The end of aid

Editor's note:

This blog post is the fourth of a four-part series about the year ahead in economic development, including topics on improving capitalismthe future of mobility, and global growth forecasts.

I spent the holiday season in Washington, with the usual end-of-year conversations with people working on international development at such venerable organizations as Brookings, Georgetown University, and the World Bank. I returned to North Carolina with two thoughts. The first was an impression that foreign aid is a dying industry, even in Africa. The second was a feeling that I should be spending more time in Beijing. In making three predictions about how 2018 might eventually be remembered, I’ll try to connect these thoughts.

International aid will end before extreme poverty is eradicated

Around Christmas, a lot of the talk was about cutbacks in development assistance from the U.S. and UK. The Americans and Brits are the two biggest donors, so this would be no small hit. (Fact 1: U.S. economic assistance to India between 1946 and 2012 totaled $65 billion USD, slightly more than American aid to Israel during those 66 years. Fact 2: Since 1990, British foreign aid has quadrupled from less than £3 billion to more than £12 billion, in 2015 prices).

The conversations made me curious about long-term trends in foreign aid, so I asked my colleagues Kenan Karakulah and Siddharth Dixit to investigate. Actually, foreign aid tracked by the OECD has increased five fold since 1960—from $32 billion to $158 billion, in 2015 prices. But the world economy has grown too. Take a look at this figure that they produced, which charts aid flows divided by developing country GDP:

Figure 1: 25 years of global economic growth—and diminishing international aid


The figure shows that, as a share of developing country GDP, multilateral aid flows peaked at 0.43 percent in 1992 and fell to 0.15 percent since then. Bilateral flows bounce around more, but the trend since the 1990s is the same: the ratio has fallen from 1.25 in 1990 percent to 0.43 percent in 2016. I won’t be encouraging my children to go into the aid industry. The next decade may be its last.

Most of us have assumed that foreign aid will continue unabated until extreme poverty is eradicated. But a look back shows that this isn’t what happens. China, India, Indonesia, and South Africa stopped getting aid some years ago, but they still have millions of people living on less than $1.90 a day. Quite reasonably, middle-income countries are expected to take care of their abject poor themselves. With more than half of sub-Saharan Africa’s population now in middle-income economies, we should expect aid to Africa to start declining.

Aid flows to Africa have already peaked

By early January, the talk in Washington was about President Trump’s putdown of Africa, which drew sharp rebukes from African leaders, and may have turned them away from the U.S. for good. Actually, U.S. aid to Africa has been rising since the presidency of George W. Bush. Between 2002 and 2015, annual U.S. aid to sub-Saharan Africa grew from $2 billion to $8 billion. It might have reached its limit.

Figure 2: Official aid to Sub-Saharan Africa may have peaked


Annual official aid to sub-Saharan Africa appears to have peaked at a little more than $40 billion in 2015. In South and Central Asia, annual aid flows might have peaked at $20 billion a few years ago; in East Asia, the peak was at about $10 billion in the late 1990s.

This may not be a bad thing. It is difficult to decide whether, on balance, foreign aid has helped or hurt the developing world. But consider this: the last time official development assistance to Africa declined was during the 1990s. The 2000s turned out to be the best decade ever for Africa—for economic growth, poverty reduction, and human development. High commodity prices may have helped, but so might have the growing substitution of philanthropy with finance.

Development’s future is finance, not foreign aid

The story goes that, when the International Development Association (IDA) was being set up in 1960, the prime minister of India, Jawaharlal Nehru, asked World Bank president Eugene Black that it be engineered to administer credit, not grants. The distinction was not just financial, but philosophical: grants connoted charity and diminished the receiver; loans encouraged accountability on the part of both debtor and creditor.

Over the next four decades, the experience with IDA played out very differently in Asia as compared with Africa. In Asia, IDA credits were repaid; in much of Africa, debts had to be renegotiated. (Fact: 34 of the 40 countries eligible for debt relief under the Heavily Indebted Poor Countries initiative were in sub-Saharan Africa; the only Asian country was Afghanistan).

With slates wiped clean through debt relief in the late 1990s and early 2000s, and China increasing its presence as an investor, financier, builder, and donor in the 2000s, development finance is being tried for a second time in Africa. Africa is increasingly looking east, towards China, India, Turkey, and other economies in Asia (Fact: between 2000 and 2015, China provided loans of about $100 billion to Africa).  Western aid, based on both altruism and political influence, is being complemented by Eastern finance, driven primarily by self-interest.

It is too early to tell whether things will work out better this time. The IMF has warned that debt-to-GDP ratios of African economies are rising rapidly. There are also concerns about destabilizing political and ecological effects of these investments. But this time round, trade with Asia is growing and investments in infrastructure are noticeable. 2018 might be the year in which the developing world decides whether foreign aid and development finance should be complements or substitutes.

Right now, I’d bet on development finance displacing official aid. If I spent more time in Beijing and less in Washington, I might hedge my bets—or double down.