Why foreign aid does not help

In the aftermath of the floods, the government of Pakistan – as well as segments of the Pakistani diaspora – have been calling for more aid to come into the country, not realising that such an inflow of free money is likely to do far more harm than good in the long run.

Over the past two decades, a consensus has arguably developed across the local political spectrum that borrowing money from foreign sources is bad. Yet somehow aid, which is seen as free money, is not viewed as a bad thing and indeed is welcomed and sometimes – somewhat embarrassingly – begged for.

While most Pakistanis suspect that much of the aid is squandered due to corruption, there has been no serious questioning as to what effect even the most successful of aid packages would have on the country.

It can be argued, however, that foreign aid – regardless of how efficiently it is utilised – causes massive long-term damage for minimal short-term gains. No country in the world that has successfully made the leap from being an underdeveloped to a developed economy has relied heavily on foreign aid. Indeed, one of the hallmarks of being a dynamic emerging economy is the lack of reliance on charity from the developed world.

There are two primary reasons as to why foreign aid has been largely worthless for the developing world at large and for Pakistan in particular.

The dependency syndrome

The foremost problem with foreign aid is that it creates dependency. Unlike loans, which need to be paid back, aid does not have any requirement for being repaid and thus is far less likely to be utilised efficiently. Even if it is used exactly as intended, it still allows the government to live beyond its means without consequences. In essence, it creates an incentive for bad fiscal behaviour.

There is no better example of this than the government of Pakistan. The state has relied on foreign aid from almost the very beginning of its history. As a result of this semi-constant flow of aid, the government never faced enough fiscal pressure to fully tax the economy, inculcating a culture of tax evasion that plagues the country today.

The government collects only a little more than nine per cent of the Gross Domestic Product (GDP) in taxes and faces an annual fiscal deficit of about six per cent of GDP.

Foreign donors, however, seem to have had enough and so the government simply prints more money to pay its bills instead, causing skyrocketing inflation. What the economy does not pay in taxes, it ends up paying with the constantly diminishing value of the rupee. The government of Pakistan, of course, has not yet learnt its lesson. Instead of going after evaders and widening the tax net, it is still hoping for more foreign aid to fill the budget gap. If Pakistanis want their government to be more accountable to them, they should start paying their bills first. In the words of the late US Supreme Court Justice Oliver Wendell Holmes, “taxes are the price we pay for a civilised society.”

Even debt forgiveness is bad for the economy in the long run since it sends a signal to the government that borrowed money need not be repaid. This in turn inculcates a sense of lethargy amongst government officials that promotes corrupt or inefficient uses of money. If loans have to be paid back, donors are likely to ask for a clear plan to raise the money for repayments. Such a plan is likely to benefit the long-term fiscal health of the country.

Structural problems with aid

And then there are problems with the mechanism of aid delivery itself. Take, for example, food aid. Unto itself it seems like a worthy cause, feeding the hungriest people in the world. Yet look more closely and what emerges is nothing short of an amoral structure that ends up scarring the recipient country for years.

The concept of such aid, by giving out free food, prices it at zero. This means that any farmer in the recipient country who may have been in a position to grow and sell food now has a competitor who sells their product at absolute zero, making it impossible for this local farmer to compete. And since most food donors do not buy the food locally but rather from their own home countries (in a backdoor subsidy to their own farmers), the local farmer cannot even sell to the aid agencies. In essence, his entire commercial enterprise is rendered worthless.

Usually, the only crops the farmer can grow for a profit are those whose primary use is as the raw material for narcotics. Instead of helping the country stand on its own two feet, the aid has ended up making narcotics manufacture the only viable business. How does that help anybody?

It is never worth it

Aid, therefore, provides only temporary solutions to chronic problems while deepening the structural flaws that caused them in the first place. This is not to question the donors’ motivations, but rather the effectiveness of the methods that they utilise. The best that they can do to help developing countries like Pakistan is to offer freer access to their markets. And stop giving more free money.

The writer is a financial and management consultant based out of Karachi

Published in The Express Tribune, October 4^th, 2010.