In Favor of Foreign Aid

Writing in favor of official aid Carol Lancaster writes that “The good works of charity and the impact of investment by entrepreneurs can also make a major contribution to helping the poor. But they are not able to do what governments can do. The impact of their good works is likely to be limited in the absence of public aid.”

This argument in favor of foreign aid is based on the FUD (fear, uncertainty, doubt) strategy pioneered by IBM, implying essentially that ”Yes, those people can do something, but without us you will not be able to achieve your objectives.” The argument goes that the problems are large, and require large scale assistance.

Yet, the size of financial transfers is one of the key objections to foreign aid. As several economists point out, it leads to the “aid curse” and to lowered productivity by stunting the private sector. Indeed, recent excitement that remittances are an effective tool for development is grounded in the understanding that they are small and encourage local consumption. So, while they are greater than total ODA, they avoid the problems associated with aid by being distributed.

That said, Prof. Lancaster does have a point. Most private philanthropists and companies in poor countries do not have the scale to deliver certain critical services, such as subsidizing millions of HIV anti-retrovirals, or providing humanitarian assistance in times of war and natural disasters.

For “Philanthrocapitalism”

On the other end of the spectrum, Michael Green’s arguments are equally polarizing. He puts his faith in what he calls “philanthrocapitalists” - the likes of Bill Gates, Mo Ibrahim, and Pierre Omidyar.

 The philanthrocapitalists’ giving will always be dwarfed by official aid. Yet their ability to lead, innovate and take risks means that they are our best bet for finding ways to make aid work. They are already using their expertise from the business world to find solutions to three big development headaches: stopping epidemic diseases like malaria, building a private sector and fixing failed political systems. Their success depends on the willingness of governments to work in partnership.

The key argument is that these individuals are more innovative and can take risks. Also, by applying principles from the private sector, they can find more efficient and effective ways to solve the world’s intractable issues.

At the macro level this argument suffers from two weaknesses. First, Mr. Green is simply trading one “big brother” for another. If big government cannot solve problems without substantial negative side effects, why would big philanthropy be any different? After all, both are a set of well-resourced interest groups that work outside the local institutional setup. As an example, the Gates Foundation has been criticiszed for having grown so big as to stiffle debate in the medical research community. And an article in the BMJ argues that the foundation’s “special brand of philanthropy is damaging health systems in developing countries and distorting aid priorities.” That sounds an awful lot like what you hear about government aid.

Second, Mr. Green’s faith in philanthropists rests on yet unproven ideas. For instance, he places a lot of hope in microfinance - yet few if any studies have shown that microfinance has any lasting developmental impact. And why is he placing so much faith in capitalism and the financial sector, when the sector has so obviously failed to guard the small investor over the past two years?

And finally, Green ignores Carol Lancaster’s key point - that philanthropic capital is simply not enough. For instance, the Mo Ibrahim Prize for good governance, while an excellent initiative to focus attention to the issue - is hardly likely to turn corrupt politicians into honest ones.

Conclusion

The debate misses the point. Neither foreign aid nor philanthrocapitalism are perfect. Foreign aid certainly works better in some areas. Yet, let us not pretend that it seeks anything more than political leverage or short-term solutions.

Green’s prognosis too is disappointing. He is full of praise for the philanthrocapitalist - yet puts too much emphasis on philanthropy and too little on the capitalist. If anyone will raise Africa’s standard of living, it is the local population. The deserving amongst them will go hungry, beg, borrow, and steal to climb up the economic ladder. The local government can help by not being an obstacle. That is how they did it in China and India, despite public aid. And they are doing it now in Africa, despite poor institutions. To suggest that Africa, or any poor country, needs some patriarch - whether a benevolent government or a benevolent philanthropist, is to continue to propogate the white man’s burden.

The authors conclude in their randomized trial of 52 (of 104) slums in India:

We show that the intervention increased total MFI borrowing, and study the e¤ects on new business starts, investment, and consumption. Households with an existing business at the time of the program invest in durable goods, and their profits increase. Households with high propensity to become business owners see a decrease in nondurable consumption, consistent with the need to pay a fixed cost to enter entrepreneurship. Households with low propensity to become business owners see nondurable spending increase. We find no impact on measures of health, education, or women’s decision-making.

