 and 1994,

Zambia’s per capita GNP dropped at an average annual

rate of 0.9 percent.

The Role of Foreign Aid

in Development

As was observed in Chapter 3, the more favorable the

overall policy environment in a developing country, the 18. Boyce, The Philippines, p. 46.
1953 1958 1963 1968 1973 1978 1983 1988 1993

0

1

2

3

4

5

6

U.S. Economic Aid U.S. Military Aid Other U.S. Aid Multilateral Aid Other Bilateral Aid Use of IMF Credit

Billions of 1997 Dollars

South Korea

1953 1958 1963 1968 1973 1978 1983 1988 1993

0

1

2

3

4

5

6

U.S. Economic Aid U.S. Military Aid Other U.S. Aid Multilateral Aid Other Bilateral Aid Use of IMF Credit

Billions of 1997 Dollars

The Philippines

a

a

48 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Figure 5.

Foreign Aid to South Korea and the Philippines, 1953-1993

SOURCE: Congressional Budget Office based on data from the Agency for International Development, the Organization for Economic Cooperation

and Development, and the World Bank.

NOTE: IMF = International Monetary Fund.

a. Mostly loans from the Export-Import Bank.
CHAPTER FOUR THE CHALLENGE OF DEVELOPMENT: ILLUSTRATIONS FROM EIGHT COUNTRIES 49

Table 15.

Domestic and Foreign Saving in South Korea, 1958-1974 (Saving as a percentage of total investment)

Total Investment Domestic Saving Foreign Savinga

Year as a Percentage of GNP Private Government Transfers Borrowing

1958 12.9 62.5 -24.1 69.8 -8.2

1959 10.7 61.5 -25.0 67.0 -3.5

1960 10.9 33.2 -18.7 82.3 -4.0

1961 13.1 42.8 -13.6 69.5 -4.3

1962 13.0 22.1 -10.7 72.9 10.0

1963 18.4 39.0 -1.4 37.8 20.6

1964 14.5 44.8 3.5 43.5 5.1

1965 14.7 38.1 11.5 44.2 -2.0

1966 21.6 41.6 13.0 26.5 12.5

1967 21.9 35.5 18.5 21.7 18.5

1968 26.7 27.5 23.5 14.6 28.5

1969 29.8 38.0 20.8 11.4 25.5

1970 27.2 34.5 25.5 8.0 27.4

1971 25.6 33.3 23.6 7.4 36.6

1972 20.9 53.1 18.6 8.3 18.4

1973 26.2 66.9 17.4 5.9 9.5

1974 31.4 51.7 9.6 4.3 38.9

SOURCE: Congressional Budget Office based on data from the Korean Economic Planning Board.

NOTES: Domestic saving and foreign saving should total 100 percent. However, the total may be off by a few percent because of various statistical

discrepancies.

GNP = gross national product.

a. Foreign transfers and perhaps a small proportion of foreign borrowing represent foreign aid. Most foreign borrowing is private capital. Negative

numbers mean that loan repayments exceeded additional borrowing.

more productive aid can be in promoting economic and

social development. Aid may also be helpful in an unfavorable environment if the recipient is willing to

make serious economic reforms. But aid given in an

unfavorable policy environment to a recipient that is

unwilling to make economic reforms may actually harm

the recipient. The foreign aid experience in South Korea and the Philippines provides an excellent contrast of

all three points.

South Korea

In the 1950s, South Korea under Syngman Rhee received massive amounts of foreign aid (see Figure 5).

In 1997 dollars, Korea received a total of $23 billion in

aid between 1953 and 1960. The average annual

amount of economic aid over that same period was $1.8

billion. Rhee followed an inward-looking, import-substitution strategy of industrialization. The result was

modest economic growth.

In the 1960s under President Park, Rhee’s successor, South Korea received the same amount of aid

overall&$23 billion in 1997 dollars&but less economic

aid. The average annual amount of economic assistance

fell to $1.3 billion. Nevertheless, the adoption of an

outward-looking, export-oriented economic strategy

produced vigorous growth in the succeeding decades.

The contrast between the two administrations is

illustrated by their respective investment and saving

rates. South Korea’s investment rates&an important

indicator of economic growth&grew from about 13

percent in 1958 to over 31 percent in 1974 (see Table

15). During the 1950s, the Rhee government made lit-
50 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

tle effort to increase domestic saving. Instead, it sought

to maximize foreign assistance. Foreign transfers made

up more than half of Korea’s total investment between

1958 and 1962. In contrast, after Park instituted the

First Five-Year Plan (and more economic reforms) in

1962, the long-term trend of total investment rose substantially, accompanied by an increase in domestic saving. The role that foreign transfers played in South Korea’s growing economy correspondingly shrank, but

they still bolstered the investment and saving rates.

The usefulness of technical assistance on economic

issues given to South Korea under Presidents Rhee and

Park also depended on having a government committed

to creating a policy environment favorable to economic

growth. Economic advisors to Rhee from the Agency

for International Development often tried to make reforms that would lead to greater economic growth, but

such advice usually went unheeded. Under President

Park, however, AID personnel played a key role in advising South Korea on reforms it needed to make in the

export sector to create an outward-oriented, exporting

economy. The government was willing to make such

reforms and, consequently, made good use of that advice.19

The Philippines

Foreign aid provided to the Philippines under Marcos

may have actually hurt its development by reinforcing

his economic mismanagement and corruption. Between

1966 and 1986, the international community gave or

lent approximately $33 billion in 1997 dollars to the

Philippines, most of which was economic assistance

(see Figure 5). But per capita GNP averaged only 0.8

percent growth during those years. Moreover, poverty

increased, and rural and urban wages declined dramatically. The Philippines’ external debt as a percentage of

GNP grew from 13 percent in the mid-1960s to 93 percent in 1986. And calculations of capital leaving the

Philippines between 1962 and 1986 totaled over $19

billion, not including an adjustment for lost interest.

