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What’s the difference between giving aid and providing a loan, and what are the implications for development?

The interchangeable language of development and the implications of ambiguity lead the terms under review to be clarified. Aid can be defined as the ‘transfer of resources on concessionary terms, or a gift, to be applied to some objective in a developing country’ (Black, 2007:38). Moyo asserts that there are three types of aid; Emergency, Charity-based and Systematic – aid which dispensed via bilateral or multilateral organisations (Moyo, 2008:7). For the purpose of this essay Systematic aid will be the focus point and in the context of this essay, shall be defined as help given without expectation of return most commonly in the form of grants, specifically directed at people in the developing world. Commonly this help is not specifically sought. Loans, in contrast, are sought by the recipient and provided under the condition of repayment through a business style contact. The terms of ‘aid’ and ‘loan’ are used interchangeably by those involved in development, despite both having distinctly different impacts on the recipient. To ensure further clarity, development itself cannot be understood as a single process. The term manifests itself in the context of experience and location. Willis indentifies development to imply; modernity, human well-being, economic process relating to scale (Willis, 2005:2-10).

This essay argues that despite differences, the key aspect of aid and loans is conditionality which can constrain effective development. This will be achieved through exploring the key differences between ‘aid’ and ‘loans’ and the impacts on development. Followed by, investigation and analysis of historic mechanisms for administering systematic aid. This is not to disregard the importance of microeconomic policy, the Millennium Development Goals as the predominate system of aid, or the responsibility and accountability generated in donor and receipt countries through aid relationships. Narrowing the field of review serves to allow more detailed analysis, instead of a general evaluation.

Systematic aid and concessional loans, despite being both distinguished as ‘aid’ and used interchangeably, provide recipient countries with additional resources from distinctly different positions. The most apparent distinction is the duty to repay the donor in the case of a loan. This obligation, it can be argued, serves to ensure investment and independence by the recipient government, ensuring that the government is induced to ‘use funds wisely and to mobilize taxes and maintain current levels of revenue collection’ (Moyo, 2008:8). This factor also serves to be less attractive to those involved in corruption, due to the contractual obligation it creates with the donor organisation. This point is supported by Knack, who finds that higher levels of aid [in opposition to loans] worsen corruption and bureaucratic quality (Knack, 2001 qtd in Knack 2004:253).

Independence empowers the recipient government and breeds accountability and responsibility, which as Knack argues, are undermined when countries are in receipt of large volumes of aid (Knack, 2004:251). The legitimacy of the argument for loans has been eroded as donor agencies frequently forgive loans, leading to policymakers in poor economies coming to view them as ‘roughly equivalent to grants’ (Moyo, 2008:8). This legitimacy is further lost through loan ‘conditions’ serving to stem independence. These conditions principally include tying loans to certain macroeconomic policies, which shall be explored later. It has been demonstrated that loans serve to support independence of governmental policy and reinforce accountability.

In contrast aid appears to offer an obligation free resource, which can provide support to recipient government’s domestic revenues (Moyo, 2008:8), lessening the states dependence on its citizens and internal mechanisms (Wood, 1980:2) and providing a plausible alternative to non-credible, highly condition based loans (Easterly, 2007:666). Donor countries commonly support a policy of grants instead of loans due to the ‘long gestation period before [investment] starts to produce the returns in revenue needed to service loans’ (Moyo, 2008:8). Black criticises aid as ‘fostering dependency’ (Black, 2007:37), while not generating accountability to the recipient countries citizens, but rather the donor country, potentially weakening government accountability through conditions set in the interests of the donor country (Knack, 2004:253). This alleviates the governments need for the type of long-run investment that would generate returns and stimulate human development or economic growth (Easterly, 2007:666). Aid has been ‘linked to coup attempts and political instability, by making control of the government and aid receipts a more valuable prize’ (Grossman, 1992 qtd in Knack, 2004:253). This has established that aid fosters dependency, and is limited through conditions applied by donor’s inline with their interests.

Both loans and aid suffer from bureaucratic shortfalls in donor governments stemming from, as Easterly declares, a lack of coordination, aid-tying – which lessens its worth while limiting the choice of the recipient. A key weakness of aid is the over-emphasis on food aid and technical assistance (Easterly, 2007:639-642). Black highlights this aspect further by stating:

Much aid has been used to help countries compensate foe their underdeveloped status in ways unconnected to poverty, tiding them over with advice, specialised expertise and subsidized contracts for high-tech investments, until the notional day when they become developed and can do these things for themselves (Black, 2007:33)

A central difference between aid and loans is underlined by the percentage of pledged money reaching the recipient country. Loans provide a guaranteed amount of support, providing conditions have been met. In sharp contrast, much of the aid never reaches recipient countries, instead being assigned to debt relief, research, donor mechanisms (Black, 2007:34-5). This lack of certainty surrounding aid reinforces disempowerment of the recipient country, while promoting neo-colonial superiority from the donor through their ability to control development trends in favour of their strategic and commercial interests (Black, 2007:43; Wood, 1980:2). It is mistakenly assumed that the conditionality’s prescribed by the aid and loan systems are reduced through the volume and diversity of donor organisations, making it possible for recipient countries to ‘play off donors against each other and to circumvent the restrictions of single donors’ (Wood, 1980:4), this is however not the case.