There are several interesting results to be gleaned for this summary, but just as many questions.

Testing the Enterprise Hypothesis

The first interesting result is that microfinance seems to encourage, or at least enable, commercial enterprise. According to the survey the presence of microfinance helps to “create and expand businesses” amongst a subset of current or “likely” entrepreneurs. However, amongst the rest of the population, it tends to increase non-durable consumption.

The last part of this result is not surprising as anecdotal evidence has long suggested that microfinance works also to smooth consumption. What is surprising, however, is the high density of entrepreneurs in the target communities. A full 31% of households run a very small business - compared to the OECD average of 12%. This may seem counter-intuitive. Then again, the opportunity cost of poor households becoming entrepreneurs is extremely low, which may explain this result.

Testing the Development Impact

The survey also tests the impact on development indicators and finds no impact whatsover on health or education. While the MF as a tool for development argument has long ago been dropped by most serious MF proponents, this undermines it further. That said, as the authors note, it may be too early to conclude that microfinance does not enhance social outcomes. Rather, “after a longer time, when the investment impacts have translated into higher total expenditure for more households, it is possible that impacts on education, health, or womens’ empowerment would emerge.”

Open Questions

Unfortunately, the study seems to leave open several questions - and the report is missing several critical pieces of information.

First, it seems 69% of households in the baseline have outstanding loans at an average rate of 3.85% per month. What is the average loan amount and rate charged after the Spandana intervention and do loan rates come down? A key criticism of MFIs has been that loan rates seem to remain stubbornly high - is that true?

Second, what is the percentage of population that are likely entrepreneurs. In other words does microfinance, on balance, lead to greater enterprise or greater non-durable consumption?

Finally, and most important, the study says nothing about the failure rate of businesses. In the baseline, 30% of households have a business. Just how many of these still exist at a later point in time? Similarly, how many of the entrepreneurs that borrow, succeed?

This point is particularly relevant if you consider that existing businesses seem to register an increase in business profits of up to INR 5,000 - a 600% maximum rate of return in some cases. Such returns cannot be had without substantial risk, a monopoly, or some other market imperfection. So, where is the catch?

Conclusion

This survey is worth reading simply because it is the first real study on the impact of microfinance. It is interesting in that the results are intuitive - credit in the BoP world seems to work similar to how it works in the developed world. Responsible and entrepeneurial individuals use it to start businesses or save for the future. But many others use it to live beyond their means and may end up in a debt trap.

That said, the survey is also interesting in what it does not reveal about microfinance. While the inconclusive evidence on human development indicators can simply be a matter of time, it is a tangential issue. At the core of microfinance today, is its value proposition as a business incubator. There are as many questions on microfinance as a business itself that must be answered.

To be sure, President Rajapaksa has made the right noises - such as addressing the country in Tamil. Yet, there are ominous signs that there will be no quick return of Tamil civilians to normalcy. The latest of these is the news that the ICRC has suspended its work in the north because the government is denying aid agencies access to relief camps. Simultaneously, Sri Lanka has also arrested its own doctors, that had served in the warzone, for providing “false” casualty figures. This suggests that Sri Lanka’s government intends to control both the destinies of Tamils and the opinions of the Sinhalese for some time to come.

To be fair, what has been achieved in Sri Lanka is most remarkable. Seldom in the history of the world has a dissident terrorist and militant movement been so strong and yet been defeated so quickly. For this the credit (or discredit) must go to the government of President Rajapaksa, which used the LTTE’s atrocities “as a license for its own abuses.”

Certainly, the LTTE’s own actions in the last days of the war showed it to be no more than a terrorist organization and the passing of Prabhakaran and his ilk should not be mourned. But in managing the aftermath Rajapaksa can learn from the experiences of Israel and India before metting out a collective punishment on those Tamils strong and lucky enough to survive.