Before being driven from power, Marcos, his family,

and close associates $recycled# a substantial amount of

the Philippines’ external borrowing by sending or taking it out of the country.20

In contrast, foreign aid probably helped the Philippines reform its economy after Marcos, even though

initially the economic policy environment remained unfavorable to growth. After Marcos was driven from

power, the major foreign donors joined together in a

cooperative aid program to the Aquino government&

the Multilateral Assistance Initiative. The MAI was an

effort designed by the United States to rally the international community to help rebuild the Philippine economy and support democracy. The reform program of

Corazon Aquino and Fidel Ramos, Aquino’s successor,

has received strong support from the MAI donors. The

United States, the International Monetary Fund, and the

World Bank played critical roles in helping amplify,

fine-tune, and promote the reform agenda.

The MAI also funded various regional development

activities, placing particular emphasis on building infrastructure. Although determining the precise responsibility of foreign aid is difficult, those efforts helped

build an economy that has flourished since the early

1990s. In 1995, Philippine Finance Secretary Roberto

de Ocampo credited the MAI with helping bring that

about: $A large part of the credit for our dramatic turnaround and persistent push towards a track of high

growth can be owed to strong international support&specifically to the Multilateral Assistance Initiative.#21

Aid and Human Capital

Foreign aid may also contribute to the growth of human

capital. Although in CBO’s cases the amount of aid

allocated to that area is a fraction of that devoted to

promoting economic growth, it has produced positive

results, particularly in education and health. For example, U.S. foreign aid in Egypt contributed significantly

to improving education among the country’s poor, despite an economic policy environment that was less

than favorable. The United States spent nearly $300

million in nominal dollars on Egypt’s Basic Education

19. See Agency for International Development, Bureau for Global Programs, Field Support and Research, USAID and Economic Policy

Reform: Origins and Case Studies (forthcoming).

20. Boyce, The Philippines, pp. 279, 295, 297. Some estimates put the

amount in the billions of dollars.

21. Quoted in Agency for International Development, The Philippines:

Results Review and Resource Request (March 1996), p. 5.
CHAPTER FOUR THE CHALLENGE OF DEVELOPMENT: ILLUSTRATIONS FROM EIGHT COUNTRIES 51

Project. That effort focused on increasing enrollment in

primary school among Egyptian children, particularly

girls. The project has constructed more than 1,800

schools that enroll 900,000 students each year; it has

also provided instructional materials and equipment.

According to one analysis, $Country-wide statistics indicate that from 1981 to 1990, total primary school

enrollment increased by 41 percent, and female enrollment increased by 57 percent; nearly four-fifths of

school-age girls now attend primary school. These dramatic increases were achieved, in significant part, due

to AID’s support of the primary education sector.#22

Bilateral Versus Multilateral

Assistance

As discussed in Chapter 3, the purposes, conditions,

and means by which donors give aid to developing

countries may affect how useful the aid is in promoting

economic and social development. The country studies

reveal problems associated with giving aid for multiple

purposes, particularly in Egypt, Costa Rica, and Honduras. Egypt also illustrates how the donors’ trade policies and tied aid may undermine developmental objectives. Those issues have been associated with bilateral

donors. Botswana demonstrates the value of effective

coordination of aid from both bilateral and multilateral

donors.

The Multiple Purposes of Aid

The problems that aid given for more than one purpose

causes for development are best illustrated by Egypt.

The Agency for International Development first set up

a mission there in 1975, the year after President Sadat

began to turn Egypt’s foreign policy toward a proWestern orientation. The United States began providing substantial economic and military assistance to

Egypt at that time, averaging $1.7 billion a year (in

1997 dollars) between 1974 and 1978.

Egypt’s willingness to seek peace with Israel culminated in the 1979 Camp David Accords. In that year,

Egypt received a large increase in military assistance

(see Figure 6). Since the Camp David Accords, the

amount of annual U.S. assistance has averaged $3.2

billion a year. In foreign operations legislation, the

Congress has expressed its view that the recommended

levels of assistance for Egypt and Israel are based

largely on their continued participation in the Camp

David Accords and on the Egyptian-Israeli peace treaty.

At the same time, the U.S. aid program to Egypt

&unlike the aid program to Israel&became a major

effort on the part of AID. The mission in Cairo soon

became the largest in the world, employing over 100

people directly hired by the United States. Thus, the

United States has been providing aid to Egypt in part

for the political objective of keeping the peace in the

Middle East but also with the hope of encouraging economic and social development.

From the political perspective, the aid seems to

have worked. Egypt and Israel have not gone to war

since 1973 and have maintained a peaceful dialogue

since 1979. Barring a radical change in Egypt’s leadership, few observers expect Egypt and Israel to return to

the pre-Camp David relationship. Furthermore, Egypt

may be considered one of the United States’ regional

allies. For example, Egypt sent 30,000 troops to Saudi

Arabia to participate in Desert Shield and Desert Storm

and provided political support to the allied coalition.

From a developmental perspective, however, the

record is mixed. Although Egypt’s GNP grew at an

average annual rate of 5.6 percent between 1974 and

1993, the country has fared far less well with respect to

economic development. The country’s external debt,

which is largely related to foreign aid, grew from about

30 percent of GNP in 1974, peaked at 170 percent in

1988, then fell back to a little more than 100 percent by

1994, largely because of debt forgiveness programs

offered by various aid donors. As a proportion of gross

domestic product, manufacturing has declined from 18

percent in 1974 to 15 percent in 1995, although that

drop is partly attributable to the growth in oil revenues.

