Foreign Aid & Civil Society

An Institutional Perspective on Development Aid

The World Bank’s excellent PSD Blog mentioned a report by ActionAid, criticizing development aid spent on expatriate consultants. The entry started a thought process to expand on that issue.

As I’ve argued with friends, the incentives of development aid are all wrong - meant to preserve the very poverty it is supposed to cure. I will return to those objections taking a theoretical and empirical perspective. But first, three points of note from the blog entry.

First, the report mentions that 25% of aid goes to expatriate consultants. The WB argues that if the consultants are the best, then they are worth it. I would have to disagree. No matter how good they are, are they delivering better value per dollar (if that can be measured)? At a price several hundred times the local salary, it is hard to understand how. The private sector learned this when it embraced offshoring, initially as cost arbitrage.

Second, the World Bank says that regardless of cost, it is important to have the right evaluation mechanisms in place. I completely agree, except with one caveat. Who will ensure the monitoring mechanisms are adhered to (I expand on this later)?

Third, the post mentions that expatriates are hired to train local experts and practitioners. But wait, if I were an expatriate consultant, would I really be interested in training my replacement? And as proof of success, after so many years of aid, has the ratio of local to expatriate experts increased?

I have, in fact, two theoretical basis for my objections, based on institutional and public choice theory (of which I know admittedly little).

The Budget-Maximizing Aid Consultant 

The first underlines the dilemma faced by individuals in groups choosing between a course of action best for themselves or best for the group.

William Niskanen, in 1971, proposed in his book Bureaucracy and Representative Government (which I have not read, yet) the theory of the budget-maximizing bureaucrat. Niskanen suggests that bureaucrats as rational individuals will maximize their utility rather than a social objective. He defines utility as a function of power, pay, and prestige, all deriving from the budget of the institution. In essence, bureaucrats maximize their discretionary budget, and to do so align their interests with those of the sponsor, rather than those served.

This theory of public administration and bureaucracy explains why the public sector is almost always worse at serving the needs of the consumer, compared to the private sector. However, the same can be applied to international development aid as well. Here too, the sponsor of the service (the donor) is someone other than the consumer of the service (the poor recipient), so service will be sub-optimal. Second, information asymmetry will favor the intermediary. And certainly, no consultant will suggest reforms that will end the institution or the practice of development aid.

Admittedly, there are ways of aligning the incentives of the bureaucrat with the social objective. Considering the issue as one of principal-agent, oversight may help. For this reason, evaluation mechanisms are essential. But those mechanisms are only as good as the will and conscience of those implementing them. Said another way, who will monitor the monitors - they are bureaucrats too?

The Aid and Resource Curse

The second interesting point to come forth from this blog entry is the aid curse. Here, then, is statistical evidence (if there is such a thing) that aid has a negative impact on democratic and economic institutions. Just as resource abundance impedes reform and makes a country’s institutions subject to corruption, aid has much the same effect. Put another way, and to summarize, aid:

1. Creates a moral hazard, encouraging lax economic management.
2. Poaches the most skilled local workers, weakening government institutions.
3. Encourages recipients to cater to donors, loosing focus of local priorities (see the budget-maximizing bureaucrat).
4. Generates a struggle for control and fights over rent.

The article mentions other macroeconomic impacts of aid, beyond the institutional. However, for the purpose of my argument, the analysis clearly suggests that institutions are not immune to aid, and are impacted, often negatively by it (really!?!)

Returning to the first point then, how can the incentives align the performance of the bureaucrat with those served? In the public sector, thankfully, some performance measures are present - response time for people serve or on time arrival of trains (where trains are a public monopoly) - that are objectively verifiable and minimize the information asymmetry, or allow rewards to be tied to results.

Unfortunately, when moving into the realm of social development such measures are difficult, if not impossible to come by - or I have not seen many good ones. And, even when they work, aid has other perverse effects, not least on institutions.

To avoid those, aid can be directed outside of government, but this too weakens the government and dilutes its incentives of elected politicians to serve sectors served by foreign donors. Aid could be directed to the private sector, but who is to say donors are better at allocating capital? And the whole point, anyway, is to function where the private sector fails, right?

Hmm…food for though. And solutions.

© 2006 The Discomfort Zone.