Foreign Aid & Civil Society

What Case for a Vulnerability Fund?

Monday’s Wall Street Journal carries an article promoting the case for a “vulnerability fund” for the poorest developing countries:

A vulnerability fund would allow timely help to the poor nations, including in particular those that are heavily dependent on remittances. It is a thoughtful proposal deserving careful consideration by the G-20.

There is nothing new in the suggestion that poor countries need help now. But this article suggests a new reason – that remittances to them are falling. Appearently, those remittances could drop by over 5%, threatening consumption in poor nations.

Remittances account for substantial transfers globally, of USD 318 billion in 2007. There is no question they will decline.  As the article points out, “remittances declined in 2008 for seven in 10 of the Hispanic immigrants in the U.S. who sent money in the last two years. For 83% of those who sent less money, the reason was economic decline and uncertainty.”

Aid: An Alternative to Remittances?

The answer, in Mr. Ghosh’s opinion, is to channel 0.7% of money earmarked by rich countries for their stability plans. And of course, the fund would be managed by the World Bank.

Now how is this any better than asking OECD nations to live up to the commitment of providing 0.7% of GDP to foreign aid? That way we don’t need yet another fund, with yet another bureaucracy. Of course, in this case the World Bank gets a lucrative fund and tons of money – maybe that’s why this option is better?

This proposal will have a serious distortionary impact on recipient nations. The reason remittances are considered good for growth and economic development is that they encourage local consumption and work through normal private and public channels. Aid, on the other hand, undermines local institutions by diverting skills and resources away from these sectors. Worse, in countries where aid is a substantial portion of GDP, it also reduces overall competitiveness – and effect known as the “aid curse” or Dutch Disease.

Mr. Ghosh suggests that while prior aid funds may not have worked, this time it will be different.

This time things ought to be different, for several reasons. First, the pitfalls and limitations of aid are now better understood by both donors and recipients than in the past. There is increased public vigilance over the planning and use of aid, and active participation of the private sector and NGOs in the whole process.

Second, the present global crisis has sharpened political sensitivity in almost every country to any misuse of taxpayers’ money, especially though corrupt practices or ostentatious projects.

But this is hardly convincing. While the problems of aid may be better understood, donors and agencies have yet to come up with a better delivery mechanism. Further, public vigilance over use of aid has hardly prevented waste – over the past several years several cases of corruption have been uncovered, even within the World Bank. And finally, such vigilance is of little use in countries that are run by dictators, or have weak or non-functioning democracies – exactly the countries the aid fund would likely target.

Conclusion

Let us presume that the article’s premise is correct and remittances will drop sharply. But this does not mean that a) they need to be compensated for by other means, and b) the “vulnerability fund” is the best way to compensate.

The countries where remittances are a large part of GDP might actually need help. But providing them relief via foreign aid will only supplant a money transfer mechanism that works (remittances), with one that causes damage (aid). The alternative of doing nothing might be better.

Second, countries where remittances are not a large part of GDP, probably don’t require that much help. Individuals in those countries probably will suffer, but it is highly unlikely that aid agencies could reach those people effectively.

Here’s a simpler solution. Why not give the money directly to the migrants in the developed world? That way they can send more home and consume locally to kickstart the economy. Or in other words, let the stimulus packages target the poor in each developed country – something they should do anyway.

For once, I must agree with the Heritage Foundation, which calls this proposal a gimmick for the poor. I suspect the reason this idea is not so attractive to the World Bank is that it does not enrich the bank’s coffers. But that goes to show exactly what is wrong with the development aid paradigm. Those involved in giving it out have an incentive to ask for more. So rather than finding the best way to solve poverty, they look for the best way to address poverty that includes them in it.