Unemployment in Egypt’s growing population has been

rising. The economy has been dominated by large public enterprises that the government has used to try to

employ more and more people. Those enterprises have

22. Roy L. Prosterman and Timothy Hanstead, Egyptian Development

and U.S. Aid: A 25-Year Perspective, Rural Development Institution

Monograph (March 1992), p. 22.
1953 1958 1963 1968 1973 1978 1983 1988 1993

0

2

4

6

8

10

12

U.S. Economic Aid U.S. Military Aid Other U.S. Aid Multilateral Aid Other Bilateral Aid Use of IMF Credit

Billions of 1997 Dollars

a

52 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Figure 6.

Foreign Aid to Egypt, 1953-1993

SOURCE: Congressional Budget Office based on data from the Agency for International Development, the Organization for Economic Cooperation

and Development, and the World Bank.

NOTES: Data do not reflect aid from former communist countries.

IMF = International Monetary Fund.

a. Mostly loans from the Export-Import Bank.

become less and less efficient, dragging the economy

down. Since 1988 in particular, Egypt’s economic

numbers have looked grim: per capita GNP has fallen

by 0.2 percent a year.

One expert has described Egypt’s situation as one

of $dependent development.# Marvin Weinbaum at- 23

tributes the relative ineffectiveness of U.S. economic

assistance not only to the unfavorable economic policies the Egyptian government pursued, but also to the

seemingly guaranteed annual commitment by Washington of nearly a billion dollars in economic assistance.

$AID officials cannot with much conviction threaten to

withdraw or withhold funds from the government. U.S.

influence over Egypt’s broad development choices notwithstanding, the U.S. desire to assure Egypt’s cooperation in international regional policies limits the demands the United States can impose.# Indeed, when 24

Egypt is under severe economic distress, Western donors are likely to provide whatever financial assistance

is necessary to ensure the survival of a moderate political regime in Cairo.

Costa Rica and Honduras. The U.S. government in

the 1980s focused an extraordinary amount of attention

on political and economic development in Central

America. The United States made opposition to the

Sandinista regime in Nicaragua a primary goal and pursued it by forming strong relationships with Costa Rica

and Honduras as well as supporting the contras in Nicaragua. The National Bipartisan Commission on Central

America, chaired by former Secretary of State Henry

Kissinger, recommended in the early 1980s that the

United States pursue large economic and military aid

programs for the noncommunist governments of the

region in order to promote democracy, encourage economic growth, and resist the spread of communism.

The Reagan Administration embraced that policy, and

U.S. foreign aid to Costa Rica and Honduras increased

substantially (see Figure 7).

23. Marvin G. Weinbaum, Egypt and the Politics of U.S. Economic Aid

(Boulder, Colo.: Westview Press, 1986), pp. 49-64.

24. Ibid., p. 64.
1953 1958 1963 1968 1973 1978 1983 1988 1993

0

2

4

6

8

10

12

U.S. Economic Aid U.S. Military Aid Other U.S. Aid Multilateral Aid Other Bilateral Aid Use of IMF Credit

Billions of 1997 Dollars

Costa Rica

1953 1958 1963 1968 1973 1978 1983 1988 1993

0

2

4

6

8

10

12

U.S. Economic Aid U.S. Military Aid Other U.S. Aid Multilateral Aid Other Bilateral Aid Use of IMF Credit

Billions of 1997 Dollars

Honduras

a

b

b

CHAPTER FOUR THE CHALLENGE OF DEVELOPMENT: ILLUSTRATIONS FROM EIGHT COUNTRIES 53

Figure 7.

Foreign Aid to Costa Rica and Honduras, 1953-1993

SOURCE: Congressional Budget Office based on data from the Agency for International Development, the Organization for Economic Cooperation

and Development, and the World Bank.

NOTE: IMF = International Monetary Fund.

a. Aid to Costa Rica in 1993 represents a large loan from the Inter-American Development Bank that will be disbursed over several years.

b. Mostly loans from the Export-Import Bank.
54 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

U.S. aid to Costa Rica and Hondoras was also motivated by a desire to alleviate their economic problems

and promote development. Both countries, in part

through their own economic mismanagement, were experiencing an economic crisis. After years of overspending, protectionism, and poor management of the

exchange rate, and in the wake of a decline in coffee

prices that reduced export earnings, Costa Rica’s financial system collapsed. Honduras also faced enormous

difficulties.

In Honduras, the deficit widened, exports declined,

and unemployment and underemployment together exceeded 50 percent. Development was financed by external borrowing, and debt-service payments soon exceeded 12 percent of export income. Rather than undertake reforms to open the economy, cut spending, and

liberalize the exchange rate, the government responded

with increased borrowing and spending. In response to

that crisis, the International Monetary Fund and the

Agency for International Development sought to impose fiscal and monetary discipline as a condition of

foreign assistance. Honduras proved reluctant to accept

such discipline, and both the United States and the IMF

suspended aid in late 1983. The United States placed a

high political value on supporting Honduras, however,

and resumed cash transfers to the Honduran government shortly after they were suspended.

Thus, aid money in 1983 and 1984, from a developmental perspective, was largely unproductive. That

tended to be the pattern for the U.S. aid programs to

Honduras throughout the 1980s. Aid carried the Honduran economy until the 1990s, when the absence of

reform caught up with the government and again sent

the economy into a crisis. That time, however, the

Honduran government was more willing to carry out

reforms, but the long-term outlook remains uncertain.

