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Foreign Aid: Positive and Negative Impact in Developing Countries

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Ishwor Thapa Public Administration Campus, Tribhuvan University, Nepal

Foreign Aid: Positive and Negative Impact in

Developing Countries
Ishwor Thapa

MPA Student, Public Administration Campus, Tribhuvan University, Balkhu, Kathmandu, Nepal

Summary:
This article tries to describe positive and negative impact of foreign aid in developing countries.
Foreign aid is defined as the voluntary transfer of resources from one country to another country.
The foreign aid has both advantages and disadvantages. The effect of foreign aid on growth is
the subject of ongoing debate. It is difficult to determine the effect of aid on growth when aid is
an integral part of an economy; there are few “experiments” in the level of foreign aid. While
most economists like Jeffery Sachs hold the view of aid as the driver for economic growth and
development, others argue that aid has rather led to increasing poverty and decreasing economic
growth of poor countries. Economists like Dambisa Moyo argue that aid does not lead to
development, but rather creates problems including corruption, dependency, limitations on
exports and dutch disease, which negatively affect the economic growth and development of
most African countries and other poor countries across the globe.

Foreign Aid:

Foreign aid is defined as the voluntary transfer of resources from one country to another country.
This transfer includes any flow of capital to developing countries. A developing country usually
does not have a robust industrial base and is characterized by a low Human Development Index
(HDI) (Wikipedia). Foreign aid can be in the form of a loan or a grant. It may be in either a soft or
hard loan. This distinction means that if repayment of the aid requires foreign currency, then it is
a hard loan. If it is in the home currency, then it’s a soft loan. The World Bank lends in hard loans,
while the loans of its affiliates are soft loans.
The term development cooperation, which is used, for example, by the World Health Organization
(WHO), is used to express the idea that a partnership should exist between donor and recipient,
rather than the traditional situation in which the relationship was dominated by the wealth and

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Ishwor Thapa Public Administration Campus, Tribhuvan University, Nepal

specialized knowledge of one side. Most development aid comes from the Western industrialized
countries but some poorer countries also contribute aid.
Aid may be bilateral: given from one country directly to another; or it may be multilateral: given
by the donor country to an international organization such as the World Bank or the United Nations
Agencies (UNDP, UNICEF, UNAIDS, etc.) which then distributes it among the developing
countries. The proportion is currently about 70% bilateral 30% multilateral. About 80–85% of
developmental aid comes from government sources as official development assistance (ODA).
The remaining 15–20% comes from private organizations such as "non-governmental
organizations" (NGOs), foundations and other development charities (e.g., Oxfam). In addition,
remittances received from migrants working or living in diaspora form a significant amount of
international transfer.
Use of Foreign Aid:
Foreign aid may be given as a signal of diplomatic approval, or to strengthen a military ally. Other
reasons to give foreign aid include to reward a government for behavior desired by the donor, to
extend the donor’s cultural influence, to provide the infrastructure needed by the donor for resource
extraction from the recipient country, or to gain other kinds of commercial access. US Aid may
often time buy assistance for American citizens in that nation, alter the course of government laws
or something similar in a way that benefits US interests.
In the case of Peru back in the 1990s, Peru conspicuously changed its policies of not allowing
religious missionaries in the country or even jailing them upon arrival. After a promise of aid to
bail out the Peso, suddenly Mormons and other groups had access to the nation without harassment.
Advantages:
The economic reasons for giving foreign aid:
 For humanitarian reasons
 To improve the country’s international image
 Continue to build positive working relationships with other governments
 To promote the conditions for peace and stability. Because many governments genuinely
believe we’ll be safer and happier when everyone else is safe and happy.
Disadvantage:
The economic arguments for not giving foreign aid:
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 According to critics, foreign aid does not promote faster growth but may hold it back by
substituting for domestic savings and investment.
 The growth of the modern sector is the focus of aid. As a result, it increases the gap in
living standards between the rich and the poor in Third World countries.
 If the aid given is concerned with unproductive fields or old technology, it will have the
effect of increasing inflation in the country.
 The most prominent objection is that donor countries interfere with the economic and
political activities of the recipient country.
Positive Impact:
The effect of foreign aid on growth is the subject of ongoing debate. It is difficult to determine the
effect of aid on growth when aid is an integral part of an economy; there are few “experiments” in
the level of foreign aid.
Galiani et al. (2017) argue that there are points on a nation’s growth trajectory at which aid inflows
drop because of the rules donors use to select recipient countries. They use the substantial changes
in aid around this point to evaluate how aid affects growth, and they conclude that aid has a
substantial positive effect.
Although aid has had some negative effects on the growth and development of most African
countries, research shows that development aid, in particular, actually does have a strong and
favorable effect on economic growth and development. Development aid has a positive effect on
growth because it may actually promote long term economic growth and development through
promoting investments in infrastructure and human capital. More evidence suggests that aid had
indeed, had a positive effect on economic growth and development in most African countries.
According to a study conducted among 36 sub-saharan African countries in 2013, 27 out of these
36 countries have experienced strong and favorable effects of aid on GDP and investments, which
is contrary to the believe that aid ineffective and does not lead to economic development in most
African countries.
Research also shows that aid per capita supports economic growth for low income African
countries such as Tanzania, Mozambique and Ethiopia, while aid per capita does not have a
significant effect on the economic growth of middle income African countries such as Botswana
and Morocco. Aid is most beneficial to low income countries because such countries use aid

