'The Donors’ Dilemma' - Aid and Growth in Africa

This column by Tony Addison and Finn Tarp is part of Global Policy’s e-book, ‘The Donors’ Dilemma: Emergence, Convergence and the Future of Aid’, edited by Andy Sumner. Contributions from academics and practitioners will be serialised on Global Policy until the e-book’s release in the first quarter of 2014. Find out more here or join the debate on Twitter #GPfutureofaid.

Last year’s UN High-Level Panel report on the post-2015 development agenda calls for: “…. A quantum leap forward in economic opportunities and a profound economic transformation to end extreme poverty and improve livelihoods”. This sounds good. But the fact is that despite Africa’s stronger economic growth, the region is still far from this ‘quantum leap’. Transformation of the productive side of the region’s economies has yet to take place in any fundamental sense. The share of unprocessed primary commodities has risen as a share of sub-Saharan Africa’s export earnings (to 80 per cent), not fallen. This leaves the region as vulnerable as ever to global economic shocks.

Without structural transformation – towards high value-added products and services – there are limited prospects for creating new and better livelihoods at scale. Africa’s youth bulge will not then constitute a demographic ‘dividend’, but a source of disaffection and instability. And transformation must adapt Africa to climate change, which is now impacting rural livelihoods, in particular, and link Africa’s fragile states to the global economy in ways that promote inclusive growth, not conflict.

How Can Aid Support the ‘Quantum Leap’?

The High Level report reaffirms the need to keep to ODA commitments, but is otherwise light on discussion of aid. How should aid position itself, so that the “quantum leap” in economies and livelihoods becomes a realistic prospect rather than just an aspiration?

First of all donors have demonstrated success in the social sectors, which receive the largest share of aid (over 40 per cent of commitments in 2011), catalyzed by the human development focus – and success – of the Millennium Development Goals (MDGs). Aid to the social sectors can be interpreted as broadly helping make the ‘quantum leap’, through human capital formation, and the economic growth that results. There is evidence for this, from UNU-WIDER research. Improving human capital is one link from aid to growth, livelihoods, and poverty, and no doubt this will be reinforced as the new goals to guide post-2015 global development are finalized.

However, we could see the High-Level panel report as attempting to catalyze a future in which donors engage more directly with transformation and livelihoods. DFID already seems to be moving that way, with an increased focus on private sector development for economic growth.

UNU-WIDER’s research calls for greater ambition: a new industrial policy that helps Africa learn to compete effectively in the global economy, in both manufacturing and services at ever higher levels of value added and skill – learning from Asian success along the way. Spreading aid across small-scale livelihood projects will not achieve the large-scale job creation demanded by the High-Level panel. Also, if we are to take the quantum leap seriously, then the present low level of agricultural aid must be reversed. Agriculture’s share fell to 2.7 per cent of OECD-DAC aid in 2005. It was 6 per cent in 2011, but US$1.7 billion is tiny given that two-thirds of Africans have a livelihood in agriculture.

Five Challenges

Yet, if donors are to help low-income countries deliver the quantum leap, there are at least five challenges that cannot be glossed over.

First, the social sectors are politically appealing to donor governments; this aid delivers a story of effectiveness and human impact that their electorates can readily understand. Donor governments could be reluctant to switch back into large-scale infrastructure that has less popular appeal, and smaller bilateral donors are unlikely to do so – they do not work at scale. There is more potential for the large multilateral donors – especially via concessional lending – but the World Bank remains cautious and itself very focused on the social sectors. If donor countries commit to raise aid significantly, then they will have more opportunity to reengage with the productive sectors and associated infrastructure without cutting into the social sectors. Keep in mind that the resulting growth will itself generate more of the domestic revenues to finance the social sectors, making them less aid-dependent for their financing. But if aid volumes stall, then the choices become a lot tougher in how aid is allocated.

Second, a renewed focus on the productive sectors needs to take place within a framework of green growth, including adaption to climate change. Both entail large-scale infrastructure investment, requiring a blend of private and public finance. Are we there yet? No. Energy is at a crunch point. Donors are committed to renewables, which feature in the doubling of aid to the SSA energy sector over 2005-11. Yet, this amounts to only US$1 billion per annum, a drop in the ocean when compared to Africa’s energy investment needs. Private sector investment in renewables is small, as the capital cost of green energy investment is high. This leaves a vast financing gap that is presently unfilled. A quantum leap in structural transformation will never leave the ground, without a parallel leap in energy infrastructure.

Third, a renewed focus on agriculture requires grasping the thorny issues around the growth and equity dilemmas in smallholder versus larger-scale farming, and the politics of land in Africa. Following disappointment with aid to large-scale farm projects in the 1970s, agricultural aid today has a smallholder focus, encouraged by the ‘small but efficient’ research literature. Is this enough? Or should we bring large-scale agriculture back into the picture for aid. Could large farms, interacting with small farms to encourage scale economies in processing and marketing, deliver the productivity surge that Africa needs? The dilemma here is that large farm investment can lead to land ‘grabbing’ when property rights are weak – and this is now a high concern in Africa. Unless aid to agriculture steps up, donors will be marginal to how the equity-growth balance is resolved in Africa’s agricultural development path.

Fourth, some donors have lost much of the expertise they traditionally had in the days when agriculture and industry featured in aid programmes. They will need to renew those skills to remain relevant. Fifth, aid is a slow moving ship, but the issues are urgent: countries need to accelerate structural transformation today, not tomorrow.

Africa’s Success is Not Assured

UNU-WIDER research shows that aid has, in aggregate, been successful in helping countries to achieve growth, though not in all countries and at all times. Fears over ‘Dutch Disease’ are inflated. When aid builds human capital and productive capacity it improves the recipient economy’s supply-side, and its ability to export. This growth provides a rising revenue base to fund more development spending. And aid has done much to rebuild the economies of Mozambique, Sierra Leone, and Uganda (to give just three examples) from the disaster of war.

That said, Africa’s growth still rests on too narrow a base; development spending is vulnerable to external shocks, because growth is vulnerable. Africa has done much to improve its macro-economic management and build up its foreign exchange reserves, but these defenses against shocks can be overwhelmed by large terms of trade shocks. The key is to diversify and build the productive side of the economy to create motors of growth that are resilient to shocks, both global and climatic. The High Level Panel report calls for a quantum leap: we need to think harder about what this means for aid policy and practice.

Tony Addison is chief economist and deputy director of the World Institute of Development Economics Research, United Nations University (UNU-WIDER). Finn Tarp is director of UNU-WIDER and Professor of Development Economics, University of Copenhagen. Visit www.wider.unu.edu/recom for UNU-WIDER’s research on aid. This post draws upon ‘Aid to Africa: The Changing Context’.