The Palestinian community has no state to call its own, but is spread out across Gaza and the West Bank, as well as in Egypt and Lebanon. In order to keep alive international claims for a separate Palestinian homeland, Arab States have denied these refugees citizenship or resettlement. As a result, Palestinians live 2nd-class lives and their ghettoization, to which Israel contributes substantially in the Gaza strip, engenders violence and anger against Israel and its allies both inside those camps, and out.

India’s handling of militancy in Punjab provides a more positive example. That movement was also silenced by the gun. But it was similar to the LTTE in that both were financed by diaspora abroad. Khalistan was funded by Sikhs in the UK, USA, and Canada. Eelam was funded by Tamils in Europe and North America.

While counter-insurgency was responsible in defeating militancy militarily, peace was won through political negotiations, a quick return to full civilian control, and by equipping a war-weary population with the tools for growth. As a result, even though support for Khalistan remained high abroad, it ebbed locally.

Sri Lanka may yet face a similar challenge because Tamils abroad are not yet ready to surrender. And no matter how hard it tries to weed out LTTE members, Sri Lanka is sure to miss some. To ensure that those that do escape remain marginalized, Sri Lanka must ensure that the bulk of the Tamil population moves forward and is not stuck in relief camps.

Sri Lanka would do well to show grace in its hour of victory. This is not a time to be searching for LTTE cadres but to prevent another LTTE from forming. To do so, President Rajapaksa should move the “biggest hostage operation” from rescue to relief. He can start by providing relief agencies unlimited access and funding.

There is a risk, of course. War crimes were probably committed on both sides and those of the government will surely come to light. For a State that has silenced dissent for so long that prospect is no doubt unsettling. But this too may be good, for a little introspection may go a long way in aiding reconciliation.

The irony of this war is that both sides purported to fight to “liberate” the Tamils. The LTTE wanted a Tamil homeland while the government called its endgame the largest “hostage rescue operation in history.” Oddly enough, they both killed, shot at, and bombed those very civilians they claimed to serve and protect. Well, the Tamils have now been liberated. If the LTTE defined the past, Sri Lanka’s government has the opportunity, indeed the obligation, to define the future of Sri Lanka. With such an overwhelming victory and public opinion in its favor, it also has the tools to do so.

To track this changing landscape, the THD (Technology, Health, and Development) Blog has reinvented itself as Global Health Ideas. Aman, the blog’s co-founder, gave this reasoning for the shift:

Because of increased attention and scope we decided it was time for a more permanent home that would also allow us to do more. We are still going to be blogging about global health solutions, innovative projects and the use of technology.

I’ve been following (disclosure: and occassionally blogging) on the THD Blog for a few years. It is an excellent resource that takes a practical perspective on health issues - looking at innovations that have the potential for real impact in developed and developing countries. If it relates to health, it likely will be discussed on this blog. And this week Aman and his co-conspirators will also be live blogging from the Global Health Council’s annual meeting in Washington, D.C.

Head over to get your dose of health ideas.

Swine flu is in. In the rush to cover this latest possible pandemic, newswires are alive with activity, blogs and social networking sites are buzzing, and the CDC and WHO are back in the limelight. This despite the fact that the number of cases are limited (only 40 confirmed infections have occurred in the US).

The rush of news has been accompanied by a rush to track that news. The WSJ, amongst others, has a tracking website, including a map of infections in North America. Best of all, Google has a map showing how the infection is traveling.

This rush was started by Google Flu Trends, a website that tracks flu-related search queries to estimate influenza levels in different US states. Further studies suggested the same approach might work for other diseases as well.

Analyzing Google Trends

So how has Google Trends, the broader application of the Flu Trends concept, performed in the current scenario? A quick analysis shows that Google search results did in fact increase over the past few days (see chart - source: Google Trends).

A quick analysis shows three items worth mentioning:

• First, while Google Trends does show an increase in search activity on “swine flu,” the first uptick in activity only occurred on April 23. By contrast, the first news stories appeared on April 21 when two cases were confirmed in California.
• Second, Google Trends reports that the majority of search queries were from New Zealand, USA, UK, Canada, and Australia. Only a very small minority were from Mexico. Yet, Mexico is the country supposedly at the heart of the pandemic.

