Stretching Foreign Aid Dollars

There are ways for Canada to provide more assistance to developing countries without putting pressure on its budget.

In these times of austerity, it is time to get smart about the role of foreign aid in development. Aid is smart when it is used to help developing countries stand on their own two feet by increasing their reliance on their own domestic financing – and thereby progressively reduce their need for foreign assistance.

At the centre of the global aid architecture is the 24-member Development Assistance Committee (DAC) of the Organization for Economic Co-operation and Development (OECD). Last year, aid from DAC countries reached US$130 billion – its highest-ever level in real terms. But while foreign aid has been growing at a rapid clip, the projection for the next three years, in the aftermath of the financial crisis, is of a substantial decline in the growth rate.

Many donors, Canada included, are squeezing their aid budgets as belt-tightening becomes a priority. So the question is whether austerity can be turned into an opportunity when it comes to international assistance.

About $3.5 trillion was spent on foreign aid internationally over the last half-century. That may sound like a lot, but most people don’t realize the amount of “phantom aid” that is buried in the numbers. For instance, the cost of settling refugees in donor countries, as well as the administrative cost of donor agencies, is counted as aid.

In fact, much of this so-called aid money never leaves the donor country. Typically, less than half of the aid from rich countries is classified as "country programmable,” which is the share over which the recipient country can have a meaningful say. For instance, only about 35 to 40 per cent of the $5 billion in aid spent annually by the Canadian government is country-programmable.

So the first straightforward idea is to increase the share of country-programmable aid. Individual countries have the power to do this on their own by, for example, controlling the costs of donor agencies and moving toward more efficient channels. In this way, the amount of assistance actually reaching developing countries can be increased even with frozen aid budgets.

The second point to recognize is that most development expenditures are financed by developing countries themselves using their own resources. These include public resources – tax and non-tax revenue – as well as private resources, such as household savings, corporate profits, and investments, channelled through the financial system. Performance on both fronts remains very weak in most poor countries. So how can aid be directed to enhance public-resource mobilization and/or ease financial-sector bottlenecks?

The key is not more aid but achieving a better balance across priorities. Over the 50-year evolution of the DAC, aid dollars aimed at building economic infrastructure, such as banking and financial services, and at productive sectors such as agriculture, have declined as the focus shifted to social sectors such as health, education, and governance. Remarkably, less than two per cent of technical assistance to Africa goes toward building tax capacity, according to the OECD’s own estimates.