In Costa Rica, the crisis in the early 1980s was

even more severe than in Honduras as reflected in the

decline in per capita GNP. Between 1981 and 1985,

Costa Rica’s declined by 22 percent compared with 10

percent for Honduras. Costa Rica was also politically

important to the United States&though less than Honduras, which provided military and training bases for

U.S. forces and served as an operating camp for the

contra forces. The Costa Rican government, however,

was more willing to undertake necessary economic reforms. Between 1982 and 1986, the United States took

the lead in supporting and encouraging reforms, providing 58 percent of all foreign assistance given to Costa

Rica. The major initiatives included liberalizing the

financial sector, reducing the size and spending of the

public sector, promoting nontraditional agricultural exports to diversify the economy, reducing trade barriers,

and supporting general macroeconomic stabilization

and adjustment.

The United States and other donors made foreign

assistance conditional on the implementation of reforms. Without a government committed to making

reforms, however, donors’ efforts would probably have

been fruitless. The result was that Costa Rica returned

to a path of rapid economic growth and continuing improvement. Unemployment fell dramatically after 1983.

Nontraditional exports to countries outside Central

America more than doubled, and foreign direct investment in Costa Rica reached new highs in the 1990s.

In short, Honduras and Costa Rica illustrate two

important points. First, the developmental objective of

foreign assistance may be sacrificed to the political objective where the two conflict, which is what happened

in Honduras. Second, the policy environment matters

more in the development process than do the reasons

for which a donor provides assistance. If a developing

country is motivated to make reforms that will open the

economy and foster growth, as in Costa Rica, even politically motivated aid can be helpful. If a government

is not motivated to make such reforms, as in Honduras,

politically motivated aid may actually undermine developmental objectives by making it easier for the government to avoid necessary reforms.

Contradictory Trade and Aid 

Policies of Donors

Egypt in the 1970s and 1980s serves as an example of

how protectionist trade policies by major donors can

undermine economic growth. In the 1970s, Egypt

adopted an economic liberalization program and was

pressured by the IMF to terminate special trade agreements with various countries and adopt a free-trade system. Despite considerable disruption to many Egyptian

firms that were unskilled at advertising and selling their

goods in new markets, such a system was in place by

1980. But it was not destined to last. Shortly thereafter, the United States and the European Community
CHAPTER FOUR THE CHALLENGE OF DEVELOPMENT: ILLUSTRATIONS FROM EIGHT COUNTRIES 55

(now called the European Union) created various protectionist barriers to Egyptian exports, such as import

quotas on textiles, Egypt’s primary manufactured export. As one analyst has written:

A striking example was in 1986-87 when, after

difficult and prolonged negotiations with the

United States, Egypt’s textile industry was

only allowed to increase its annual quota to the

United States by 6.5 percent for cotton yarn,

cotton fabrics, and T-shirts, to reach a rough

estimate of $70 million for 1987. No allowance seems to have been made for the fact that

Egypt’s staple raw material is cotton, that

Egypt’s textile exports to the United States

started from a negligible base, that the United

States’ total imports of textiles are about $21

billion, or that Egypt’s imports from the

United States had soared from $610 million in

1976 to $2,323 million in 1985.25

Tied Aid

Despite the large share of U.S. assistance devoted to

project aid to Egypt in the 1970s and 1980s&about 42

percent&one could argue that such aid has done relatively little to promote employment, production, or exports. For example, the first loan of $32 million to

Egypt’s private sector was made available in 1976, but

disbursing the loan took five more years. According to

Heba Handoussa, $the main problem seems to have

been the tied loans, which forced private businessmen

to purchase American machinery and equipment.#26

Overall, tied aid to Egypt has made projects costly because capital goods, technology, and technical assistance are packaged together and must be bought from

the donor.27

Coordination of Donors’ Efforts 

Recently, the coordination of donors has come under

more scrutiny as a means to improve the effectiveness

of foreign aid. In some countries, the proliferation of

aid projects is so extensive that it is difficult to keep

track of them all or to ensure that they are contributing

to overall development. Of all the cases CBO examined, Botswana seems to have created the best system

of coordinating donors.

The government of Botswana has identified its investment needs in its National Development Plan. That

plan serves as a guide for public expenditures and investment; it does not plan the economy or control the

Table 16.

Sectoral Emphasis of Donors in Botswana in 1991

Donor Emphasis

United States Education

Generating private-sector employment

Sweden Water resources

Training local government officials

Small businesses

Norway Health

Britain Training public-sector officials

Germany Energy

Vocational training

China Agriculture

Railways

United Nations Population

Development Food aid

Programme General technical assistance

African Develop- Infrastructure lending

ment Bank

World Bank Group Infrastructure lending

European Union Agriculture

Health

Natural resources

SOURCE: Congressional Budget Office based on data from the

Agency for International Development.

25. Heba Handoussa, $The Impact of Foreign Aid on Egypt’s Economic

Development, 1952-1986,# in Uma Lele and Ijaz Nabi, eds., Transitions in Development: The Role of Aid and Commercial Flows (San

Francisco: ICS Press, 1991), p. 223.

26. Ibid., p. 220.

27. Ibid., p. 224. See also Weinbaum, Egypt and the Politics of U.S.

Economic Aid, p. 51.
56 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

private sector. It also serves as an investment guide for

donors, since any project that is financed must be in the

plan, and the recurrent costs must be incorporated into

the national budget. The government’s Ministry of Finance and Development Planning acts as donor coordinator, a role that gives the ministry greater influence in

designing and establishing the projects. According to

one study on Botswana’s development process:

The National Development Plans were constructed around a $shopping list# of projects

for which finance was sought, which gave donors the flexibility to choose projects, but ensured that projects addressed government priorities. Each development plan listed projects,

priorities, and expected foreign-exchange resources&including donors (who in some cases

are yet to be identified when the plan is published). Donors selected projects to support

and assessed how much support to give to Botswana’s total programme, through project aid

or general programme support.28

By encouraging individual donors to specialize in particular sectors of the economy, there is little duplication

among donors (see Table 16 on page 55). By focusing

on certain areas, donors have been able to learn from

their experiences, and the staff of the Ministry of Finance and Development Planning works with the same

organizations from year to year.