Explaining the Discrepencies

I had used a Google Trends like methodology two years ago to track the evolution of climate change as an issue in news coverage. Having worked on that, I can propose a few general reasons that explain why Google Trends is limited in this case.

First, it appears that Google Trends follows with some time lag, actual infections. This should not be surprising, as people are not likely to search for a disease before having had some exposure to it. This does not mean that it is not a useful tool for tracking diseases over the long term. At the very least, the response time of a system based on GT might be lower.

Second, the current scenario shows that Google Trends is highly susceptible to “noise.” Prior to this outbreak, swine flu was probably not a commonly known disease, and queries on it were extremely rare (if not non-existent). Thus, even the slightest uptick in search activity would show up as a major change. That uptick was provided by the highly charged media coverage of the subject. Given this, one wonders if the search results are more “noise” and less people with a genuine interest in the subject. So, Google Trends is likely to be more accurate where general knowledge of a subject (the baseline) is high, and media coverage (noise) is low.

Finally, and most interestingly, why is it that most of the search results came from the US, while Mexico is more exposed to it? Not surprisingly, this methodology only works where both a large number of the population and media are on the internet.

What Next for Google Trends?

When discussing why most search queries occurred in the US, it is worth noting another fact about the swine flu outbreak - that it has traveled extremely fast. Originating in Mexico, it has been carried to the USA, Spain, and New Zealand. This brings into question the validity of using the geographic source of search queries as a reliable indicator of where the disease actually is.

Still, it may also offer a way to enhance Google Trends. What if Google Trends data was combined with travel data on the number of people traveling from a “hotspot” of an infectious disease. It would be logical to assume that popular destinations, or ones which receive travel groups, would be the most likely next locations for further infections. Thus, a map could potentially be created of not only where the disease is generating interest, but where it might be headed.

Of course, Google does not have access to such data - though at some point it may decide to acquire a travel operator. But the general lesson is simply that to make Google Trends more useful, search query data needs to be looked at together with real-world data (such as travel data or hospital records).

It is still early days for the swine flu outbreak, but some commentators are already suggesting the “social web” has actually created hysteria rather than help track the disease. That may be true, but it is hardly a problem of the “social web.” As a reader on the FP pointed out, “Twitter is only a natural extension of a typical neighborhood.”

So, in this “typical neighborhood,” what the swine flu outbreak has done is illustrate where Google Trends does well - in tracking general interest amongst heavy Internet users. But it also exposes limitations - the methodology is (not surprisingly) susceptibility to “noise” from media coverage and is biased towards countries and issues that are online. This does not mean that the idea itself is flawed. Just that it must be taken with a pinch of salt, and that it needs work - especially interfacing it with real-world data streams - to make it really useful.

But hidden amongst those massive numbers is something that is far more relevant to India - the variance in the achievement gap across income and racial groups.

Furthermore, the gap between students from rich and poor families is much more pronounced in the United States than in other OECD nations. In a world-class system like Finland’s, socioeconomic standing is far less predictive of student achievement. All things being equal, a low-income student in the United States is far less likely to do well in school than a low-income student in Finland. Given the enormous economic impact of educational achievement, this is one of the best indicators of equal opportunity in a society, and one on which the United States fares poorly.

This is lesson number one for an India that is still deciding on which model is best for its education system. Since India must provide equal opportunity to its many minorities, no matter which model it chooses its defining purpose must be to promote upward mobility through equal access to education. Or, in other words access, not just quality, is important.

Highlighting the problem is the fact that the differential in achievements is even wider for minority groups:

On average, black and Latino students are roughly two to three years of learning behind white students of the same age. This racial gap exists regardless of how it is measured, including both achievement (e.g., test score) and attainment (e.g., graduation rate) measures.

In India one would expect the same to be true of students from lower castes or from economically poor backgrounds. The vast majority of those students go to government schools, and thus this adds weight to the argument made by Azim Premji that India must improve its government schools:

This is what the government school classroom represents; it represents the dreams and aspirations of India in a way that no other school system can. If we wish to transform India, this is where we have to begin. I suppose it is clear why we do grave injustice when we think of government schools as “schools for the poor”.

