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by Phuong Vu Quynh

Created on: February 11, 2011

Should the Developed world focus on enabling trade or donating aid as an instrument to induce pro-poor growth?

INTRODUCTION

Enabling trade and donating aid are two of the main ways have been being used by the developed world to penetrate the pro-poor growth in developing countries (Stiglitz and Charlton, 2006 ). However, currently when measuring the effectiveness of both these two means, scholars have raised a disputable argument on whether developed countries should focus on trade or aid (Burnside and Dollar, 2001; Easterly, 2003; Lundsgaarde et al, 2007). The question of “trade or aid” has long been discussed and figured prominently in foreign aid discussions in the United States at least since the Eisenhower administration (Lundsgaarde et al, 2007). Unfortunately, either trade or aid by itself succeeds in nourishing the pro-poor growth of any developing country. Hence, there hasn’t been any common answer to all cases of developing world since each country has different socio-economic context as well as different level of growth. Both trade and aid are essentially important for poor countries in their development process. But the manner of how trade and aid are delivered is the determinant of their helpful contribution into the pro-poor growth of developing countries. Therefore, to explore the issue, this essay shall be broken into three parts. The first part reviews empirical literature on the context of trade and aid given to the developing world in cohesion with pro-poor growth. Accordingly, the second part analyzes why both trade and aid have not yet contributed effectively to the pro-poor growth in developing countries. And the final part concludes with some recommendations to tackle the issue.

TRADE AND AID AND PRO-POOR GROWTH

Pro-poor growth, as stated by Kakwani and Pernia (2000, p.3), “can be defined as one that enables the poor to actively participate in and significantly benefit from economic activity”. It has three components including: “a high growth rate of average incomes; a high sensitivity of poverty to growth in average incomes; and a poverty-reducing pattern of growth in relative incomes (2000, p.199). Therefore, it is unfortunately that sometimes high economic growth does not always pro-poor or even increases poverty when inequality appears largely so “the beneficial impact of growth is more than offset by the adverse impact of rising inequality” (Kakwani and Pernia, 2000, p.2). From this view of pro-poor growth, let’s take a look at its nexuses in relations to trade and aid in developing countries.

Trade and Pro-poor growth

According to Kraay (2006), the poor lacks of access to resources to meet their basic necessities of well-being. Therefore, any growth of a country is seen as pro-poor only if it promotes the poor’s benefit strategy which favours the poor so that they can enjoy proportionally more than the better-off. The trade and growth of Viet Nam is a case in point of pro-poor one, though a drastic increase in per capita GDP did not result any big difference in inequality. Thanks to its open trade, the rise of rice export volume, the poor’s income rose significantly with a sharp decrease of absolute poverty rate during the period of 1988 – 1998 from 75% to 37% (Dollar and Kraay, 2004). However, the case of China is very vivid when its rapid growth with stunning poverty reduction from end of 1970s to 1990s was not seen as pro-poor since the poor gained equally or less than the non-poor (Kraay, 2006). In addition, there is sometime a big disproportion in term of benefiting from the growth of the poor in different areas. Lao PDR is an example, Kakwani and Pernia (2000, p.8) found that the Lao PDR’s growth thanks for trade played a slight contribution to poverty reduction but there was a big difference of impact on the poor in different areas since the pro-poor growth ratio was 0.22 in rural areas and 0.12 in urban areas.

Furthermore, let alone the growth of a country “where it occurred was mainly the consequence of favourable internal factors, and external demand represented an added stimulus which varied in importance from country to country and period to period”(Kravis, 1970, p.850). Therefore, among many factors resulting growth, Kravis proved that trade by itself was not the dominant variable (1970, p.869). Moreover, in developing countries, trade played as a “handmaiden” rather than an “engine” of growth in many instances (Kravis, 1970, p.869).

Hoekman and Wilson analyzed that trade would benefit all, not only the poor in least developed and other low-income countries, but also citizens in middle income countries and those in the most developed nations of the globe (2010). Furthermore, Dollar (2001) pointed out that when trade bloomed with the rapid growth rate in China, India, and many other countries it brought about good impact on majority of population in developing world. However, he also criticized that “the poor may not benefit proportionately” thanks for growth or “growth of income of the poor less than per capita GDP growth” (Dollar, 2001, p.3). More importantly, Dollar found there was no “association between changes in trade to GDP and changes in the Gini measure of inequality, or between changes in trade to GDP and changes in the income share of the poorest quintile” (Dollar and Kraay, 2004, p.4). He concerned that in many cases, some poor were even badly influenced “in the short run by trade liberalization” (Dollar and Kraay, 2004, p.4)

In sum, the nexus of trade and pro-poor growth would be stated that trade is not always the dominant variable of growth or pro-poor growth in developing countries. It depends somehow on the different contexts and the manner that it is invested (Kravis, 1970; Dollar and Kraay, 2004; Kraay, 2006). 

