Washington, D.C. - The type of aid that Western donors most frequently provide is not necessarily the most effective for developing countries. This “exogenous” approach stresses the centrality of external donor ideology, administrative involvement and aid-flows - frequently loans - to public sectors. This is supposed to improve governance and, through this, economic growth.
However, this type of aid seems mainly to suppress private political and economic enterprise, making countries even more aid-dependent. A relatively new (twenty-year old) “endogenous growth” paradigm of foreign aid reverses things by first aiding in the growth of private initiatives. In this schema, recipient governments become more dependent on domestic private sector growth and less on external, donor-provided aid. Adopting the new approach requires a decisive break with old aid ways: it begins with external public sector debt forgiveness, and encompasses a new government determination to significantly limit public sector external borrowing.
Dubai is an excellent example of an endogenous approach that is succeeding. The Afghan government, on the other hand, has chosen the wrong, aid-dependent path. Each year, aid to Afghanistan finances over 50% of public sector expenditure and massive balance of payments deficits. Public sector external debt, much of it unrecorded, is a large share of GDP and the government appears uninterested in reducing reliance on it. Currently the IMF-advised government badgers a few formal sector businesses to pay onerous taxes, suppressing new private investment and growth in the tax base. Prospects of increasing foreign debt service payments and hoards of cheap, aid-financed imports destroy private, domestic investment incentives.
Most donors and donor governments, predominantly from the West, are at best sceptical and at worst hostile to this endogenous approach, even though when they try to “push” development, they fail: it’s like pushing on a string. The formal private sector fails to expand and there’s no growth in private sector employment. Smaller, less intrusive governments and private sector perceptions of business and political opportunities at home and abroad liberate private political and economic initiatives. China, Chile, Hong Kong, Singapore and Mauritius are examples of this “new” approach.
A key example of differences in approach comes when donors aid public sector development of service-providing institutions, such as civil and commercial legal systems, to relatively sophisticated levels as a precursor to development. Endogenous growth advocates see such growth-necessary institutions as consisting mainly of staff and knowledge that should change and grow in size and technological sophistication along with, or as part of, private sector growth. Afghanistan, siding with donors against its own businessmen, has made this expensive, time-consuming government-first choice, thus chasing away sophisticated Afghan entrepreneurs who know it will lead to corruption and stagnation.
To be effective, the choice of an endogenous growth program must be explicit, coherent, well publicised and include a private-sector-friendly and credible initiative regarding sovereign external debt overhangs. Donors can begin by giving grants, not loans. First, they can finance non-donor-allied expertise to construct private-sector-friendly sovereign debt workouts. Second, they can finance the independent expertise needed to spell out the particulars of a coherent endogenous growth program. And finally, donors can finance the public sector’s portion of the costs of building private sector institutions and expertise to jump-start the endogenous growth program. A crucial example of this is to cover the costs of constructing the fiscal systems needed to enable tax collection and domestic borrowing in ways consistent with rapid private sector growth. Another involves the costs of fostering growth in “Economic Processing Zones”, areas where a hands-off attitude by governments allows international business and commercial legal climates to emerge. These EPZs can then serve as demonstration areas for reforming the rest of the economy.
If Western donors want to assist predominantly-Muslim countries that are aid recipients in a way that contributes to their long-term stability, they can begin reorienting themselves toward this endogenous approach by adopting two indices as prime measures of development success. One is a growing tax base and consequent expansion in levels of domestic revenue, with constant or falling tax/GDP ratios. The other is sustained expansion in formal, urban, private sector employment. Improved foreign aid policies can contribute to a better global environment in our intertwined world.
* Robert Myers is a Ph.D. economist with forty years of applied experience, much of it in developing Muslim countries. He helped found the Afghan-American Chamber of Commerce, a non-profit organisation. This article is part of a series on economics and Muslim-Western relations distributed by the Common Ground News Service (CGNews) and can be accessed at www.commongroundnews.org.
Source: Common Ground News Service (CGNews), 19 December 2006, www.commongroundnews.org
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