[stop-imf] Aid, Growth and IMF Orthodoxy

[robert weissman]

From: ncalexander@igc.org


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Aid, Growth and IMF Orthodoxy

In Part I, this note reviews selected IMF documents pertaining to the
macroeconomic impacts of aid inflows on growth and human development.
The IMF documents respond, in part, to the declared intention of the aid
community to double the level of official development assistance.

In Part II, other perspectives are set forth in  =E2=80=9CChanging Course:
Alternative Approaches to Achieve the Millennium Development Goals and
Fight HIV/AIDS=E2=80=9D by Rick Rowden, Action Aid USA, September 2005.  Se=
e:
  http://www.actionaidusa.org/pdf/Changing%20Course%20Report.pdf

Analyses of the macroeconomic impacts of aid inflows (especially high
aid inflows) can strengthen analyses of the impacts of the policy
conditionalities attached to these inflows.  Aid critics have paid more
attention to the latter than the former.

Importantly, there are signs that the IMF is recognizing that its
insistence on excessively low levels of inflation has generally
diminished growth rates in borrowing countries.  Moreover, the
institution is identifying a few circumstances in which high levels of
aid inflows fail to contribute to growth and human development.

A deeper understanding of impacts can shed light on reasons why, during
the 1990s, when sub-Saharan Africa received funding amounting to 12% of
GDP, on average, the average growth rate per capita in declined by 0.6%
per year.  (For statistic, see Birdsall, Rodrik and Subramanian, =E2=80=9CH=
ow
to Help Poor Countries,=E2=80=9D in =E2=80=9CForeign Affairs,=E2=80=9D July=
/August 2005.)


-------------

Part I

A. Aid vs Growth
There has been considerable controversy over the circumstances in which
aid inflows (purchasing imports, among other things) can diminish growth
rates by, among other things, contributing to inflation and a rise in a
country=E2=80=99s exchange rate, which diminishes growth.  This phenomenon =
is
called the =E2=80=9CDutch Disease.=E2=80=9D  [The term =E2=80=98Dutch Disea=
se=E2=80=99 was used
to describe the adverse impact of a discovery of natural gas on Dutch
manufacturing because of a surge in income and consequent appreciation
of the real exchange rate.]

In June 2005, Raghuram Rajan, Chief Economist of the IMF and his
colleague, Arvind Subramanian, published a paper, =E2=80=9CAid and Growth:
What does the Cross-Country Evidence Really Show,=E2=80=9D
http://www.imf.org/external/pubs/ft/wp/2005/wp05127.pdf  which found
that there is:

=E2=80=9Clittle robust evidence of a positive (or negative) relationship
between aid inflows into a country and its economic growth.  We also
find no evidence that aid works better in better policy or geographical
environments, or that certain forms of aid work better than others.  Our
findings=E2=80=A6suggest that for aid to be effective in the future, the ai=
d
apparatus will have to be rethought.=E2=80=9D

These results are stated more strongly in a paper by Subramanian and
another IMF researcher, Simon Johnson, entitled =E2=80=9CAid, Governance, a=
nd
the Political Economy: Growth and Institutions,=E2=80=9D February 10, 2005.
They say:

=E2=80=9CRajan and Subramanian (2005)=E2=80=A6find strong evidence of an ad=
verse
impact of aid on an economy=E2=80=99s competitiveness and hence on long-run
growth.=E2=80=9D

Neither of these papers articulate the views of the IMF, as an
institution, but rather IMF staff members writing in their personal
capacity.  Indeed, some members of the IMF=E2=80=99s Board of Executive
Directors were outraged by these findings.