The third insight is that higher expenditure on the education system does not automatically translate into better achievement. The US spends the most, per capita, of any OECD country, yet is ranked 25th. The McKinsey report concludes that “by one measure we get 60 percent less for our education dollars in terms of average test-score results than do other wealthy nations.”

Of course, I do not wish to say that India does not need to spend more. It does. Yet, more money is not the only solution, and for a resource constrained country other alternatives must be looked at. A lot can be achieved through non-monetary incentives involving social engineering and treating the teaching profession with an element of decency.

There is much that separates the US from India. But appearently one problem that we do share is the inability of school going children to access a relatively decent education, despite the presence of world-class institutions. This problem is not simply one of quality, but also of access to quality, and there is a dichotomy between the two because resources must be addressed to only one problem at a time. In finding a solution Indian policymakers would do well to learn from the reality in the USA. They must turn the debate on education away from a focus on improving quality per se, to one of improving the quality of education where it is most lacking.

The hijacking of the Maersk Alabama, the first ship hijacked by Somali pirates with an all-American crew, might be a turning point in America and Europe’s efforts to fight piracy off the Gulf of Aden. Within days French special forces stormeda hijacked French yacht, while American special forces freed the captain of the Maersk Alabama, killing three pirates. But if anyone thought this would deter pirates, they were wrong. Within days pirates had hijacked 4 more ships. At least some of these attacks were clearly in revenge for the American operation.

Secretary of State Hillary Clinton unveiled a four-point plan to fight piracy. The plan has several elements, but perhaps the most defining aspect is the “more muscular approach” propagated by it. In Secretary Clinton’s words, “The United States does not make concessions or ransom payments to pirates.”

But what is the track record of more muscular efforts? Since June 2008, when the UN Security Council sanctioned military intervention (under resolution 1816), naval operations by 18 countries have succeeded in thwarting some hijacking attempts. Yet, the sophistication and range of pirate activities in the Indian Ocean has continued to increase. Hijackings can now occur as far as 350 nautical miles off the Somali coast, and have grownfrom 59 in 2007, to 184 in 2008, and 65 so far in 2009 (see NATO chart).

Piracy-related incidents off Somalia. Source: NATO

More muscle may not be the answer. Secretary Clinton’s plan has an uncanny resemblance to the US’ “war on drugs,” which costs the US taxpayer over USD 40 billion annually, yet has had a questionable impact on the flow of drugs into the US.

Piracy emerged as a problem after the fall of the General Siyad Barre regime in 1991, which left Somalia without an effective government. Post 1991, the only period when piracy declined or was effectively contained was when the Islamic Courts Union ruled Mogadishu for a brief six-month period, re-surfacing again when Ethiopian forces drove the ICU out of power.

For anyone wishing to address the piracy problem, the UNSC resolution and ICU rule present two extremes of enforcement codes. Their respective outcomes show the extent to which military responses can succeed – they douse the fire but piracy tends to flare again when suitable winds blow.

Understanding the Fundamental Drivers

While it is easy to blame piracy on the lack of effective governance in Somalia, there is another deeper issue at play. Somalia’s fishing industry is in crises because an ineffective government is unable to guard its coastline and EEZ, which are immensely rich in marine resources. Somali piracy, in other words, shares its origins with an intense increase in illegal, unreported, and unregulated (IUU) fishing in Somali waters – which has deprived fishing communities of their livelihoods. As the FAO notes, “there are also an estimated 700 foreign-owned vessels that are fully engaged in unlicensed fishing in Somali waters.”

It is thus interesting to note that Somali pirates claim legitimacy as being de facto coast guards. Last September, Sugule Ali, spokesman for a group that hijacked the MV Faina, said in an interview:

We don’t consider ourselves sea bandits. We consider sea bandits those who illegally fish in our seas and dump waste in our seas and carry weapons in our seas. We are simply patrolling our seas. Think of us like a coast guard.

