Global Policy Forum

The Fallacy of Foreign Aid as


By Teketel Haile-Mariam

Addis Tribune
October 4, 2002

The World Bank and International Monetary Fund held their annual meetings in Washington, D.C. this past weekend, and repeated their promises at previous such meetings to make the poor nations of the world more prosperous. And Ethiopia had sent its own delegates to the meetings to plead for more loans. Protesters from across the globe, who believed these institutions had done (and continue to do) more damage than good through their ever increasing loans and misleading policy prescriptions, had also gathered to demonstrate their opposition to the activities of the institutions, which they also believed contributed to environmental degradation (and the changing weather pattern around the globe) and economic rape of the world's poor.

What roles did the international financial institutions play (and continue to play) in Ethiopia? Did their policy prescriptions and loans have significant and sustainable impact on improving macroeconomic performance and standards of living of ordinary citizens?

Ethiopia had (and continues to have) a history of dependency on foreign assistance, whether that be in the form of food donations, military hardware, or loans for public investment. Although this history applies to all three recent successive regimes, non-military loans contracted by the current government over the last eleven years exceeded similar loans obtained over a span of about sixty years by the two prior regimes combined. And there had been negative correlation between the ever increasing loans and the levels of poverty. As loans increased, the per capita income (brute measure of the level of economic development) had stayed virtually unchanged, poverty had spread and deepened, and even by African standards, Ethiopia had lagged miserably and had become an example of most things wrong in that unfortunate continent, rather than being a symbol of freedom, unity, and prosperity.

Then why borrow more? And why do international lending institutions want to repeatedly extend additional loans (often for the same intended purposes) when previous loans did not have much positive impact?

The most common explanation given by the Ethiopian government to justify more borrowing is a fight against poverty. It usually quotes common statistics on widespread poverty, hunger, diseases, low level of agricultural technology, the AIDS epidemic, high level of unemployment, and such other indicators of a seriously ailing economy, and how foreign loans help in the fight against those ailments. Rarely does the government mention whether or not past loans had generated more benefits than their costs. It also does not mention the recent catastrophic consequences of high external indebtedness in countries with much more powerful economies like Argentina and Brazil, and other states in Latin America and Africa.

There is another less obvious explanation as to why countries like Ethiopia need to borrow more despite the poor records of past loans, which is rooted in inferiority complex. Insecure governments usually consider their relationships with international lending institutions as forms of legitimization of their regimes, and they believe those perceptions would help them prolong their hold on to power. They get opportunities to attend international meetings organized by such institutions to be seen as legitimate members of the international community, and use such forums to lash out at their domestic opponents. They also use the staff of the international institutions to write reports favorable to their policies (similar to recent scandals in the United States securities industry where research analysts have been caught writing favorable but misleading reports on companies in the hope that would give their brokerage firms competitive edges in accessing investment banking businesses with the companies), and use those reports as affirmations of their repressive political and economic policies. We have heard and read this many times before, where the Ethiopian regime proudly stated the approval it had received from international financial institutions (such as the World Bank and International Monetary Fund) about the soundness of its policies of state ownership of land as well as ethnic regionalization under cover of decentralized administration.

The international financial institutions know all too well that they have the upper hand in their dealing with insecure governments (and their employees), and are prepared to capitalize on the insecurity to advance their own agenda; the more insecure a government (and its employees), the better for the lenders. They are interested primarily to lend more for their own survival and to promote exports from the industrialized countries, rather than to help promote the economic development in the borrowing poor countries. They use academic, professional, and intellectual discourse and reports as covers to advance their real and hidden agenda of lending more, often by replicating previous programs under different name designations (such as policy adjustment, structural adjustment, sector adjustment, numerous variations of sub-sector rehabilitations, emergency recovery, emergency demobilization, and multiple variations of same project investment programs across all sectors and sub-sectors under different nomenclatures).

