How foreign aid can negatively affect developing countries' institutions

Table of Contents

Introduction 2

The foreign aid model 2

Defining foreign aid 3

Negative impacts of foreign aid in developing countries’ institutions 3

Increased corruption 3

Reduced governance improvement 4

Increased debt 4

Increased conditionality and exploitation 5

Reduced wealth creation and trade 6

Increased poverty 6

Conclusion 6

References 7

 

Introduction

Foreign aid to developing countries is a controversial topic that continues to confront many economists. While some economists have argued and proved through research that foreign aid has a positive impact in the long run, questions still linger on whether this foreign aid has negative impacts on institutions (Elaya 2016). Some researchers have shown that foreign aid does indeed promote economic growth even though this could also be accompanied by reduced quality in governance structures and institutions (Jones & Tarp 2016). This essay attempts to explain how foreign aid can negatively impact developing countries’ institutions. The essay will start focus on the foreign aid theory proposed by Leonard M. Dudley and Claude Montmarquette: “A model of the supply of bilateral foreign aid”. The essay will then go on to define foreign aid and discuss the negative impacts of foreign on the institutions of developing countries. 

The foreign aid model

The foreign theory by Leonard M. Dudley and Claude Montmarquette was published in the American Economic Review and it suggests that foreign is aided by three key motives: the expectation that the recipient country will be more friendly to the donor country in terms of supporting the donor’s political interest; expectations that the recipient country will import more from the donor country; and the expectation that standards of living of people in the recipient country will improve (Dudley & Montmarquette 1976). Further, the theory suggests three conditions for the supply of foreign aid: the high value of the aid is high enough; the per-capita of the recipient country is low; and the recipient country has a low population.

Defining foreign aid

Foreign aid refers to the flow of finances from the donor country to the recipient country (Elaya 2016). The aid could be in form of loans, grants, funding of institutions and charity organizations, economic aid, military aid, security aid and political aid (Elaya 2016). The foreign assistance or donation could be meant to serve humanitarian purposes, for philanthropic motives or to promote the interests of the donor country (Murshed & Khanaum 2013). Foreign aid can occur between two countries (bilateral) or could involve many countries (multilateral). In most cases bilateral donation is tied to conditions by the donor country while multilateral donation is often not conditional.

Negative impacts of foreign aid in developing countries’ institutions

The foreign aid theory proposed by Leonard M. Dudley and Claude Montmarquette suggest that while foreign aid could be useful in the economic development of the developing countries, it could also be accompanied by several political and economic hazards to institutions in the developing countries. These negative impacts include the following:

Increased corruption

A key negative impact of foreign aid on the institutions of developing countries is increased corruption. According to Elaya (2016), donor countries have been giving financial assistance to developing countries to help combat corrupt regimes. The foreign assistance comes in form of regime programs and development measures that are accompanied by financial and monetary assistance. However, these finances often end up supporting the corrupt regimes and vicious cycles of unnecessary bureaucracies in the recipient country. This implies the donation ends up being used for other things including corruption and not being used for the programs and development measures for which it is intended. The donor money further encourages corruption as some governments prevent the creation of the needed conditions for reform and development, and demand some forms of bride in order to allow the donors to establish programs. Besides, the recipient government often fails to account for the foreign aid suggesting the institutional level of corruption. 

Reduced governance improvement

Research has also shown that increased foreign aid in developing countries could be a recipe for blocked governance improvement. According to Omotola and Saliu (2009), foreign aid could weaken governance in two ways: first, the way in which foreign aid gets to the recipient country is accompanied by high transaction costs and fragmentation that undermine governance; and second, the foreign aid could act as an incentive that makes it difficult to overcome problems of governance. In another research, Niyonkuru (2016) termed foreign aid as ineffective and unfavorable when it comes to good governance. This is because the mode of disbursement of foreign assistance is too lengthy as much as it is costly, making the recipient country to lag behind in starting and competing programs. Besides, foreign assistance is too unpredictable when it comes to disbursement and this negatively impacts good governance, accountability in government expenditure. and the development of sound institutions (Niyonkuru 2016)

Increased debt

Developing countries, particularly in Africa and the Middle East have accumulated so much debt to the level that they can no longer manage these debts. While the high debt level of the developing countries could be as a result of a weak economic base characterized by high export dependence and concentration on a few commodities, foreign aid has also contributed to increased debt. Research has shown that wealthy donor countries have been pushing foreign aid packages and loans on developing countries so that greedy politicians and businessmen could benefit from the interests (Jones & Tarp 2016). An often overlooked factor of foreign debt is the conditionality that comes with it, especially loans. Some donor countries as suggested by the foreign aid model give financial assistance to developing countries on condition that the assistance comes with a loan that the recipient country should repay. Once the developing nation is unable to repay the loan, the donor country uses institutions like the IMF and World Bank to access strategic resources in the developing country. Since most developing countries rely on foreign aid and cannot refuse the assistance, debts continue to accumulate (Jones & Tarp 2016).

Increased conditionality and exploitation 

Conditionality is another negative impact of foreign and according to a research by Murshed and Khanaum (2013), it restraints the economic and political development of the recipient country as the donation requires the recipient country to act in certain ways. Conditionality refers to the terms and conditions that accompany any financial aid. As discussed above, these conditions could come in for of a requirement to take a loan from the donor country, or in some cases, import more from the donor country. Conditionality affects institutions in the developing countries such that they cannot be independent, self-reliant or make their own decisions regarding trade, imports, and other economic activities. The conditions that accompany the foreign aid could also encourage exploitation of the recipient country in terms of the requirement to take loans or only do business with the donor country. In some instances, the donor country might send government representatives to the recipient countries to monitor the funded programs and ensure that the agreement is followed (Niyonkuru 2016). In some cases, donor countries impose economic policies on the recipient nations. 

Reduced wealth creation and trade

Studies have also shown that foreign aid directed to developing countries is related to reduced wealth creation and trade in the developing countries. According to Elaya (2016), foreign aid to developing countries have led to the creation if what is known as “a vicious cycle” whereby recipient countries become heavily dependent on the assistance. As a result, the recipient countries spend less time and energy in bringing reforms that are meant to increase wealth creation and trade. For instance, some developing countries spend foreign aid on recurrent expenditure and other non-productive activities. For example, research has shown that 95% of government expenditure in Yemen is financed either by foreign aid or oil revenues (Elaya, 2016). Other developing countries that have become heavily reliant on foreign aid to the extent of reduced internal wealth creation include Jordan, Sudan and Lebanon. 

Increased poverty

While one of the intentions of foreign aid is to alleviate the living standards of people in the developing world (Dudley & Montmarquette 1976), the same foreign assistance have been found to encourage poverty rather than help eradicate it. According to Niyonkuru (2016), foreign aid is accompanied by foreign policies that dictate how funds should be used and this is highly unlikely to yield any fruits when it comes to poverty alleviation. This is because of a disconnect that exists between foreign policies and the objectives of the recipient government. In addition, foreign aid is tailored to address current problems instead of looking into the origin of the problem.

Conclusion

In summary, as much as foreign aid could be beneficial, research shows that the assistance could also have negative impacts on the developing countries’ institutions. For instance, foreign has been associated with increased corruption, increased debt, increased conditionality, reduced governance improvement, reduced wealth creation and increased poverty. Such issues should therefore be addressed to ensure that foreign aid is effective.

 

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