Justified or not, pirates see ransoms as fees extracted in return for illegal fishing in their waters. Of course, the ransom collected – between USD 30-150 million in 2008 - does not go into the national kitty. However, a large part of it is indeed spent in the local market. According to Peter Lehr of St. Andrews University, 700 Somali pirates directly support a shore-based infrastructure employing between 10-15,000 people. And indirect impacts are even broader, providing the impoverished masses visible economic imperatives to tolerate or support pirates. As reported by the NY Daily News, the pirate port city of Eyl now sports, “Big villas and hotels, former subsistence fishermen are driving Mercedes-Benzes and gold-digging women are showing up.”

For a country with no welfare programs piracy may be the only hope and those involved in it can seek statehood in the eyes of the people. The pirates turned patriots shall celebrate the bigger catches and the masses shall rally behind their providers. In such a scenario, how easy would it be for foreign militaries to chase pirates on the land or sea?

Break the Legitimacy

Why not break this cycle of legitimacy and win the trust of the masses first? To do so the international community needs to act urgently to return Somalia’s marine resources to the people of Somalia.

The UN estimates that illegal fishing conservatively costs Somalia about USD 100 million per year in revenue due to IUU activities by European and Asian vessels. This situation been described by Lehr as a “resource swap” with Somalis “taking $100 million annually in ransoms while Europeans and Asians poach $300 million in fish.”

The UN Convention on Law of the Sea recognizes sovereign rights of states over territorial waters and Exclusive Economic Zones. The absence of effective governance in Somalia has meant no controlling authority over these areas. Rather than allowing private profiteers from filling this gap, the international community and the UN should come forward and do so by establishing a Regulatory Authority for the Somali EEZ. The EEZ should be broken down into different areal sectors. Based on the potential fishery and other living stocks in each sector, the authority should decide the limits for maximum, safe and environmentally sustainable exploitation. Fix the minimum bid price for each sector depending on the varieties of stocks especially tuna, sharks and lobsters. Invite global tenders and award the fishing contracts to the highest bidders for each sector.

The proceeds of this fishing activity should go to yet another international body (a Development Commission for Somalia). The Commission would spend the money on creating productive assets in Somalia - in the fields of education, health and infrastructure - in the process creating livelihood options for the masses.

Territorial waters and some inshore areas should be reserved for traditional artisan fishing communities, with a possible tie up with foreign vessels to buy the artisan catch. The armada of 18 international navies could extend their mandate not just to fight piracy, but to ensure that only legitimate fishing occurs in the EEZ.

Conclusion

Secretary Clinton’s plan for the “war on piracy” ignores a fundamental reality – that piracy has its roots in a loss of livelihood, yet provides the fuel for pirates to gain the support of the local populace. While military actions may reduce piracy in the short term, a populace deprived of every other means of living, and desperate enough to risk lives crossing the Gulf of Aden, will certainly return to piracy.

As mentioned by Cristopher Jasparo, piracy partly reflects the failure of governance in Somalia itself. More important, it illustrates the insufficiency of a military response in combating non-state actors that represent the losers of globalization. A plan that truly solves piracy must address these realities if it is to be both effective and morally justifiable.

The plan proposed here strikes a balance between the legitimate rights of the international community for safe passage and its responsibilities to govern Somali waters “for the people,” in the absence of a functioning Somali state. It takes away the cover of national cause from pirates and shifts resource legitimacy and popular support towards the international community. Thus, it should contribute to a conducive climate for both political negotiations for government formation as well as concerted efforts in chasing the pirates and their supporters - wherever they are!

This is the first guest post by Bhagirath Jogdand, a graduating student from the International Organizations MBA program at the University of Geneva, Switzerland. He is currently working on a plan to rebuild Somali fishing communities, as an complement to combating piracy off the coast of Somalia. Prior to joining the MBA, Bhagirath worked for several years in the federal and state police and security services in India.

But the article points to a seminal Cato Journal article written in 1987, on the complete “disregard of reality” that economists sometimes show. Written by Peter Bauer, a leading development economist, it should be required reading for all economists - and indeed social scientists.

Before commenting on this article, it is worth noting that this article was written at a time when foreign aid was very much en vogue. At the time most developing countries had adopted centralized state planning and import substitition policies, often at the behest of economists from America and the UK. In the 1960s, India was a case in point. As noted in this 1992 Cato paper (Foreign Aid and India: Financing the Leviathan State), John P. Lewis - the head of USAID at the time argued:

that India’s planned development was the most feasible and desirable path for a country at an early juncture in the development process and that the decentralized market system was inappropriate, destined to fail, and had only led to the development of Great Britain and the United States because of “special circumstances.”

