The establishment of modern-day ‘foreign aid’

Foreign aid is a much-discussed subject in Bangladesh, as it is in many other countries all over the world. It is also a much-misunderstood subject. 

Quite a bit of the misunderstanding centres around the perception that donors often and unduly influence policies in the recipient countries, especially by attaching various conditionalities to the loans that they provide. Many people take the position that these conditionalities are driven by the priorities or ideologies of the donor countries and are not consistent with the ground reality and aspirations of the recipient countries. 

In other words, the conditionalities are inappropriate and have caused more harm than good to the recipient countries. It is also believed by many that donor money is often used to hire expensive consultants who provide advice derived from the experience of the developed countries and not tailored to the needs and conditions of the recipient countries. 

I shall come back to these issues later but let me first describe the nature and evolution of foreign aid with particular reference to Bangladesh. 

Down the history lane 

While recognising that there is a wide variety of official donors in the world, such as international and regional aid organisations, aid agencies belonging to individual governments, and international NGOs, I shall focus much of my writing on the organisation I know best, i.e., the World Bank Group. The World Bank, as well as the International Monetary Fund, is a product of the deliberations held in July 1944 at a place called Bretton Woods in the New Hampshire state of the United States. 

Because of the location of the deliberations that led to their creation, these two organisations are often called the Bretton Woods institutions.

It may be useful to think about the context in which these organisations were conceived as the second World War was coming to an end. One of the major concerns in the minds of the Western powers, particularly those who won the war such as the US and the United Kingdom, was to help in the reconstruction of the European countries that suffered much damage due to the World War. 

An ambitious programme of support called the Marshall Plan was put in place to provide such assistance. 

At the same time, it was felt that the developing countries, many of whom were expected to become free of colonial rule in the near future also needed help - first to reconstruct their economies and then to achieve long term development. This led to the establishment of the World Bank. 

Its more formal name, the International Bank for Reconstruction and Development, reflects the concerns and aspirations that I mentioned above. In its early years, the World Bank also provided support to the developed economies of Europe that had been badly affected by the World War. 

The people who met at Bretton Woods were also conscious of the need to provide a cushion against short-term fluctuations in economic conditions. They were particularly concerned about the balance of payment problems that developing countries may face if their export earnings drop relative to their import spending. 

Both economic theory and the actual experience of countries tell us that such short-term fluctuations can often lead to long-term problems. Thus, there was also a need to address these short-term fluctuations by providing timely balance of payments support to certain countries. These considerations led to the creation of the International Monetary Fund.

So, in brief, the World Bank was going to focus on long term development once the initial needs of reconstruction were met while the International Monetary Fund would deal with short-term fluctuations. 

However, it was also recognised that developing countries may face balance of payment problems not only due to exogenous factors, such as a sharp drop in the prices of commodities exported by them or a rise in the price of their imports but also due to problems of their own making. 

A particular concern was fiscal deficits. Economic theory tells us, and experience confirms it, that a profligate fiscal stance can lead to balance of payments problems for at least two reasons. Government spending increases demand in the economy which may be partly met by increased imports. 

It may also lead to inflation which makes exports uncompetitive. Reduced exports combined with increased imports can lead to balance of payment deficits. As a result, IMF loans to help address balance of payment problems often come with conditions to keep the fiscal house in order. 

Over time, the mandate of the IMF has expanded considerably, and now we can see them moving into areas that have long been the domain of the World Bank. 

The Articles of Agreement drawn up when the World Bank was established mention five purposes. It is interesting to note that three of these provisions emphasise private capital flows across countries. 

The World Bank is a public sector organisation owned by the different governments of the world and its primary function is to provide loans and advice to governments of the world. Why is it that such an organisation puts so much emphasis on facilitating private capital across borders? 

It was because the founders of the World Bank believed that the enormous volume of resources needed by the developing countries cannot come from developed country governments alone. The bulk of the resources will have to come from the private sector. 

It was also believed that the returns to private capital may be higher in many developing countries than in the developed world. This is because many profitable business opportunities existed in the developing countries and, therefore, the rate of return on investments in these activities may be higher than on investment in the developed countries.

However, the founders were also very aware that the private investors would be hesitant to go into developing countries. They would be concerned about many things, such as the lack of infrastructure and skilled workers, the poor capacities of the government, and the uncertainties created not only by the marketplace but also by the policies and regulations of the government. 

Thus, there was a need for the government to step in and provide the enabling condition for private investment. 

Since most developing countries lacked good infrastructure, a lot of the emphasis of the World Bank in the early years was on infrastructure building. At the same time, the World Bank also invested in analytical work and knowledge building efforts. It was believed that foreign investors would be hesitant to invest in a country unless they had minimum information about the economies of these countries, including market dynamics and government policies. 

Therefore, even in the early days, the World Bank invested in producing detailed analysis of the economies of the developing countries both at the macro-economic and sectoral levels. This tradition continues even today although the private sector now has a much greater capacity to obtain information on the developing countries on their own. 

The analytic and knowledge work of the World Bank, embodied in the hundreds of documents it produces each year and the advice it gives to the developing countries, is still considered to be one of its most important contributions.  Governments, investors, and others interested in the developing world take these reports seriously.  

After implementing hundreds of projects during the 1950s, 1960s and 1970s, many of which were in infrastructure, the World Bank became increasingly concerned about the effectiveness of such projects. Internal project reviews revealed that, in many cases, the expected development returns had not materialised. 

The World Bank concluded that there were deep structural problems in the developing countries that were preventing these projects from achieving their goals. It was particularly concerned about the policy regimes in these countries and concluded that significant policy reforms were needed in various areas, from trade policy to industrial policy, from monetary policy to fiscal policy. 

The World Bank was also concerned about the allegedly poor performance of public enterprises, whether in manufacturing, trading, infrastructure, or utilities. There was a bit of irony in this because, in many countries, several public enterprises had been established at the behest of the World Bank. 

This is because when the World Bank provided loans to develop a particular sector, it was often hesitant to provide the funds to the ministry overseeing the sector and thus often it asked for the establishment of public enterprises in the sector, through which to provide the funds. The expectation was that such public enterprises would be more efficient than a government ministry. 

In many cases, these expectations were not fulfilled, and the World Bank started advocating for privatisation, starting in the 1980s. I shall come back to this subject later.

Syed Akhtar Mahmood

The author is an economist who previously worked for an international development organisation. The second part of this two-part analysis will be published tomorrow. 

A shorter version of this full article was recently published in Bonik Barta.