Foreign aid and its effectiveness

By Dr Marian Tupy | 28 June 2005

Tony Blair arrived recently in Washington to ask President George Bush to increase substantially U.S. aid to Africa. His visit came a few months after Columbia University Professor Jeffrey Sachs unveiled his own plan to end extreme poverty around the world by 2025. In The End of Poverty, Mr. Sachs argues rich countries should commit themselves to transferring some $1.5 trillion over the next decade to the poorest nations - primarily in Africa. But, in truth, foreign aid is unlikely to succeed, because most of Africa's problems are internal.

In the 1960s, many developmental economists believed in the "vicious cycle of poverty" theory, which argued poverty in the developing world prevented accumulation of domestic savings. Low savings resulted in low domestic investment and low investment was seen as the main impediment to rapid economic growth. Foreign aid, therefore, was intended to fill that apparent gap between insufficient savings and the requisite investment in the economy.

And so, between 1960 and 2005, foreign aid worth more than $450 billion, inflation adjusted, poured into Africa. Result? Between 1975 and 2000, African gross domestic product (GDP) per capita declined at an average annual 0.59 percent rate. Over the same period, African GDP per capita fell from $1,770 in constant 1995 dollars adjusted for purchasing power parity (PPP) to $1,479.

In contrast, South Asia performed much better. Between 1975 and 2000, South Asian GDP per capita grew at an average annual 2.94 percent. South Asian GDP per capita grew from $1,010 in constant 1995 dollars adjusted for PPP to $2,056. Yet, between 1975 and 2000, the per capita foreign aid South Asians received was 21 percent that received by Africa. The link between foreign aid and economic development seems quite tenuous.

Dr Marian Tupy is assistant director of the Project on Global Economic Liberty at the Cato Institute.