As the aid community pledges to double the level of aid in order to
ostensibly achieve the MDGs, the IMF has studied the impacts of aid,
particularly the impact of high aid inflows in low-income countries.  It
conducted case studies of the phenomena in five countries -- Ghana,
Ethiopia, Mozambique, Tanzania and Uganda.  [See: The Macroeconomics of
Managing Increased Aid Inflows: Experiences of Low-Income Countries and
Policy Implications, August 8, 2005
Link:  http://www.imf.org/external/np/pp/eng/2005/080805a.pdf ]

The IMF found that, due to downside impacts of aid, Government of Ghana
did not spend its aid inflows from 2001-2003, but rather sold them into
the foreign exchange market to stabilize the currency after a
terms-of-trade shock and accumulated them as reserves.  Put differently,
if the financing was spent, then other spending was reduced by the same
amount.  Hence, Ghana avoided any exchange rate appreciation.  The case
study of Ethiopia shows a similar pattern.  The IMF concludes that,
=E2=80=9Cto neither absorb nor spend may be an appropriate short-run strate=
gy
where aid inflows are volatile or international reserves are
precariously low=E2=80=9D or if it is felt that concerns about exchange rat=
e
appreciation =E2=80=9Cfully outweigh the benefits from the absorption of ai=
d
inflows.=E2=80=9D  (p. 17)

In Mozambique, Tanzania and Uganda =E2=80=9Cspending exceeded absorption,
creating a surge in domestic liquidity.  In Mozambique, this led to high
inflation.  In Uganda and (initially) Tanzania, treasury bill sales were
used to contain inflationary pressure, leading to a rise in interest
rates and the domestic debt burden.=E2=80=9D  (p. 4)

The IMF concludes that, to spend and not absorb aid flows =E2=80=9Cwould
appear to be the least attractive option.  The use of aid to build
reserves while financing the increased deficit domestically is generally
unwise.  Inflation can only finance a small amount of expenditure;
attempts to go further tend to raise little finance while damaging the
economy.  The use of domestic sterilization* is also unlikely to be a
sensible medium-run strategy =E2=80=93 it tends to shift resources from the
private to the public sector and does not allow the country to benefit
from a real transfer of resources financed by aid.=E2=80=9D  (p. 17)

IMF analysts indicate, the purpose of aid is not to boost expenditures
(e.g., the hiring of teachers or nurses), but to provide the foreign
exchange needed to either sterilize the money injection associated with
the expenditure or to satisfy the increased demand for foreign currency
as a result of higher import demand.  They conclude that aid works
ultimately by financing net imports.

B. Aiding Growth

In their paper, =E2=80=9CThe Macroeconomic Challenges of Scaling Up Aid to
Africa,=E2=80=9D (IMF, September 2005), S. Gupta, R. Powell and Y. Yang loo=
k
more closely than Rajan and Subramanian at the circumstances in which
aid impacts positively or negatively on macroeconomic stability.  They
state that one cannot generalize about impacts without asking basic
questions about circumstances in specific countries, such as: how the
aid is spent? Are aid increases temporary? Are they in the form of
project finance or budget support?  What is the balance of current and
capital expenditure?  What is the share of additional public spending
earmarked for imports?  What are the implications of recurrent costs
(e.g., salaries) for public investment?  They review the diminishing
returns for aid at different saturation levels and when supply
bottlenecks (e.g., transfers of aid to local governments) impede growth.


Departing from the orthodoxy, Gupta et al. discuss the evidence that the
=E2=80=9CDutch Disease=E2=80=9D is not inevitable.  [This case is also made=
 in the
UN Discussion Paper, =E2=80=9CWhy Is =E2=80=98The Dutch Disease=E2=80=99 Al=
ways a Disease?
  The Macroeconomic Consequences of Scaling Up ODA=E2=80=9D by Terry McKinl=
ey,
UNDP, New York (undated).]

Gupta et al. also state that an inflation target below 5% may not be
appropriate.  Inflation policy is also discussed in =E2=80=9CMonetary and
Fiscal Policy Design Issues in Low-Income Countries,=E2=80=9D (IMF, August =
8,
2005) in which the authors support inflation in the range of 5-10%.
(See page 19.)  Link:
http://www.imf.org/external/np/pp/eng/2005/080805m.pdf

The authors make unexamined assumptions about the benefits of trade
liberalization and the impact of infrastructure investment on growth.

Importantly, all of the IMF studies assume that the critical constraint
on growth is a lack of foreign exchange!