28. Gervase S. Maipose, Gloria M. Somolekae, and Timothy Johnston,

Aid Effectiveness in Botswana (Washington, D.C.: Overseas Development Council, February 1996), pp. 47-48.
Appendixes

T

Appendix A

U.S. Spending on Foreign Aid

his appendix includes tables that provide a

breakdown of U.S. spending on foreign aid by

category and program. The six general categories are military assistance, bilateral development assistance, other development-related programs, humanitarian assistance, assistance to Eastern Europe and therepublics of the former Soviet Union, and multilateral

assistance.
60 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table A-1.

Appropriations for Military Aid in 1997

1997 Appropriation

Program Function (Millions of dollars)

Foreign Military Funds U.S. overseas arms transfers. Primarily loans for 

Financing Greece and Turkey and grants for Egypt and Israel. 3,284

Peacekeeping Provides U.S. contributions to operations in Sinai and Haiti 

Operations as well as other training and monitoring of sanctions. 65

International Military Provides military training to selected foreign military 

Education and Training and civilian personnel. 43

Military-to-Military Supports exchanges between U.S. military personnel and 

Contact Programs counterparts in Eastern Europe and the Pacific. 0

3,392

SOURCE: Congressional Budget Office.
APPENDIX A U.S. SPENDING ON FOREIGN AID 61

Table A-2.

Appropriations for Bilateral Development Assistance in 1997

1997 Appropriation

Program Function (Millions of dollars)

Development Assistance Funds the development activities of AID to promote growth,

and Population population stability, environmental protection, and democracy. 1,630

Agency for International Funds operating expenses of AID, the organization that 

Development administers most U.S. bilateral economic assistance. 519

Peace Corps Sends U.S. volunteers abroad to provide technical assistance

and promote mutual understanding. 220

P.L. 480, Title III Promotes policy reforms and food security goals in 

developing countries. 30

Debt Restructuring Provides funds to reduce and forgive debts that poor countries 

owe to the United States. 27

Inter-American Finances small-scale enterprise and grassroots activities 

Foundation aimed at helping poor people in Latin America. 20

African Development Finances small-scale enterprises and grassroots activities 

Foundation aimed at helping poor people in Africa. 11

Housing Guarantee Guarantees private loans that finance shelter and 

Program infrastructure projects abroad. 10

Micro and Small Promotes expansion of micro and small enterprises in 

Enterprise Development developing countries. 2

Enhanced Credit Permits AID to use market-rate loans and guarantees for 

Program leverage to support larger development projects than it 

could otherwise afford with grant-only programs. n.a.

2,469

SOURCE: Congressional Budget Office.

NOTES: The Economic Support Fund, though it is administered by the Agency for International Development (AID), is excluded from the table

because it is explicitly reserved for countries that are politically and strategically important to the United States.

n.a. = not applicable.
62 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table A-3.

Appropriations for Other Development-Related Agencies and Programs in 1997

1997 Appropriation

Program Function (Millions of dollars)

Export-Import Bank Promotes U.S. exports by offering insurance guarantees 

and loans to U.S. companies operating or selling abroad, 

including in developing countries. 715

International Narcotics Helps other countries counter the production, processing, 

Control Program and trafficking of illegal drugs. 213

P.L. 480, Title I Makes low-interest loans to finance U.S. agriculture 

exports. 202

Nonproliferation, Provides training and equipment for foreign civilian law 

Anti-Terrorism, enforcement to combat terrorism. Also provides funding 

and Demining for nonproliferation and programs to remove mines. 151

Trade and Development Finances feasibility studies and other services for major 

Agency activities in developing countries to support economic

development and U.S. exports. 45

Overseas Private Offers political risk insurance, guarantees, and investment 

Investment Corporation financing to encourage U.S. firms to invest in developing countries. -141a

1,185

SOURCE: Congressional Budget Office.

a. Reflects loan repayments.
APPENDIX A U.S. SPENDING ON FOREIGN AID 63

Table A-4.

Appropriations for Humanitarian Aid and Programs in 1997

1997 Appropriation

Program Function (Millions of dollars)

P.L. 480, Title II Provides humanitarian and emergency food grants. 837

Refugee Assistance Supports refugee relief activities worldwide. 700

International Assists nations struck by natural and man-made 

Disaster Assistance disasters and emergencies. 190

1,727

SOURCE: Congressional Budget Office.
64 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table A-5.

Appropriations for Assistance to Eastern Europe and the Former Soviet Union in 1997

1997 Appropriation

Program Function (Millions of dollars)

Newly Independent States Regional program by which AID extends 

of the Former Soviet Union economic aid to those states. 576

Eastern Europe and Regional program by which AID extends 

the Baltic States economic aid to Eastern Europe. 475

Cooperative Threat Reduction Promotes the dismantling of the nuclear arsenal 

(Nunn-Lugar) Program of the republics of the former Soviet Union. 328

1,379

SOURCE: Congressional Budget Office.

NOTE: The Cooperative Threat Reduction program is funded and administered through the Department of Defense. It is not part of budget function

150 (international affairs).

AID = Agency for International Development.
APPENDIX A U.S. SPENDING ON FOREIGN AID 65

Table A-6.

