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Could aid revive business instead of stamping it out?

This post is by Claudia Williamson, a post-doctoral fellow at DRI.

This is a central question of The Aid Trap, by Columbia professors R. Glen Hubbard and William Duggan. Instead of supporting development, the authors argue, aid creates additional hurdles. While aid ‘crowds out or corrupts the business sector,’ we remain caught in an aid trap because business doesn’t pull at the heartstrings the way charity does.

The first half of the book documents the historical roots of prosperity and poverty. While people in today’s rich countries rose out of poverty as it became easier to do business, bad institutions and policies in poor countries have created perverse business incentives (for example: it takes 361 days and costs seven times the average per capita income to go through the seventeen procedures required for a firm in Mozambique to get the government licenses it needs to operate).  Not only does aid support bad policies and the government that created them, but by decreasing the reliance on taxes for funding aid removes incentives for reform.  Why become a less corrupt, more business-friendly government when aid makes it unnecessary?

Aid stifles the private sector by hindering local entrepreneurship, decreasing reliance on market transactions and trade.  It is often more profitable to work for an aid agency or a NGO than to start a business. Locals get squeezed out of business when an aid agency shows up, so instead of competing with aid agencies most try and join them. Why buy grain from the local farmer when a NGO is giving it away for free?

The second half of the book describes Hubbard and Duggan’s proposed alternative, a modern “Marshall Plan” that would support business directly without channeling money to governments or through NGOs. An independent agency would loan money to local businesses, and these loans would be repaid not to the agency but to those local governments that have agreed to reform the business sector and spend the money on public infrastructure.

The Aid Trap’s focus on private markets and the need for change in the business environment is a laudatory move in the right direction for helping the world’s poor. But the authors’ new Marshall Plan raises some obvious questions

As the authors acknowledge, post-war Europe is very different than most poor countries today. Reconstruction is completely different than building from scratch. Most European countries had a healthy private sector before the war, implying that many of the barriers to business in today’s poor countries were absent. Removing these barriers is part of the new Marshall Plan, but transforming bad institutions into good ones remains elusive. And if such barriers were removed, wouldn’t private financing find it profitable to provide loans as we see in India or China, possibly making the new Marshall Plan unnecessary?

Despite this, the book as a whole is a great description of the current gridlock in the aid debate, and a creative attempt to get out of it.

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  1. J. wrote:

    Talking a bit off the top of my head here…

    As I remember it, the original intent of the kind of aid that (I guess) is being discussed was to target the “bottom rung”, the “poorest of the poor”, those who in theory were below the range that could reasonably be expected to benefit from small, local for-profit sector development. But by the late 1990’s it seemed clear that the “poorest of the poor” were, well, not ideal candidates for small business development and micro-credit schemes. Rather than re-tool programming models to address the specific needs of the poorest, most NGOs simply shifted their targetting to those segments of the beneficiary populations who were more ideal candidates. Apparently with the result complained about in this book.

    In my opinion, it is probably time for NGOs to re-think micro-credit.

    Posted July 30, 2010 at 1:48 am | Permalink
  2. AndyB wrote:

    I’ve come across a few blog posts lately discussing the negative impact of the NGO sector on business environments. Claudia, does this book provide any hard evidence for this impact? The idea that aid allows governments to stay corrupt seems suspect to me. In my own anecdotal experience, a shrinking pie, makes officials more, not less, corrupt. The negative effects of aid on the business environment, especially issues like hiring the best talent, are definitely there, but I’ve only seen anecdotes from individual businesses not any analysis of the aggregate impact on a developing economy.

    Posted July 30, 2010 at 4:05 am | Permalink
  3. Claudia wrote:

    Dear Claudia and AidWatch,
    Thanks very much for this. I’m so grateful you wrote about it. A few days ago, I sent out to my list (and AidWatch was copied), Bill Easterly’s excellent blog on “The answer is 42! Why Development is not about solutions, it’s about problem-solving systems”, along with some commentary on The Aid Trap as follows:

    Professor Glenn Hubbard, Dean of Columbia Business School, and Professor Bill Duggan address the role of entrepreneurship to lift parts of Africa out of chronic, institutional dependency. Name one problem solving system other than democracy, and a free and robust marketplace run by profit-oriented people of good will. Africa needs a middle class, not billions in aid to prop up the status quo – other than humanitarian support.