As amply demonstrated in Ethiopia, the long record of borrowing by successive regimes had been ineffective in promoting sustainable development and in alleviating poverty. In fact, the reverse might have been true where more lending had driven the country into deeper poverty. As export earnings from traditional sources (such as coffee) decline, ever increasing shares of those earnings would be used to pay the rising debt services, thus leaving ever diminishing proportions of foreign exchange earnings for economic development (and poverty reduction). To add insult to injury, the loans can be used as instruments of foreign policy, as demonstrated during the Ethio-Eritrean conflict when donors (led by the above mentioned international financial institutions) attempted to withhold their funding as a leverage to get political concessions from Ethiopia. The more the dependency, the more the exposure to international political arm twisting and blackmailing.

The typical and predictable response of the Ethiopian government to the above would be: you are only criticizing us for what we are trying to do, but what alternatives do you have to offer? Here are my suggestions.

The first suggestion concerns principle. The key principle must be that government control of resources and micromanagement of economic activities by the public sector have not worked anywhere in the world, and there are no convincing reasons to believe such a policy framework would work in Ethiopia. Instead, private sector based economic policy framework is a superior prescription for economic success. That key principle must be modified slightly while dealing in international trade, which these days is commonly referred under the general term of globalization.

While recognizing that exports are the key to future economic prosperity (and hence policies should focus on improving the country's international competitiveness), allowing indiscriminately imports of goods that unfairly kill domestic manufacturers would not be prudent. The most prudent approach should be to first promote competition among domestic producers while protecting them initially from outside competition. As the domestic producers mature, protection can be lifted gradually. All developed economies have used this approach (and are still using it) under cover of "infant industry protection" or some other similar justification. Just see how the domestic textile and leather manufacturers are being decimated by cheap imports from Asia and second hand products from North America and Europe. Of course, the lending institutions would not support protection to be extended to the domestic manufacturers, often at the urging of exporting nations from behind, because that would undermine the market in Ethiopia for such imports.

And the second suggestion concerns fundamental policy measures the government should take to promote rapid economic development and poverty reduction. Without being exhaustive, such policy measures should include:
(a) letting the private sector be the engine of growth,
(b) privatizing all land ownership, including agricultural land, which is the foundation of the economy and a source of employment for about 80 percent of the labor force,
(c) purging all other policies that have been designed to stifle entrepreneurship, such as political parties' ownerships of businesses and their involvement in commerce,
(d) building strong financial system to promote saving, borrowing and investment. The nucleus for this exists since there are already many private banks which can be used as a base for strengthening the system,
(e) maintaining small groups of highly paid professionals to manage the normal functions of government under a free market environment, and reducing the number of people working as government employees. These managers should contract with the private sector to handle as much as possible of the government's work,
(f) restructuring the federal system of government to organize regional administrations along geographic rather than ethnic groupings, with strong federal laws to protect the interests of minorities anywhere. This will promote free movements of capital and labor, and exchanges of ideas, as these are essential features of private sector based economy,
(g) strengthening the rule of law to protect civil liberties and private property rights, and to strengthen commercial transactions,
(h) aggressively containing the population explosion, and
(i) making it easier for citizens to manage their own affairs by, for example, eliminating bureaucratic bottlenecks that encourage corruption and taking other small but tangible pro-citizenry actions.

In summary, Ethiopia should proceed with vigorous programs of economic growth (which in due course would also reduce poverty) by harnessing her own resources first, supplementing those with foreign grants to the extent possible rather than with foreign loans. The government should refrain from investment in directly productive activities and engaging in commerce, and leave such undertakings to the private sector. Public investment should focus on improvement of infrastructure that would promote private sector investment and economic growth (such as in telecommunications, power, and transportation) and education. Under no circumstances should foreign loans be used to finance items that have dubious investment merit such as vehicles, studies by foreign "experts", and any items that can and should be financed using domestic human, material, and financial resources. Local capacity building should be given top priority by giving preferences to domestic rather than foreign consults and contractors, and by strengthening local training institutions rather than sending trainees abroad. If necessary, foreign experts should be contracted to conduct their training in such local institutions rather than sending the trainees abroad since that would be more cost effective, sustainable, and best for building the human resource base.

The above suggestions, if implemented, would surely reduce the need for heavy external borrowing, while at the same time promoting domestic resource mobilization, local capacity building, and the emergence of critical mass of middle class entrepreneurs. The suggestions would also provide a more solid basis for well-anchored, gradual, and sustainable development that would reduce poverty.

More Information on Poverty and Development in Africa
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