Appropriations for Multilateral Organizations and Programs in 1997

1997 Appropriation

Program Function (Millions of dollars)

World Bank Group

International Bank for Reconstruction Makes loans at near-market rates to promote 

and Development economic development in middle-income countries. 0

International Development Makes loans at concessional rates to low-income 

Association countries. 700

International Finance Makes loans and equity investments to promote growth 

Corporation of productive private enterprise in developing countries. 7

Multilateral Investment Promotes private investment by offering insurance against 

Guarantee Agency noncommercial risks in developing countries. 0

Global Environment Facility Makes grants to developing countries to deal with 

global environmental problems. 35

Asian Development Bank Finances economic development programs in Asia and 

the Pacific at near-market rates. 13

Asian Development Fund Makes loans at concessional rates to the poorest countries 

in Asia for development. 100

Inter-American Development Bank Promotes economic and social development in Latin America 

and the Caribbean with loans at near-market rates. 26

Fund for Special Operations Provides loans at concessional rates to the poorest

countries in Latin America for development. 10

Inter-American Investment Makes loans and equity investments to promote the growth 

Corporation of private enterprise. 0

Enterprise for the Americas Provides technical and financial assistance to help Latin 

Multilateral Investment Fund American countries reform their investment policies in order 

to attract foreign investment. 28

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

(Continued)
66 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table A-6.

Continued

1997 Appropriation

Program Function (Millions of dollars)

African Development Bank Lends at near-market rates to countries in Africa 

emphasizing agriculture, infrastructure, and industry. 0

African Development Fund Makes loans at concessional rates to low-income 

countries in sub-Saharan Africa, emphasizing health,

education, and other social programs. 0

European Bank for Reconstruction Makes loans at near-market rates to help Eastern Europe and 

and Development the republics of the former Soviet Union adopt market 

economies. Focuses on private firms as well as public firms 

that are privatizing. 12

North American Development Bank Provides financing for environmental infrastructure projects 

in the border region between the United States and Mexico 

and for NAFTA-related community adjustment and

investment to the United States. 56

Enhanced Structural Subsidizes the interest on balance-of-payment loans from 

Adjustment Facility the International Monetary Fund to low-income countries. 0

International Organizations Receive voluntary donations made in addition to the assessed 

and Programs contributions paid by the Department of State. 272 a

1,259

SOURCE: Congressional Budget Office.

NOTES: The International Bank for Reconstruction and Development, the Inter-American Development Bank, the African Development Bank, and the

European Bank for Reconstruction and Development have callable capital limits totaling $2.5 billion. Callable capital is a commitment by the

United States to transfer additional resources in the event that borrowers from those multilateral development banks (MDBs) need, as a last

resort, funds to repay their creditors. Callable capital does not require appropriations, and the MDBs have never made a call on this

guarantee financing.

NAFTA = North American Free Trade Agreement.

a. The recipients of those donations are the United Nations Development Programme, the United Nations Children’s Fund, the United Nations

Environment Programme, the International Fund for Agricultural Development, and the International Atomic Energy Agency.
T

Appendix B

Economic and Social Indicators

of Developing Countries

he development experience of eight countries

was discussed in detail in Chapter 4. Tables

B-1 and B-2 present economic and social indicators of more than 80 developing countries. The

tables provide a useful compilation of data for comparing the experience of those countries.
68 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table B-1.

Economic Indicators of Developing Countries

Net

Official Devel- Private

U.S. Economic Aid to opment Finance Capital

Developing Countries GNP per Capita as a Percentage of Flows as a

(Millions of 1997 dollars) (1987 dollars) GNP, 1990-1993 Percentage a

1961- 1971- 1981- 1961- 1971- 1981- Gross Net of GNP,

1970 1980 1990 1970 1980 1990 Flows Flows 1990-1993

Low-Income Countries

Zaire 203 53 71 244 196 339 n.a. n.a. n.a.

Chad 5 14 19 546 400 401 22.0 21.4 0.3

Tanzania 34 51 28 227 256 407 54.8 47.2 -0.1

Malawi 12 12 32 271 348 410 29.0 26.8 -0.8

Somalia 35 26 79 447 333 427 67.2 66.5 0.9

Sierra Leone 16 12 16 n.a. 440 500 24.8 19.1 7.2

Burundi 4 4 11 246 390 518 27.1 24.8 -0.5

Zambia 3 33 43 560 500 561 36.0 25.3 1.4

Burkina Faso 7 29 26 376 379 591 16.1 15.2 -0.3

Ghana 107 47 33 620 449 599 14.5 11.6 1.9

Guinea-Bissau 0 3 6 n.a. 299 599 49.5 48.0 -0.8

Nigeria 166 31 11 399 397 608 5.2 3.3 2.6

Madagascar 7 2 21 872 630 629 18.0 13.3 0.7

Myanmar 16 5 31 272 417 674 0.6 0.5 0

Niger 8 27 43 923 605 683 18.5 16.5 -1.6

Middle-Income Countries

Mali 12 33 37 n.a. 565 736 18.5 17.5 -0.3

Central African Republic 2 3 6 1,082 935 740 16.5 15.5 -0.2

Togo 8 8 15 525 560 749 14.7 12.5 -1.9

Gambia 1 6 11 548 717 768 33.5 30.2 3.1

Mauritanlia 1 14 17 781 769 808 30.7 24.3 -0.4

Uganda 18 6 24 n.a. n.a. 834 20.0 18.7 -0.3

China 0 0 0 123 273 844 1.2 1.0 5.2

Rwanda 3 5 17 1,004 858 885 19.9 19.3 0.3

Guyana 27 19 5 702 1,091 898 72.2 46.1 10.2

Kenya 34 52 90 429 613 918 18.1 13.2 1.9

Mozambique 0 11 45 n.a. n.a. 963 110.9 101.1 -1.3

Zimbabwe 1 4 54 n.a. 787 1,119 13.5 11.8 1.3

India 2,878 565 286 554 694 1,199 1.8 1.3 0.5

Benin 6 12 5 1,097 958 1,212 15.7 14.5 n.a.