    Business can work with churches (that provide the backbone of social justice and education programs because the corrupt governments can’t support its citizens), NGO’s and most of all, the African people. It’s minimal risk considering all the trillions already spent with little to show for it. And we could have more interesting conversations instead of lamenting Africa.

    Here is a 3.5 minute video on The Aid Trap to sum it up:

    Claudia McGeary
    Faith in Africa

    Posted July 30, 2010 at 8:13 am | Permalink
  4. Dan Kyba wrote:

    Read the book several months ago. As Prof. Easterly comments in the second-last paragraph creating the conditions for a market economy is an ‘elusive’ process. The Marshall Plan succeeded because Europe had the institutional memory, skills and networks to operate a market economy and method of governance to provide the public and quasi-public goods to underpin it. It just needed money to jump start the process.

    The developing world does not have the same kind of institutional and governance package as did Europe post WWII so using the term ‘Marshall Plan’ for programmes to that world is somewhat misleading especially in terms of time lines.

    Laying aside issues of accountability and effectiveness, the problem of aid comes down to volume. Too much aid will overwhelm or severely distort a nation’s GNP and tax base and will act as a disincentive to a government providing the necessary public goods for a market economy…. and as the previous post alludes, it is very easy to dismantle such goods and create a manmade crisis of the market economy.

    Posted July 30, 2010 at 10:21 am | Permalink
  5. Lynnae wrote:

    Claudia, thanks for your engaging review of The Aid Trap. I am confused on one point, though; you say that Hubbard & Duggan suggest the establishment of an “independent agency” that gives loans to local businesses, who then repay the local government, rather than the third-party independent agency, so there’s a pay-it-forward kind of model. This is interesting, but as I understand it, it sounds like it’s still aid. Perhaps a different kind of aid, but those loans are producing the same non-tax revenue for the government that an NGO’s aid would produce, no? If I’m understanding it correctly, I don’t see how Hubbard & Duggan’s idea is anything new or improved.

    Posted July 30, 2010 at 1:21 pm | Permalink
  6. Paul Rigterink wrote:

    One way universities could help AID workers is to prepare better texts and reference material for AID workers. For example, given the climatic zone of the region, an AID worker helping subsistence farmers in extreme poverty should have a text that describes methods for:
     Improved grain production
     Improved production of vegetables
     Improved fruit orchards and fruit nurseries
     Improved poultry production
     Improved small animal production such as goats and pigs
     Improved general purpose micro-farms

    In addition, the text should describe
    • Variety Selection
    • Fertilizer Selection and Use
    • Feed Selection
    • Pest and Disease Control Practices
    • Water Use
    • Quality Control Procedures
    A reference document should be available that describes the supplies that are needed for a particular type of subsistence farm in a particular climatic region and where missing supplies can be obtained. International Development professors working to help subsistence farmers should teach this information to their students in my opinion.

    Posted July 30, 2010 at 2:42 pm | Permalink
  7. Steven Segerlin wrote:

    Lynnae brings up an interesting point. You would think it would be in the interest to support the tax-base and revenue collection process – therefore supporting these institutions in building capacity and becoming a legitimate stakeholder in the society to which the government must be accountable. Additional benefits would be more power to vet when corruption and waste of funds are apparent.

    Posted August 5, 2010 at 4:05 pm | Permalink
  8. Robert Tulip wrote:

    The paradox here is that helping the poor does not reduce poverty. This is a counterintuitive claim that is rejected out of hand by charities. But it is true, given the evidence of how aid causes dependency and corruption. Aid should reorient to support business development, for example through first loss partial credit guarantees for commercial bank loans to firms who lack fixed collateral but have cash flow that can service loans. Support success and the poor will become rich. Private firms are the key to economic growth.

    Posted August 6, 2010 at 7:52 am | Permalink

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    The Aid Watch blog is a project of New York University's Development Research Institute (DRI). This blog is principally written by William Easterly, author of "The Elusive Quest for Growth: Economists' Adventures and Misadventures in the Tropics" and "The White Man's Burden: Why the West's Efforts to Aid the Rest Have Done So Much Ill and So Little Good," and Professor of Economics at NYU. It is co-written by Laura Freschi and by occasional guest bloggers. Our work is based on the idea that more aid will reach the poor the more people are watching aid.

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