Aid, Inflation and Entrepreneurship

By; Bikal Dhungel 

Global official development assistance (ODA) is not without criticism. In the last 5 decades, over one trillion dollar has been given as aid. Still, many countries especially in sub-Saharan Africa are poorer than 40 years ago. Per capita income did not rise there.  Based on this figures, the backlash on aid has been rampant recently. People are grouped into three categories. First, those who support aid unconditionally (like Jeffrey Sachs), second, who thinks aid should be conditional (Esther Duflo ) and third, who think aid does not work at all (Dambisa Moyo, William Easterly). All three groups have robust data and well-grounded reasoning. Whatsoever, the initial reason for development aid, (to foster development) could not be realised. Otherwise over 1 billion people living below $1.25 a day would not be a reality today. However, it does not necessarily mean that aid has completely failed. As Esther Duflo puts it, ‘Aid might have helped to avoid even bigger disaster’.

The portion of poor people worldwide has decreased but this decrease mainly took place in South East Asia, especially in China. In least developed countries, the situation has not changed much. Despite huge amount of aid, development failed. The figure below shows aid as a percentage of government expenditure. From the figure it can be concluded that countries receiving highest amount of aid are in Africa and three in Asia, which includes a war torn Afghanistan, Cambodia and Nepal.

Source: World Bank, 2012

Also in the past these countries have been receiving a high amount of aid per capita. So, what was the role of aid in these countries? Has aid been fruitful at all?

There is no single answer to these questions. There are many unique factors that caused under-development. Some of the countries mentioned above are landlocked. Landlocked countries are in comparison poorer than countries that have access to the see. They also trade less especially due to the high cost of trading. A recent survey has showed that the cost of shipping good is 19% of the total price in Africa whereas it is less than 5% in the US. Why I mentioned trade is because trade is about trading goods and services. To trade, it is necessary to produce these goods and services. Producing goods and services means creating employment and that will eventually contribute to development. This is where the role of aid comes. First, what happens when aid is pumped into a country that produces less and trades less? A recent case study in Mogadishu, Somalia showed that the influx of aid has caused massive price hikes for basic goods that the most vulnerable were unable to afford it. With increased aid and remittance inflow but with a constant supply of goods, price normally goes up. When aid and remittance doesn’t go hand in hand with increased supply of goods and services, the money will be lost in inflation. So, even a well-intentioned support can worsen the situation further. A similar pattern is visible in Nepal. The high inflow of remittances has caused the price level to go up. From the year 2000 to 2013, inflation averaged 6.8% whereas GDP grew only by 4.1% in average. At the same time manufacturing and agricultural yield shrank but import sky-rocketed. Hence, it will be correct to conclude that remittance and aid has increased our foreign dependency but caused our manufacturing sector to vanish. This phenomenon is also called ‘The Dutch Disease’. Moreover, it also caused a price hike in non-tradable goods like real-state and housing. Such development puts Nepal in a vulnerable situation especially when the remittance and aid flow is disturbed by economic crisis.

The National Living Standard Survey 2010/11 shows that almost 80% of remittance is used for consumption and less than 5% is used for income generation. As mentioned above, once remittance flow reduces, it is likely that more people will be pushed below poverty line due to the lack of saving and income source. So, putting aside some remittance for investment is a form of insurance for rainy days. Moreover, the government has a role to play to avoid any inflationary tendency so that the remittances are not simply lost in price rise. Some countries including Nepal have introduced the instrument called remittance bond but it has failed to generate any positive result in Nepalese case. In terms of Aid, how they are spent is not known. The government spending process is in-transparent.  Still, like remittance, more inflow without accompanied by more production, there will be no long term gain.

Hence, main focus should be on entrepreneurship. If aid and remittance are invested, they create jobs and will help the people to sustain even without them in the future. Simply giving more and more aid both in the form of cash and goods is harmful in the long run. The famous story of mosquito nets clarifies this.

Malaria is one of the largest causes of death worldwide. According to the World Health Organisation, in 2013 alone, almost one million people died due to Malaria. But Malaria can be easily prevented, for example by vaccination or by using mosquito nets. So, an aid organisation decided to distribute mosquito nets for free in some rural area. Before the distribution, there was an entrepreneur who produced mosquito nets. She had 20 employees who could support ten family members each by their job. Now the aid organisation has distributed mosquito nets for free in the whole area and the local net producer was out of business. 20 employees and their family members lost their income source. In the short term it was still good for the general public because they all got free mosquito nets. After few years, the nets become old and cannot be used anymore. So, again the aid organisation should come and give them free nets. If they cannot do it anymore due to whatever reason, prevalence of malaria will again rise. Had they built the capacity of local net producer, the supply of nets in the absence of aid had continued but now the local net producer has gone out of business and the donor agency cannot give aid anymore. So, everybody is worse off.  The vicious circle of aid goes on like this. Aid should be given again and again.

How aid can be used in order to boost sustainable economic growth depends on how the receiving government chooses to use it. In the aftermath of World War II, the famous Marshall Plan was initiated with a total of $14 billion to rebuild Europe. The amount was used to build critical infra-structures that were vital for growth. Within five years, Europe built a robust economy and the period of ‘Economic Miracle’ started in Germany. The only difference between the Marshall Plan and Development Aid today is, Marshall Fund was perceived as a ‘one time’ support whereas recipients of Development Aid get it in yearly basis without having used it efficiently in the previous year. Marshall Fund was spent responsibly with targeted investments whereas Development Aid mostly vanishes within the recipient government and bureaucracy.

The lesson to take is simple: when the donors teach how to fish and actively support in the process until the capacity is built, no aid is required in the future. In contrast, if aid is given for the sake of giving, first it can cause inflation putting the vulnerable in even more risk and second it should continue further as it kicks small scale entrepreneurs out of business, like the story of mosquito nets.