Bauer’s paper is a good early rebuttal of this view. Bauer argued against many of the popular views at the time, including “that there is by necessity a widening gap between rich and poor countries, and that central economic planning and large-scale capital investment are prerequisites for growth” (see this paper). Criticizing the concept of a vicious circle in development, he said “if the notion of a vicious circle were valid, mankind would still be in the Stone Age at best.”

The Causes of this Disregard

Bauer’s article is revealing in how despite his faith in economics he also held strong reservations on the subject, and particularly on its practice. While an economist himself, he was highly suspicious of the tendency of economists for groupthink and their ability to confuse economics with the natural sciences.

That second comment is particularly telling because economists today seem to fall into the same trap and think their ability to quantify social processes set them apart from other social scientists. Yet, Bauer argued that:

In the course of this shift of approach pertinent differences between the study of nature, especially physics, and economics have not been sufficiently recognized…the use of mathematics is particularly effective because of the language barrier it provides. What we see is an inversion of the Emperor’s New Clothes. Here there are new clothes…But all too often there is no Emporer within.

Implications for Today

Bauer’s observations have implications far beyond foreign aid because policy advocates tend to overlook the obvious, even today. There are two areas in particular where economists, have often neglected this basic test.

First, the current crises has led many economists to herald a new era. Those on the left declare this to be the end of capitalism. As Gordon Brown proclaimed at the G-20 summit, the “Washington Consensus is Over.” Those on the right, however, take it to mean that we have not had enough capitalism - and that we need to re-commit ourselves to free trade, liberalization, and the other tools at the disposal of free-market economists.

Both sides tend to ignore reality. On the left, they ignore that the world is inexorably moving towards greater, not lesser, capitalism simply because the hordes of Indians and Chinese are choosing to trade and consume? And those on the right ignore that countries that had embraced these free-market ideals have suffered the most.

The truth is simply that we have always had a mixed economy. This view, in the Indian context, was underlined most recently by the Indian PM Manmohan Singh (covered very well here). As Amartya Sen said in his article Capitalism Beyond the Crises (excellent recommended reading):

The market economy has depended for its own workings not only on maximizing profits but also on many other activities, such as maintaining public security and supplying public services.

So, if society has depended always on a mix of public and private institutions and players, what is needed is a healthy mix of the two - rather than a substantial reliance on any single one. This is a lesson Indian liberals should do well to remember.

The second area where economists have been particularly vocal these days, at the expense of the obvious, is in espousing the privatization of education in India. They moan regulation that prevents businesses from investing in and profiting from education providers. Implicit in their proposals is the claim that public education cannot work.

Yet, this ignores reality because public education worked in many places, including the entire communist world. This is not to say that the communist system is better. Yet, anyone that suggests public education doesn’t work needs to first explain why, according to the latest UNDP statistics, Cuba has the highest literacy rate in the world (which at 99.8% is 17 ranks above the USA at 99%).

Conclusion

According to O’Grady, Tim Geithner disregarded reality by thinking that the solution to any problem is to “throw more money at it.” This is not true of foreign aid. Nor is it true of free-markets (the PPIP), or education, or healthcare. More money will not solve the problem. Nor will replacing one incomplete system with another.

However, the answers to our problems may not be that elusive. Rather than trying to rethink everything, or change the system we see as failing, we may wish to look at something more obvious but perhaps less sexy. As Amartya Sen says of the “new capitalism” what is needed is “a new understanding of older ideas, such as those of Smith and, nearer our time, of Pigou, many of which have been sadly neglected. What is also needed is a clearheaded perception of how different institutions actually work, and of how a variety of organizations can go beyond short-term solutions to contribute to producing a more decent economic world.”

And above all what is needed is, in Orwell’s words, “the restatement of the obvious.”

A vulnerability fund would allow timely help to the poor nations, including in particular those that are heavily dependent on remittances. It is a thoughtful proposal deserving careful consideration by the G-20.