Aid and pro-poor growth

Aid which is also known as international aid, overseas aid, or foreign aid is a voluntary transfer of country to another, given at least partly with the objective of benefiting the recipient country (OECD, 2006). Aid has been allocated from developed world to developing one with a humanitarian hope of a better life for the poor, but there emerges doubts surrounding the issue. Some oppose and others support increasing more aid in poor countries due to the disputable effectiveness of aid around the world to date.

Easterly (2003) praised some good practices of aid effectiveness in Uganda, earlier in South Korea and Taiwan, specifically, the World Bank’s $70 million credit to the Ceara state in

Brazil in 2001. However, he recalled a number of aid failures including Canadian aid aiming at providing market access to mountainous farmers of Lesotho who already got access to markets long time ago (Easterly, 2003). Easterly strong critized the World Bank on its numerous and continuously failed aid in Africa but the Bank still found reasons to “try to finesse the issue by promising that better times are ‘just around the corner’” (Easterly, 2003, p.35).

Burnside and Dollar (2000) believed that aid only had good positive effects on growth in countries with better institution and policies. They proposed a shifting aid from countries with ‘poor’ policies to those with ‘good’ policies made total aid more effective. Better policies would also be instrumental to improve the effect of aid on poverty reduction while aid could play as an incentive to promote the impact of ‘good’ policies on growth (Collier and Dollar, 2001).

Chong et al (2009) found the relationship between corruption and poor institutions with the failure of aid in reaching the poor, but there was no strong evidence to prove that good institutions would help poverty reduction and equality. They concluded that “aid by itself does not appear to have a statistically significant effect on inequality and poverty reduction” (Chong et al, 2009, p. 79). Economides et al shared the same doubt on “effects of foreign aid on recipient countries’ macroeconomic performance, and especially growth, are ambiguous”(2008, p.463)

“It is likely that there are some systematic lessons to be learnt in respect both of the choice of recipient country and the style of relationship with the government” (Collier and Dollar, 2004, p.244).

FAILURE OF TRADE AND AID - BEHIND THE SCENE

The goal of having the high-income people make some kind of transfer to very poor people remains a worthy one no matter what through trade or aid. However, looking at evidences from trade and aid impacts on the poor in developing countries, one can’t help raising a question why such activities haven’t reached the final outcomes as expected and what stays beyond?

Trade or trick

For many years, the world trading system has been blamed of going against pro-poor growth in developing countries. The poor become the disadvantaged and more vulnerable in globalization since their products and main assets – their own labor – are restricted and face “high barriers” to world market (Dadush, 2005). Dadush also claimed that “a vacuous agreement that looks good on the surface but does little or nothing to widen opportunities for poor traders in the global market place” (2005, vii). The true nature hidden behind trade, globalization ... all terms introduced by developed world is seen as something makes the poor become poorer and the rich get richer.

Newfarmer (2005) took an example of U.S. subsidy to cotton growers with total income of $3.1 billion in 2003, approximately 1.5 times higher than U.S. foreign aid to Africa. He argued that “these subsidies depress world cotton prices by 10–20 percent, reducing the income of thousands of poor farmers in West Africa, Central and South Asia, and other poor countries”. Newfarmer analyzed that income for farmer from cotton lost more than $150 million annually (2005, p.18). In general, “subsidies make the poor poorer and the rich richer” (Newfarmer, 2004, p.18).

Apart from domestic subsidy, tariff is also a big constraint for developing countries in their  accessing to the world market since their manufactures are charged approximately twice higher by developed importers than those from other industrial counterparts. Particularly, Newfarmer compared that:

“Exporters of manufactures from industrial countries face, on average, a tariff of 1 percent on their sales to other industrial countries; exporters in developing countries, by contrast, pay anywhere from 1.2 percent (if they are from Latin America, where NAFTA weighs heavily) to 5.4 percent (if they are from South Asia)” (2005, p.18).

Other forms of protectionism are disguised under free trade create unfair conditions for developing countries when penetrating developed markets. According to the announcement of the U.S Department of Commerce (DOC), catfish exporters from Viet Nam have to pay US $4.22 per kilo of frozen pangasius fillet while the retail selling prices are lower in the US market, which goes against the bilateral trade agreement signed between two countries. DOC also raised the duties from 2.89% to 4.27% on shrimp imported from 6 countries including Brazil, China, Ecuador, India, Thailand and Viet Nam (Government of Viet Nam, 2010). Unfair conditions in the world trading system affect directly to the poor people in developing countries as these products are produced by them and generate the sole income for such vulnerable group (Dadush, 2005).

