Branko Milanovic argued that loans through the IMF and World Bank should not be considered aid since they have to be repaid, but this argument ignores the fact that these loans are offered at interest rates substantially below market otherwise, governments would have no reason to accept them, given the policy strings attached (known as conditionality).Grants-in-aid are largely conducted bilaterally, government-to-government, or through United Nations agencies.The fifth section concludes with recommendations for both developed and less developed countries.
Government-led industrialization is a risky business, and it usually fails. He points to six specific policy errors: 1) high inflation, which can be combatted through an independent central bank, dollarization, or a currency board; 2) high black market premiums, which can be eliminated by removing exchange controls; 3) high budget deficits, which can be tackled with a strong finance minister or a constitutional requirement that all legislation increasing spending must be fully costed; 4) killing banks, which doesnt happen if inflation is low, black market premiums are low, and interest rates are liberalized; 5) closing the economy, which can be averted by slashing tariffs and restrictions on investment; and 6) government disservice, which can be caused by foreign aid or natural resource dependence and can often be addressed through the creation of private, competitive markets. Robert Barro finds that high government consumption also reduces growth rates. Cross-national studies of FDI inflows specifically have found similar results: countries that are open to trade and have low inflation, budget deficits, and corruption attract more FDI.
Moreover, democratic countries attract more FDI than authoritarian ones, while IMF agreements cause a decline in FDI inflows. Having the right policies is important for development, but what makes it more likely that a country will have the right policies in the first place?
Institutions can constrain politicians and provide them the incentives to pursue growth-enhancing policies.
Competitive elections generally place a constraint on the most ravenous, destructive kinds of rent-seeking, and Milner and Kubota have found that among developing countries, democracies are more likely than authoritarian regimes, particularly military regimes and personalist dictatorships, to liberalize trade. Barro finds an upside-down U-shaped relationship between level of democracy and growth and, echoing the concerns of classical liberals such as Lord Acton about universal suffrage, infers that overly inclusive political systems can be bogged down with redistributive interest-group politics. The real issue is whether institutions constrain politicians so that there is a credible commitment to maintaining private property rights and free markets. Political systems that give market-friendly constituencies effective veto power over future policy proposals help to establish credibility, because entrepreneurs then believe that they can make long-term investments without much risk of future expropriation.
The evidence that foreign aid generally has not enhanced economic growth is well-known.
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In The Elusive Quest for Growth, Easterly shows that in the vast majority of countries, development aid has not increased investment share of gross domestic product (GDP), and growth in investment share of GDP has not caused subsequent increases in GDP per capita.
Presumably growth-killing policies benefit the politicians who implement and maintain them; otherwise, they would not exist.
To answer this question, we need to turn to the study of political institutions.
Easterlys argument suffers from the economists tendency to exogenize the state, to assume that government actors are beyond the mechanisms of maximization that drive market actors.
By contrast, this paper presents a political economy model of foreign aid and argues that both humanitarian aid and multilateral structural adjustment and development assistance through the International Monetary Fund (IMF) and World Bank have actually been designed to fail in their ostensible aims: if they were to be reformed along the lines Easterly suggests, they would lose their political raison dêtre.