There is nothing new in the suggestion that poor countries need help now. But this article suggests a new reason - that remittances to them are falling. Appearently, those remittances could drop by over 5%, threatening consumption in poor nations.

Remittances account for substantial transfers globally, of USD 318 billion in 2007. There is no question they will decline.  As the article points out, “remittances declined in 2008 for seven in 10 of the Hispanic immigrants in the U.S. who sent money in the last two years. For 83% of those who sent less money, the reason was economic decline and uncertainty.”

Aid: An Alternative to Remittances?

The answer, in Mr. Ghosh’s opinion, is to channel 0.7% of money earmarked by rich countries for their stability plans. And of course, the fund would be managed by the World Bank.

Now how is this any better than asking OECD nations to live up to the commitment of providing 0.7% of GDP to foreign aid? That way we don’t need yet another fund, with yet another bureaucracy. Of course, in this case the World Bank gets a lucrative fund and tons of money - maybe that’s why this option is better?

This proposal will have a serious distortionary impact on recipient nations. The reason remittances are considered good for growth and economic development is that they encourage local consumption and work through normal private and public channels. Aid, on the other hand, undermines local institutions by diverting skills and resources away from these sectors. Worse, in countries where aid is a substantial portion of GDP, it also reduces overall competitiveness - and effect known as the “aid curse” or Dutch Disease.

Mr. Ghosh suggests that while prior aid funds may not have worked, this time it will be different.

This time things ought to be different, for several reasons. First, the pitfalls and limitations of aid are now better understood by both donors and recipients than in the past. There is increased public vigilance over the planning and use of aid, and active participation of the private sector and NGOs in the whole process.

Second, the present global crisis has sharpened political sensitivity in almost every country to any misuse of taxpayers’ money, especially though corrupt practices or ostentatious projects.

But this is hardly convincing. While the problems of aid may be better understood, donors and agencies have yet to come up with a better delivery mechanism. Further, public vigilance over use of aid has hardly prevented waste - over the past several years several cases of corruption have been uncovered, even within the World Bank. And finally, such vigilance is of little use in countries that are run by dictators, or have weak or non-functioning democracies - exactly the countries the aid fund would likely target.

Conclusion

Let us presume that the article’s premise is correct and remittances will drop sharply. But this does not mean that a) they need to be compensated for by other means, and b) the “vulnerability fund” is the best way to compensate.

The countries where remittances are a large part of GDP might actually need help. But providing them relief via foreign aid will only supplant a money transfer mechanism that works (remittances), with one that causes damage (aid). The alternative of doing nothing might be better.

Second, countries where remittances are not a large part of GDP, probably don’t require that much help. Individuals in those countries probably will suffer, but it is highly unlikely that aid agencies could reach those people effectively.

Here’s a simpler solution. Why not give the money directly to the migrants in the developed world? That way they can send more home and consume locally to kickstart the economy. Or in other words, let the stimulus packages target the poor in each developed country - something they should do anyway.

For once, I must agree with the Heritage Foundation, which calls this proposal a gimmick for the poor. I suspect the reason this idea is not so attractive to the World Bank is that it does not enrich the bank’s coffers. But that goes to show exactly what is wrong with the development aid paradigm. Those involved in giving it out have an incentive to ask for more. So rather than finding the best way to solve poverty, they look for the best way to address poverty that includes them in it.

In a new article (by yours truly) in the latest issue of the Economic and Political Weekly (India as an Emerging Donor), I have sought to understand both the size of India’s giving and its strategic drivers and strengths. Some interesting points highlighted below.

• In 2008, India allocated approximately INR 26.7 billion (USD 547 million at current Jan 2009 exchange rates) to aid-related activities.
• In addition, it also approved USD 704 million in lines of credit through the EXIM Bank. By March 2008, USD 2.96 billion in LOCs had been approved - much of it for Sub-Saharan Africa
• The aid program has changed in two critical ways. First, the aid periphery has expanded beyond South Asia. Second, India’s giving is increasingly bilateral and thus focused more on projecting “hard” rather than “soft” power.

For more and an analysis of the implications, see the article online.