Watkins took a very good example on the case of trading between America and Africa stipulated in a so-called the Africa Growth and Opportunity Act (AGOA). Looking at this Act, it seemed like a free access to American market was open to Africa. However, peeling off the mask, a real picture was exposed with rules of origin provisions. According to these rules, yarn and fabric which were used to produce garments for exporting to American market must be made either in the United State or an eligible African country. Given that they were made in Africa, 1.5% would be on the share of the US market. This meant that Africa was free to export to America but it must use American products rather than competitors’. It was estimated by the International Monetary Fund that benefits would be five times bigger without such rules of origin (Watkins, 2002).

AID fails to aid

According to Hattori, originally, in the Cold War, foreign aid was created as a policy tool to “influence the political judgements of recipients” (2001, p.641). This point of view was initiated by Boone in 1995 when he found aid was primarily motivated to assist the poor, substantial evidence points to political, strategic, and welfare interests of donor countries as the driving force behind aid programs. Collier and Dollar also agreed on the political purpose of aid allocation where the motivation to give aid differs from donor to donor and is “influenced by the lobbying of  interest groups” (2004, p.267).

Viewing aid in a political economy approach, de Mesquita and Smith raised a question that “Do donors give assistance for humanitarian reasons or for domestic gains?” (2009, p.335). In fact, the result found from their research indicated that the determination of aid came along with political target of leaders in both giving and receiving countries (de Mesquita and Smith, 2009). More importantly, humanitarian need which is seen on the surface of aid “seems not to motivate the decision to give aid by the United States or other OECD member” (de Mesquita and Smith, 2009, p.336).  In other words, donors often give aid to countries “with whom they maintain trade relations or whose security alignments may be up for grabs” thus, in many cases, the “neediest do not receive the most” (de Mesquita and Smith, 2009, p.336). They suggested that aid would not be supported if it did not serve the political survival of leaders in recipient and donor states. Aid may be given because the of military relationship or of domestic politics regardless its effectiveness (Chong et al, 2009). Besides, aid also improves welfare of donors’ citizen thanks for conditionalities attached to aid makes it always favour the giver’s citizens rather than the “nominal beneficiaries” in poor countries as it is supposed to serve (2009, p.336). Therefore, it can be said that developed countries do not donate aid purely for the poor or pro-poor growth of developing countries but for the benefit of themselves in many ways.

Many aid flows have been wasted on poor performance of recipient countries, often linked to bureaucracy, corruption, incompetent governance..., which makes aid never come fully to the hands of the neediest. Burnside and Dollar (2004,p.3) quoted a result from opinion survey commissioned by the World Bank and conducted by Princeton Survey Research Associates that “ In Sub Saharan Africa, 84% of opinion makers agreed with the statement that, ‘Because of corruption, foreign assistance to developing countries is mostly wasted’”. The ultimate goal of giving aid is to bring about relief to the poor, however, due to the weak of institution in many developing countries, their poor citizens have to bear their governments’ fault since many developed countries decide to shift to countries with sound institutions and policies like the suggestion of the Economist (1998) that “mainstream aid should be directed only to countries with sound economic management”. This trend is even supported by many scholars including Burnside and Dollar (2000). Hence, the consequential loss finally burdens the poorest, the most vulnerable ones.

Since the first initiative was raised in 1970, there has still remained a big gap between the target rate of 0.7 per cent of OECD countries’ annual GNP to be spent for Official Development Assistance and the actual average rate for all donor countries (0.22 per cent in year 2000 and 0.47% in 2008) (Langhammer, 2004; OECD, 2009). Though it was stated clearly in the 8th goal of the MDG about the volume of aid from developed world, there is no obligation nor responsibility stipulated to attach the role of developed world with such goal. Therefore, up to date, the commitment or target rate or aid volume is still a target to reach.  

Easterly said that “a Planner believes outsiders know enough to impose solutions. A Searcher believes only insiders have enough knowledge to find solutions, and that most solutions must be homegrown”(2006,p.4) while Easterly noted that politicians were often “Searchers” at home but “Planners” abroad because at home they had constituencies to whom they were usually accountable; in contrast they were not accountable to people in other countries (Easterly, 2006). This explains one of the reasons for the failure of aid granted in developing countries where it is given without accountability and feedback. The lack of information, research before aid is    granted as well as ill convergence among donors in many cases is also another reason why it fails to aid the poor such as dam projects help to improve infrastructure but result displacement of many poor households due to floods. Lusaka and Gaborone, noted some examples in Mali where fish farm was built in canals that had been dry for long time (Lusaka and Gaborone, 1999). In 2003, the UN Development Program reported 40 donors maintained 2,000 different aid projects in 1980s in Tanzania, which created chaos and burden of management on recipient government (Fleshman, 2004).