Bangladesh 0 481 248 657 676 1,250 9.0 7.9 0.2

Pakistan 1,256 365 437 439 664 1,267 5.0 3.6 2.0

Indonesia 308 473 146 580 552 1,333 4.9 3.2 4.5

Cameroon 15 12 37 996 820 1,415 9.4 7.0 -0.2

Senegal 17 28 67 1,255 1,146 1,423 15.1 12.3 -0.1

Bolivia 158 105 92 1,877 1,733 1,580 17.7 13.7 -0.3

Papua New Guinea 0 0 1 2,123 1,739 1,620 13.3 11.4 5.7

Côte d’lvoire 14 5 5 1,471 1,751 1,624 15.6 11.3 0.2

Philippines 142 215 311 1,048 1,460 1,680 6.0 4.3 1.9

Honduras 41 55 187 1,217 1,605 1,745 20.3 12.7 2.0

Egypt 322 1,141 1,590 471 865 1,810 19.3 11.3 -1.2

El Salvador 56 30 407 1,981 2,499 1,860 9.2 6.0 -0.1

Paraguay 43 19 6 1,131 1,293 1,880 2.8 1.1 0.9

Dominican Republic 195 67 111 655 1,033 1,895 3.5 1.8 1.9

Lesotho 4 16 30 413 1,093 1,917 14.6 13.9 0.8

Guatemala 67 49 122 1,414 1,856 1,919 2.9 2.0 1.6

Sri Lanka 50 92 99 531 935 1,993 9.0 7.8 n.a.

Botswana 8 27 27 694 1,046 2,060 5.5 4.2 -1.4

Morocco 235 95 116 903 1,059 2,085 8.9 5.3 1.8

Swaziland 0 10 16 1,120 1,541 2,188 7.0 4.6 5.4

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
APPENDIX B ECONOMIC AND SOCIAL INDICATORS OF DEVELOPING COUNTRIES 69

Table B-1.

Continued

Net

Official Devel- Private

U.S. Economic Aid to opment Finance Capital

Developing Countries GNP per Capita as a Percentage of Flows as a

(Millions of 1997 dollars) (1987 dollars) GNP, 1990-1993 Percentage a

1961- 1971- 1981- 1961- 1971- 1981- Gross Net of GNP,

1970 1980 1990 1970 1980 1990 Flows Flows 1990-1993

Middle-Income Countries (Continued)

Congo 3 2 3 1,104 1,229 2,204 9.2 8.3 0

Peru 141 84 121 2,223 2,388 2,300 4.7 3.3 1.3

Jamaica 21 40 157 1,753 2,062 2,415 16.2 5.5 1.9

Upper-Middle-Income Countries

Tunisia 246 75 48 1,003 1,424 2,628 7.9 4.9 1.5

Colombia 425 153 14 1,384 2,056 2,762 2.3 -0.2 2.1

Thailand 164 63 50 1,088 1,556 2,762 1.8 0.9 7.6

Ecuador 98 29 49 n.a. 2,149 2,770 4.2 2.5 4.3

Algeria 86 5 0 2,369 2,715 2,992 3.9 1.5 -1.6

Chile 393 73 6 2,107 2,215 3,187 2.4 0.9 5.5

Iran 136 3 0 n.a. 4,646 3,250 0.2 0.1 3.9

Panama 88 59 73 1,977 2,799 3,263 10.4 0.5 -1.8

Costa Rica 60 24 195 2,130 2,542 3,370 5.1 3.1 2.4

South Africa 0 0 16 2,994 3,239 3,535 0.2 0.2 n.a.

Brazil 970 83 2 2,044 2,777 3,714 0.8 0.1 2.2

Turkey 733 119 223 1,551 1,871 3,856 1.4 0.4 4.3

Jordan 186 197 65 n.a. n.a. 4,015 20.4 16.7 -1.1

Malaysia 17 8 1 1,572 2,222 4,022 1.8 0.8 12.5

Gabon 4 3 3 4,880 5,261 4,127 6.4 4.4 -0.6

Mexico 76 13 28 2,404 2,892 4,241 1.4 0.7 5.8

Uruguay 45 13 4 4,880 4,163 4,546 2.5 1.7 0.6

South Korea 965 314 10 1,083 1,806 4,720 0.2 -0.2 2.1

Venezuela 90 5 0 3,658 4,347 4,895 1.9 2.1 3.1

Argentina 94 0 1 5,645 3,960 5,030 1.2 0.7 3.6

Mauritius 2 5 8 3,061 3,139 5,264 3.7 1.9 2.4

High-Income Countries

Trinidad and Tobago 19 0 0 7,867 7,920 7,365 2.4 1.2 1.6

Saudi Arabia 0 0 0 6,108 8,445 8,030 0 0 n.a.

Singapore 1 0 0 2,466 4,493 8,911 0.4 0.2 n.a.

Israel 206 1,093 1,712 4,856 7,232 9,096 2.9 2.5 n.a.

Insufficient Data to Rank

Liberia 69 39 74 783 925 n.a. n.a. n.a. n.a.

Nepal 54 31 28 439 655 n.a. 11.7 11.3 -0.2

Vietnam 1,686 822 0 n.a. n.a. n.a. 3.6 3.2 1.6

Ethiopia 94 56 48 n.a. n.a. n.a. 13.8 13.2 0.5

SOURCE: Congressional Budget Office based on data from the Agency for International Development, the Organization for Economic Cooperation

and Development, the University of Pennsylvania, and the World Bank.