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received for to provide education and healthcare for citizens, which eventually improves economic
growth in the long run.
Negative Impact:

While most economists like Jeffery Sachs hold the view of aid as the driver for economic growth
and development, others argue that aid has rather led to increasing poverty and decreasing
economic growth of poor countries. Economists like Dambisa Moyo argue that aid does not lead
to development, but rather creates problems including corruption, dependency, limitations on
exports and Dutch disease, which negatively affect the economic growth and development of most
African countries and other poor countries across the globe.
Death of local industries.
Foreign aid kills local industries in developing countries. Foreign aid in the form of food aid that
is given to poor countries or underdeveloped countries is responsible for the death of local farm
industries in poor countries. Local farmers end up going out of business because they cannot
compete with the abundance of cheap imported aid food, that is brought into poor countries as a
response to humanitarian crisis and natural disasters. Large inflows of money that come into
developing countries, from the developed world, in a foreign aid, increases the price of locally
produced goods and products. Due to their high prices, export of local goods reduces. As a result,
local industries and producers are forced to go out of business.
Neocolonialism.
Neocolonialism is where a state is “in theory, independent and has all the outward trappings of
international sovereignty. In reality its economic system and thus its political policy is directed
from outside”. The political and economic affairs of a state under neocolonialism, is directly
controlled by external powers and nations from the Global North, who offer aid or assistance to
countries in the Global South or developing countries. Neocolonialism is the new face of
colonialism, which is made possible by foreign aid. Donor countries offer foreign aid to poor
countries while bargaining for economic influence of the poor or receiving countries, and policy
standards that allow donor countries to control economic systems of poor countries, for the benefit
of the donor countries.
Aid dependency
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Ishwor Thapa Public Administration Campus, Tribhuvan University, Nepal

