A Novel Idea

March 16th, 2011

Foreign aid is an odd concept.  Or maybe I mean a unique concept.  Yes, that’s it.  Foreign aid is a unique concept.  Most of our world works on a capitalistic system, particularly when it comes to investments.  Of course there are government programs worldwide which transfer wealth from the rich to the poor, but they fit into a capitalistic framework.  Unemployment, welfare, medicare, medicaid, and social security benefits are almost identical to insurance policies.  The public education system may primarily and directly benefit those without the resources to pay for a private education, but they also provide the human capital which helps a nation grow, thereby increasing the prosperity of all. 

Foreign aid isn’t like any of these.  There is little economic benefit to the donor nation.  It does not serve the role as an insurance policy for taxpayers.  And though it is frequently ineffective or embezzled by corrupt officials, most citizens of the U.S. and Europe believe it should play a role in our governments’ agendas.  In fact, according to a World Public Opinion poll of eight developed countries, majorities in all countries polled are willing to “contribute the funds necessary to cut hunger and severe poverty in half by the year 2015.”  This annual contribution per household would range from $10 in Turkey to $65 in the U.S.

What is most unusual to me about foreign aid is that in today’s wonderful world of brilliant thinking, we still have not thought of a way to really make it work.  There have been some breakthroughs, to be sure.  One of my favorite solutions is microlending: the practice of extending small loans,” often no more than $20 or $30, to borrowers who have “traditionally lacked access to credit.”  Lenders provide credit directly to those who need it, thereby cutting off corruption and bureaucracy and expect borrowers to pay them back (with interest) to reduce dependency.  Recipients include the poor, often in developing countries, but most notably women who want to start a business or grow an existing business. A traditional bank or other lender would consider these loans too risky and too small to justify, but from a philanthropic perspective they are quite worthwhile.

But microlending—one capitalist’s solution to foreign aid—is mainly a private venture and isn’t popular within official foreign assistance programs.  The Millennium Challenge Corporation (MCC) is an example of capitalism’s influence on public aid.  Created by U.S. Congress in 2004 with the encouragement of President George Bush, the MCC aims to encourage innovation and competition in foreign aid.  The MCC forms partnerships with countries to fight against poverty, but through a competitive selection process in which the recipient country must prove its performance on a set of policy indicators.  While the MCC is innovative and successful, it is not without its limitations.  For example, many developing countries are ineligible for MCC funds and are unlikely to achieve eligibility in the near term.  On the one hand, we do not want to throw money into a pit from which it will never return, but on the other, we can’t turn on backs on these nations, many of which are the poorest in the world.

So what do you get when you add just a bit more capitalism to foreign aid?  Perhaps the new solution is Cash on Delivery, an intriguing idea put forward by the Center for Global Development, a Washington think tank.  The concept is simple, instead of paying for the inputs of a development program; a developed country would pay for only good outcomes.  It’s actually so intuitive I’m not sure how the idea is still new.  For example, if the United States were paying for education in Malawi, instead of paying for more teachers and more buildings and more books, the U.S. would set up a contract offering to pay Malawi for each additional student that finishes school above the expected baseline.  The results would be audited independently and there would be steep penalties for lying.

This could be more practical and effective for a host of reasons.  It might reduce dependence on aid, create more accountability, reduce corruption, and increase effectiveness.  It might also meet its share of challenges—for one, it would certainly present a strong incentive for developing countries to overstate results.

Accountability and competition are what make capitalism such a strong and effective path to development.  Trying to achieve these components in foreign aid—a practice that is by nature not very capitalistic—is smart and might yield surprising results.  From an Economist’s perspective, explorations into this area can only yield a better understanding of the world and ultimately may contribute to an improvement in our ability to fight poverty worldwide.  I welcome it.

Written by Ann Hollingshead

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