And finally, when development assistance is transferred in the form of concessional loans or tied aid, the ultimate beneficiaries must be questioned. The issue was officially raised in the Accra Agenda for Act where it required donors to reduce conditions attached to aid and to untie aid from obligations of forcing recipients to procure goods and services from the donor country with aid budget (OECD Observer, 2008).

HOW TO MAKE TRADE AND AID EFFECTIVE INSTRUMENTS TO PRO-POOR GROWTH

This paper does not aim to deny the essential roles of trade and aid playing in the pro-poor growth of developing countries to date even though these two instruments have seen several empirical failures in many cases. The growth is pro-poor if only it is highly sensitive to poverty and sees the poor as the center of the stage (Kakwani and Pernia, 2000). However, it is difficult for developing countries to achieve this target by themselves without support from developed world since they are lack of both capital resources and capacity (HDR, 2003). Therefore, trade and aid provided from developed countries are essential tools. While aid helps to tackle emergent issues such as poverty, diseases, policy reform, capacity building… to achieve the pro-poor development in short term, trade plays as an active actor to generate incomes for sustaining the pro-poor growth in the long run.  Hence, to ensure this targets will be achieved trade and aid must be delivered in the purely pro-poor manner.

The issue becomes burning than ever since the gap between the rich and the poor is increasingly larger and economic downturn causes bigger losses to vulnerable groups. Therefore, there appear many recommendations of how to enable trade and donate aid effectively to serve the pro-poor growth in developing countries by the World Bank, to OECD and several conferences and forums. Market access, fair trade, effective and deep tariff cuts, limitation of exclusions for sensitive products from developing countries, and nonfarm trade are among many initiatives (Newfarmer, 2005). The international community should be more co-operative to together bring about better contribution (Newfarmer, 2005). “Open trade policies with effective social protection measures such as unemployment insurance and food-for-work schemes” are complemented (Dollar and Kraay, 2004, p.4)

Meanwhile, aid should be aimed at right projects in the consideration of where to donate for ensuring the results are achieved and the poor beneficiaries are reached (HDR, 2003; Sach, 2005). “This requires a scientific approach to projects: need to estimate returns in advance, monitor outcomes and design projects” (Boone, 2006) and three issues need to be encountered: strong governance, increased ownership of reciepient countries and better aid practices (HDR, 2003, p.147)

Aid for pro-poor growth can only be achieved through policy support with the poor inclusion. The OECD policy statement in 2006 also suggested that donors should enable developing countries in the development policy process which saw the poor’s interest as the center of the process. Donors support should also be responsive to the policy environment, particular contexts of recipient countries, other interactive factors including risk, vulnerability, social protection, human security to design proper agendas in giving aid (OECD, 2006). 

“Donors need to enhance their organizational capacities to effectively support country-led, pro-poor growth. Donors need to provide appropriate support and incentives to field staff, build multi-donor and multidisciplinary teams at the field level, and empower them to negotiate, co-ordinate and implement programmes. Recent progress to establish such teams in several partner countries should be replicated” (OECD, 2006, p.3)

The Accra Agenda of Action (AAA) in 2008 also recommended a number key points in achieving effective aid namely. It required donors to reduce conditionality of how and when aid would be spent and untie their aid. All actors were encouraged to use the Paris Declaration principles, the value of South-South cooperation was welcomed with transparency would be futher promoted (AAA, 2008).

CONCLUSION

What can be advised for the question that should the developed world focus on enabling trade or donating aid as an instrument to induce pro-poor growth? Despite the empirical literature shows the fact that both trade and aid do not have a direct link to pro-poor growth but they are all important for the pro-poor growth in developing countries in terms of reducing poverty.  As the 2003 Human Development Report stated that without the support from international community, it would be impossible for developing countries to achieve pro-poor growth since these countries could not wait until their economy “take off” to generate enough capital resources for fulfilling the development goals. It is no doubt that the assistance channeled through trade and aid from developed world is crucial for the pro-poor growth of developing countries. However, the obvious challenge is how to determine when, where and how much trade or aid or both should be promoted in a particular country. There is no common answer for all developing countries. It depends very much on the situation, need as well as approach in pursuing the pro-poor growth goal of each country. 

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