Aid dependence is defined as the "situation in which a country cannot perform many of the core
functions of government, such as operations and maintenance, or the delivery of basic public
services, without foreign aid funding and expertise". Aid has made many African countries and
other poor regions incapable of achieving economic growth and development without foreign
assistance. Most African economies have become dependent on aid and this is because foreign aid
has become a significant norm of systems of international relations between high and low income
countries across the globe.
Corruption
While development aid is an important source of investment for poor and often insecure societies,
aid's complexity and the ever-expanding budgets leave it vulnerable to corruption, yet discussing
it remains difficult as for many it is a taboo subject. Foreign aid encourages rent-seeking, which is
when government officials and leaders, use their position and authority to increase their personal
wealth without creating additional wealth, at the expense of the citizens. Most African leaders and
official, are able to amass huge sums of personal wealth for themselves from the foreign aid
received - they enrich themselves and do not use the aid provided for its intended purpose.
Corruption is very hard to quantify as it is often hard to differentiate it from other problems, such
as wastage, mismanagement and inefficiency, to illustrate the point, over $8.75 billion was lost to
waste, fraud, abuse and mismanagement in the Hurricane Katrina relief effort.
Concluding Remarks:
In economics, there are two competing positions on aid. A view pro aid, supported by Jeffrey
Sachs and the United Nations, which argues that foreign aid will give the big push to break the
low-income poverty trap poorer countries are trapped in. From this perspective, aid serves to
finance “the core inputs to development – teachers, health centers, roads, wells, medicine, to name
a few” (United Nations 2004). And a view that is skeptic about the impacts of aid, supported by
William Easterly, that points out that aid has not proven to work after 40 years of large investments
in Africa.
In order for aid to be productive and for economic policy reform to be successfully implemented
in Africa, the relationship between donors and governments must change. Van de Walle argues
that aid must be made more conditional and selective to incentivize states to take on reform and to
generate the much needed accountability and capacity in African governments.
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Ishwor Thapa Public Administration Campus, Tribhuvan University, Nepal

Additionally, information asymmetries often hinder the appropriate allocation of aid; Blum et al.
(2016) note that both South Sudan and Liberia struggle tremendously with paying employees and
controlling the flow of money - South Sudan had a significant number of ghosts on its payroll,
while Liberia's Civil Service Agency could not adequately pay civil servants because there was
minimal communication from the Ministries of Health and Education regarding their respective
payrolls.
Many econometric studies in recent years have supported the view that development aid has no
effect on the speed with which countries develop. Negative side effects of aid can include an
unbalanced appreciation of the recipient's currency (known as Dutch Disease), increasing
corruption, and adverse political effects such as postponements of necessary economic and
democratic reforms.

References:

1. Adamu, P. A. (2013). The impact of foreign aid on economic growth in ECOWAS

countries: A simultaneous-equation model (No. 2013/143). WIDER Working Paper.
2. Bandow, Doug. "Foreign Aid, Or Foreign Hindrance". Forbes. Retrieved 2019-04-05.
3. Foreign aid. (2019, May 22). Wikipedia, The Free Encyclopedia. Retrieved 15:00, July 13,
2020.
4. Galiani, S., Knack, S., Xu, L. C., & Zou, B. (2017). The effect of aid on growth: Evidence
from a quasi-experiment. Journal of Economic Growth, 22(1), 1-33.
5. Martinez, Pablo, 2015. "The impact of foreign aid on economic growth," MPRA
Paper 66588, University Library of Munich, Germany.
6. Moyo, D. (2009). Dead aid: Why aid is not working and how there is a better way for
Africa. Macmillan.
7. Nkrumah, K. (1966). Neo-Colonialism: The Last Stage of Imperialism. 1965.
Introduction. New York: International.
8. OECD, DAC1 Official and Private Flows (op. cit.). The calculation is Net Private Grants /
ODA.

An Article “Foreign Aid: Positive and Negative Impact in Developing Countries”

 Ishwor Thapa Public Administration Campus, Tribhuvan University, Nepal

9. Qian, Nancy (2015-08-03). "Making Progress on Foreign Aid". Annual Review of

Economics. 7: 277–308. doi:10.1146/annurev-economics-080614-115553
10. Sarah Bailey (2008) Need and greed: corruption risks, perceptions and prevention in
humanitarian assistance Overseas Development Institute.
11. Sharma, K. (2011). Foreign aid, governance and economic development in Nepal. Asia
Pacific Journal of Public Administration, 33(2), 95-115.
12. Vengroff, R. (1975). Neo-colonialism and policy outputs in Africa. Comparative Political
Studies, 8(2), 234-250.
13. WHO glossary of terms, "Development Cooperation" Accessed 25 January 2008
14. Wikipedia contributors. (2019, September 30). Foreign aid to Nepal. In Wikipedia, The
Free Encyclopedia. Retrieved 14:57, July 13, 2020.
15. Wikipedia contributors. (2020, June 6). Development aid. In Wikipedia, The Free
Encyclopedia. Retrieved 15:06, July 13, 2020.

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