----------------
Part II

=E2=80=9CChanging Course: Alternative Approaches to Achieve the Millennium
Development Goals and Fight HIV/AIDS=E2=80=9D by Rick Rowden, Action Aid US=
A,
September 2005.
http://www.actionaidusa.org/pdf/Changing%20Course%20Report.pdf

This report expresses views from outside of the IMF=E2=80=99s conceptual
=E2=80=9Cbox=E2=80=9D on fiscal and monetary possibilities.  While much of =
the
recent discourse has been primarily concerned with the macroeconomic
impacts and responses to larger flows of official development
assistance, there are other deeper issues about how developing countries
could use alternative macroeconomic policies to generate more of their
own resources internally as part of a long-term development strategy and
reduce dependence on foreign aid.

The Action Aid USA report highlights that, even though the IMF has taken
some minor steps and made some changes to its rhetorical discourse on
being more =E2=80=9Cflexible,=E2=80=9D most countries currently implementin=
g IMF
loan programs will not be allowed the =E2=80=9Cpolicy space=E2=80=9D within=
 which to
experiment with more expansionary fiscal and monetary policies.  More
expansionary policies are required in order to both accept, absorb and
spend higher levels of ODA, and also to make the larger, longer-term
public investments in rebuilding their health and education systems.

Under current IMF loan programs, borrowers are compelled to achieve
ideologically-based tight inflation-reduction targets and deficit
reduction targets (along with exchange-rate, interest rate and
money-supply targets) that are not justified by the peer-reviewed
economics literature and which constrain overall national public
expenditure at levels that are unnecessarily low.  This current level of
low public spending has characterized much of the last 20 years of
neoliberal policy reforms under the IMF and World Bank, but these low
levels of spending are nearly completely inconsistent with the levels of
public expenditure projected to be needed to meet the Millennium
Development Goals (MDGs) or to fight HIV/AIDS effectively.

The very short-term time frame of IMF programs which monitor tight
macroeconomic targets from year to year, and further structural reforms,
such as capital account liberalization (CAL) and central bank
independence (CBI), all play a role in preventing low-income countries
from ever undertaking longer-term national development plans that might
require more expansionary policies with moderately higher deficits or
inflation rates over the medium-term.

UNDP and others have noted that relatively higher deficit spending and
inflation rates may have negative effects in the short-term (depending
on how the increased deficit spending is strategically invested).
However, if the long-term benefits of such policies are higher economic
output (higher spending, higher economic growth rates, higher employment
and greater human capital development), then the long-term benefits
would easily outweigh the short-term negatives.

Currently, borrowers from the IMF cannot even consider undertaking such
a course.  If countries deviate from the IMF=E2=80=99s orthodoxy, they coul=
d
be punished by the IMF with a negative =E2=80=9Csignal=E2=80=9D to other cr=
editors
and donors to suspend aid or cut-off debt-cancellation programs.  Or,
they could be punished by global financial forces in the form of sudden
capital flight from their economies, the dumping of their bonds on
global markets or speculative attacks on their currencies by investors.
  Therefore, a radical rethinking of the IMF=E2=80=99s stranglehold on what
actually constitutes =E2=80=9Csound macroeconomic policies=E2=80=9D is long=
 overdue.
This report suggests that if health, education and HIV/AIDS advocates
want low-income countries to be able to higher the many more teachers,
doctors and nurses projected to be needed, advocates will have to work
more closely with progressive economists in becoming aware of, and
advocating forcefully for the =E2=80=9Cpolicy space=E2=80=9D for countries =
to be
free to chose to experiment with various alternative macroeconomic
policies.




*Sterilization is defined as the use of open market operations to
counteract the effects of exchange market operations on a country=E2=80=99s
monetary base.  It can also be achieved through an increase in the
reserve requirements or by shifting government deposits from the banking
sector to the central bank.  When the government keeps its deposits at
the central bank, a tightening of fiscal policy would also result in a
sterilization of foreign exchange flows.  For a discussion of
sterilization and its impact on welfare, see =E2=80=9CIs there a Case for
Sterilizing Foreign Aid Inflows?=E2=80=9D A. Prati, R. Sahay and T. Tressel=
,
IMF Research Department, Draft, July 14, 2003.

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