Foreign Aid Might Help More People as a Grant

Nancy Birdsall
Nancy Birdsall
Nancy Birdsall Senior Fellow and President Emeritus - Center for Global Development

April 24, 2002

From the outside looking in, this year’s spring meetings of the IMF and World
Bank in Washington, D.C., were relatively tranquil, with fewer and quieter
street protesters. But inside, tempers were flaring over a nasty spat between
supposed allies in the global war on poverty.

The U.S. wants 50 per cent of the resources of the International Development
Association (IDA), the World Bank’s fund for low-cost loans to the world’s
poorest countries, to be used to make grants rather than, as has been the case
for many decades, to make low-cost loans.

The Europeans don’t like the proposal at all. They’ve want to assign a much
smaller proportion of IDA funds to grants—not more than 10 or 20 per cent.

What’s the fight really about? First, the Europeans fear switching to grants
would jeopardize the bank’s long-term finances, since the bank would lose the
future repayments of today’s loans. They had reasonable doubts about the Bush
administration’s commitment to the World Bank and figured they could hardly
count on the U.S. to make up later any difference in the bank’s lost resources.
(After all, last summer in Ottawa, and several times after, U.S. Treasury
Secretary Paul O’Neill has resisted calls for increasing foreign aid flows,
saying foreign aid programs had wasted billions of dollars.)

In fact, the argument is weak. Whether it’s 50 per cent, or something less,
matters little from a financial point of view. It would be a decade before the
change made any difference at all to the bank’s balance sheet, since IDA loans
have a 10-year grace period before any repayment begins. And it would be 20 or
more years before the amount of foregone loan repayments became substantial.

Moreover, last month U.S. President George W. Bush linked the war on global
poverty to the war on terror and promised to add $10 billion to the U.S. aid
program over the next three years. In a late attempt to quiet the Europeans, the
U.S. administration suggested it would make up any difference in financing that
a switch to grants would imply.

The Europeans have been bullied, but the Bush administration in this case has
the right idea. It’s time for both sides of this spat to move on to the real
issue of increasing aid flows and making aid programs, whether financed by soft
loans or by grants, more effective in helping people and reducing poverty.

Here is a worthy task for Finance Minister Paul Martin—to help his
colleagues in the U.S. Treasury use some gentle diplomacy, smooth the ruffled
feathers of the Europeans and get to a rapid conclusion.

The fact is that a serious move to grants for the poorest countries, most of
which are heavily indebted, makes sense.

Weak government institutions, high disease burdens, a poorly educated labour
force and the declining price of commodity exports have all made it tough for
these countries to get onto a sustainable growth path.

In addition, some are coping with the costly burden of the AIDS pandemic.
They are going to need external assistance for many years if they are to meet
their citizens’ most basic needs for health care and schooling, and at the same
time invest in roads, judicial systems, adequate policing and so forth.

Adding to their debt burden with additional loans, even low-cost loans, makes
little sense. It risks a new round of accumulation of unsustainable debt —
generating a future need for still more transfers to provide the cash they’ll
need to pay their debts.

There has always been the argument that grants would be treated as easy come,
easy go. Loans, in contrast, were supposed to motivate recipients to use the
resources well, for programs that would encourage private-sector growth,
yielding increased tax revenue, or for building up human capital and
strengthening institutions, ensuring more rapid overall economic growth and thus
the ability to easily service debt repayments.

But the evidence of the past 20 years is that government leaders are often
perfectly happy to accept loans today without worrying about the burden they are
imposing on their successors in government tomorrow and on future taxpayers.
Donors, too, have shown themselves more than willing to lend to countries
despite the likelihood, in some countries in some circumstances, that there was
little or no prospect for repayment.

More important than the choice of loans or grants is that the World Bank, as
well as donor governments, become more selective with aid, limiting large
transfers to those countries truly able to absorb the resources effectively.

If the World Bank’s IDA window is to make grants, the Canadians and the
Europeans ought to insist on one thing. The bank’s singular strength lies in its
capacity to work with governments on setting budget priorities, implanting
structural reforms and building effective public institutions to support a
market economy.

The bank has the carrot of big loans or grants for governments making
good-faith efforts to implement their commitments, and the stick to stop
providing them when governments descend into corruption or outright thievery.

The Canadians and Europeans should agree to grants on the condition that the
bank work only with and through governments, and leave the financing and
monitoring of humanitarian and emergency relief programs, and support for
non-governmental civic programs, to the UN agencies and to private and bilateral

For countries that are not performing well, the bank could still make small
grants, to support policy dialogue in particular sectors where leaders are
willing and capable, and for training of judges, educators and other public