NOTES: Countries are ranked according to GNP per capita from 1981 to 1990. The income categories and the countries assigned to each are

roughly comparable with those used by the World Bank in its 1996 World Development Report. Data for U.S. economic aid and GNP per

capita are 10-year averages, and those for official development finance and net private capital flows are four-year averages.

GNP = gross national product; n.a.= not available.

a. GNP per capita was calculated using estimates of purchasing power parity.
70 THE ROLE OF FOREIGN AID IN DEVELOPMENT May 1997

Table B-2.

Social Indicators of Developing Countries

Literate

Infant Mortality Rate Population

(Deaths per in 1990 Population

thousand live births) (Percentage Percentage

Decline, of population 1994 Growth,

1967 1992 1967-1992 age 15 and over) (Thousands) 1960-1994

Low-Income Countries

Zaire 137 92 45 72 42,552 178

Chad 179 120 59 30 6,183 102

Tanzania 135 84 51 n.a. 28,846 183

Malawi 197 142 55 n.a. 10,843 207

Somalia 162 120 42 24 9,077 140

Sierra Leone 204 164 40 21 4,587 105

Burundi 140 101 39 50 6,209 111

Zambia 115 103 12 73 9,196 193

Burkina Faso 185 129 56 18 10,046 126

Ghana 117 79 38 60 16,944 150

Guinea-Bissau 189 138 51 37 1,050 94

Nigeria 118 83 35 51 107,900 155

Madagascar 195 93 102 80 13,101 144

Myanmar 136 82 54 81 45,555 109

Niger 176 122 54 28 8,846 192

Middle-Income Countries

Mali 206 157 49 32 9,524 119

Central African Republic 150 101 49 38 3,235 111

Togo 141 83 58 43 4,010 165

Gambia 193 130 63 27 1,081 207

Mauritanlia 157 99 58 34 2,217 124

Uganda 118 114 4 48 18,592 183

China 81 30 51 73 1,190,918 79

Rwanda 143 109 34 50 7,750 183

Guyana 82 47 35 96 825 45

Kenya 108 61 47 69 26,017 212

Mozambique 175 146 29 33 16,614 123

Zimbabwe 101 67 34 67 11,002 189

India 145 80 65 48 913,600 107

Benin 160 85 75 23 5,246 135

Bangladesh 140 106 34 35 117,787 129

Pakistan 145 88 57 35 126,284 153

Indonesia 124 56 68 77 189,907 97

Cameroon 136 61 75 54 12,871 143

Senegal 154 67 87 38 8,102 154

Bolivia 157 73 84 78 7,237 116

Papua New Guinea 130 67 63 52 4,205 119

Côte d’lvoire 143 91 52 54 13,780 263

Philippines 72 42 30 90 66,188 140

Honduras 119 41 78 73 5,493 190

Egypt 170 64 106 48 57,556 107

El Salvador 110 45 65 73 5,641 119

Paraguay 59 37 22 90 4,830 172

Dominican Republic 105 40 65 83 7,684 138

Lesotho 140 77 63 n.a. 1,996 129

Guatemala 108 46 62 55 10,322 160

Sri Lanka 61 17 44 88 18,125 83

Botswana 105 42 63 74 1,443 201

- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
APPENDIX B ECONOMIC AND SOCIAL INDICATORS OF DEVELOPING COUNTRIES 71

Table B-2.

Continued

Literate

Infant Mortality Rate Population

(Deaths per in 1990 Population

thousand live births) (Percentage Percentage

Decline, of population 1994 Growth,

1967 1992 1967-1992 age 15 and over) (Thousands) 1960-1994

Middle-Income Countries (Continued)

Morocco 138 66 72 50 26,488 128

Swaziland 147 73 74 n.a. 906 178

Congo 110 84 26 57 2,516 155

Peru 126 63 63 85 23,331 135

Jamaica 45 14 31 98 2,496 53

Upper-Middle-Income Countries

Tunisia 138 42 96 650 8,815 109

Colombia 82 36 46 87 36,330 128

Thailand 84 36 48 93 58,718 122

Ecuador 107 49 58 86 11,220 153

Algeria 150 53 97 57 27,325 153

Chile 89 16 73 93 14,044 85

Iran 145 35 110 54 65,758 205

Panama 52 24 28 88 2,585 130

Costa Rica 68 14 54 93 3,304 167

South Africa 83 52 31 n.a. 41,591 139

Brazil 100 57 43 81 159,143 119

Turkey 153 62 91 81 60,771 121

Jordan n.a. 27 n.a. 80 4,217 400

Malaysia 50 13 37 78 19,498 140

Gabon 147 92 55 61 1,035 113

Mexico 79 35 44 87 91,858 149

Uruguay 47 19 28 96 3,167 25

South Korea 58 11 47 96 44,563 78

Venezuela 60 23 37 92 21,378 182

Argentina 57 24 33 95 34,180 66

Mauritius 67 17 50 n.a. 1,104 67

High-Income Countries

Trinidad and Tobago 46 18 28 n.a. 1,292 53

Saudi Arabia 140 28 112 62 17,498 329

Singapore 24 6 18 n.a. 2,819 73

Israel 25 9 16 n.a. 5,420 156

Insufficient Data to Rank

Liberia 173 123 50 40 2,941 183

Nepal 164 96 68 26 21,360 126

Vietnam 118 41 77 88 72,500 109

Ethiopia 167 117 50 n.a. 53,435 135

SOURCE: Congressional Budget Office based on data from the World Bank.

NOTES: Countries are ranked according to average gross national product per capita from 1981 to 1990 as presented in Table B-1.

n.a. = not available.

T

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