Why Foreign Aid Doesn’t Work

There is a talk on EconTalk by Bruce Bueno de Mesquita, co-author of The Logic of Political Survival. The talk is on The Political Economy of Power. Here is his argument why foreign aid doesn’t work.

Any leader of an organization or a state is selected by a winning coalition within a selectorate. In a democratic nation, the selectorate is the electorate. For the election of a new pope, it is the College of Cardinals.

A government does three things,

  1. Picks a tax rate
  2. Provides public goods
  3. Provides private goods for members of the winning coalition

Autocratic leaders of poor countries are dependent on small winning coalitions. The leader of the government only depends on the leaders of military, the police, and parts of the civil service. When the coalition is small, it is efficient to spend money on private rewards and privileges, corruption, bribes, etc.

If the winning coalition is very large, as in democracies, it is more efficient to provide public goods that also benefit the average voter.

In the rich, democratic countries, there is a demand for helping poor people. A leader in a rich country will give money to the government of a poor country in return for policy concessions.

However, since the winning coalition in the poor country is very small, the rational leader should pay off his coalition, not spread the money around. Indeed, if he tried to avoid paying off his cronies, his coalition would defect and look for a new leader.

Foreign aid therefore works for the winning coalition in the rich country, it works for the donor government of the rich country, it works for the recipient government of the poor county, but it doesn’t work for the poor people in the poor country.

Foreign Aid therefore works just like the Resource Curse. It is money that goes to the recipient government, which it will spend on its small winning coalition, its cronies. There is no need to build a a functioning economy with proper institutions and a system of taxation.

I haven’t read the book yet. Judging from the talk, it is another example of how useful game theory is. Other interesting recent books using game theory include Avner Greif, Institutions and the Path to the Modern Economy: Lessons from Medieval Trade and Daron Acemoglu & James A. Robinson, Economic Origins of Dictatorship and Democracy: Economic and Political Origins.

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8 thoughts on “Why Foreign Aid Doesn’t Work

  1. Thank you for the references. There are of course, foreign aid success stories. Given the huge number of aid projects, it would have been surprising if there weren’t any. With respect to NGOs, I like the approach of Technoserve (http://www.technoserve.org/), although my knowledge of the organization is limited to the website. The site lists a number of countries where Technoserve has previously worked. It does see a bit strange that they no longer work in these countries. It is not as if the problems of these countries have been solved.

  2. Pingback: Stern review on the economics of climate change « Natural Capital

  3. I agree that a lot of the money simply given to the governments of countries in need of foregin aid is squandered. However it is very important that something be done about the problem of world in-equality. Underdeveloped countries do have an advantage in that they can learn from the mistakes of countries that have developed before them. Environmental issues must be taken into account from the start. If environmental reforms can be part of the development process, they will be able to catch up and sustain themselves much more effectively. There are many environmentally responsible technologies being created today that developed countries are having difficulty integrating into their economies that these developing countries could get involved with from the “beginning”. e-mail: cmazurak@hotmail.com if you would like to discuss this issue.

  4. i also agree that much foreign aid is given to governments who, perhaps, due to corruption, state of domestic political and economic policies etc, use it ineffectively, and thus may also deter the growth of their country. However, is this to say that the developed world should leave them be and stop foreign aid? the answer is of course no. There has been much reserach on the topic, and therefore, there are 2 sides to the story. Many academics have founded evidence that suggests foreign aid has a negative impact on growth, but this research is not without its downfalls. Many regressions on which the evidence is based on has the fundamental problem of engogenous variables treated as exogenous ones. On the other hand, there has been substantial evidence to suggest that in a good policy environment aid will have a positive impact. If this is the case, yes aid allocation should be reviewed, but great emphasis should always be placed on foreign aid, as this is the only way the developed world can possibly help to reduce world poverty.

  5. Hi,
    I am currently doing some research on foreign aid and growth of developing economies, and was wondering if anyone has any ideas on soem interesting approaches i could take.

  6. Rina,

    Look at the debate between Jeffrey Sachs and William Easterly. Read also about the “developmental state”, e.g. Haa-Jong Chang’s “Kicking Away the Ladder”.

  7. One problem with direct aid to a government is that it can turn the thing the aid is intended to alleviate into a source of income for the government.

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