To explore the differences between aid and loans further this essay now addresses two key mechanisms formulated and implemented through the United States and its agencies. Firstly looking at the Marshall Plan as an example of an aid policy; its structure and resulting arguments for development, then going on to analysis the key Bretton Woods institutions of the World Bank and IMF (International Monetary Fund) and there use of the Structural Adjustment Loans. The Marshall Plan and World Bank emerged within a narrow space in time at the close of the 1940’s (McMichael, 2004:40), for this reason these examples have been chosen as both have played a key role in the historic trajectory of the aid system.

The Marshall Plan is a bilateral aid program, also known as the European Recovery Program, provided aid from the United States to Europe and Japan in the aftermath of World War II (Willis, 2005:38). The Plans aim was to restore trade, stabilize prices, expand production, secure private enterprise and offer a strong alternative to the Socialist movement, while containing Communism and the labour militancy which dominated the region East of Europe (McMichael, 2004:41-2; Willis, 2005:38). It did this through bilateral aid of equivalent to 2-3 percent of the US GDP, the equivalent of $13 billion in aid and technical assistance (Ghani & Lockhart, 2009:87; Willis, 2005:38).

The Marshall Plan is an early example of the idea of ‘national ownership of development’ (Ghani & Lockhart, 2009:34). The key distinctions between aid programs employed today and the Marshall Plan is the emphasising of the recipient countries role in development, implementation and ongoing project manager of strategy, while removing conditionality. The role of assistance was to cure issues surrounding development, opposed to providing purely palliative support and the final key aspect was the lack of conditions which surrounded the dispersal of aid, which are so prevalent today (Ghani & Lockhart, 2009:87-8). This freedom of recipient countries to control development aid, and mange resources without the constraints and liabilities of repayment or other conditions appears to address many of the shortfalls levelled at current aid programs, while offering many of the benefits usually associated with development loans; such as, government independence, accountability and responsibility. This positive position is further enhanced when figures show the Marshall Plans success at producing the fastest growth period in European history; 35 percent increase in industrial production between 1948-52 (Ghani & Lockhart, 2009:87). The implications for development include reinforcement of the concept of aid; the Marshall Plan often cited as an example of successful aid, despite as Black asserts the inappropriateness of the model (Black, 2007:39). Black identifies key differences in human capital and technological capacity between Europe and the developing world as components for its unsuitability (Black 2007:35), nor does it address the issue of dependency associated with aid in the short and medium term. Notwithstanding Blacks criticisms, Ghani & Lockhart state that the Marshall Plan ‘still stands as a unique act of visionary statesmanship and an illuminating example of strategic instrument for state building’ (Ghani & Lockhart, 2009:87). Further investigation is needed as to understand why aspects of the Marshall Plan have not been present in recent aid programs, although the removal of conditionality in an aid program alleviates problems concerning donor interest. Structural Adjustment Loans (SALs), now known as ‘Development Policy Loans’ were originally developed as rapid disbursing loans in 1979, in response to crisis in ‘balance of payments’ within Latin America, initially designed to ‘achieve one-off correction of macroeconomic imbalances and policy distortions (Easterly, 2007:660).

SALs provide evidence of a shift in loan-based aid agency’s approach, from project based infrastructure lending, to influencing macroeconomic policy through evaluation of the role of national government in development (Easterly, 2007:659). SALs applied stringent conditions to recipient governments, created with the purpose of shifting economic policy and management in the direction of the Washington Consensus, which focused on liberalising trade, tight control of monetary and fiscal policy, privatisation of industry, deregulation and securing property rights, tax reform and openness to foreign direct investment (Black, 2007:59; Brown, 2009:433; Burnell & Randall, 2008:257; Wood, 1980:4). Brown argues that these conditions appear to limit government control in contrast to the strengths of loans demonstrated above, removing independence and empowerment of recipient governments by enforcing the previous inducements to invest (Brown, 2009:433), and are in contradiction to the program of the responsibility implemented through the Marshall Plan. However, the stringent conditions of SALs are backed by a study in conducted in 2000 by Burnside & Dollar which found that ‘aid raised growth only in countries with good policies, as measured by low inflation, low budget deficits, and high openness to trade’ (Burnside & Dollar, 2000:847) which backs the reforms of the Washington Consensus. The structure of SALs, and there impact on policy reforms in recipient governments may discourage governments investing in development until situations become critical. This in action can be attributed to many factors including, questions of legitimacy of the conditions, which are normally dismissed through reference to the World Banks ‘best possible technical research’ (Wade, 2001:128). Further factors include the use of multiple ‘one-off’ corrections being placed on countries, which even if they produce a positive exit tendency, still produce ever increasing debts (Easterly, 2007:660). Imposition of Anglo-American political values, in opposition morally or culturally to the recipient countries values (Brown, 2009:433; Wade, 2001:129). Further lose of credibility follows the announcement at the 2005 G-8 summit of 100% multilateral debt cancellation for the poorest countries (Easterly, 2007:665), which serves to devalues the SALs reforms through questioning the World Banks authority. The implications of SALs on development, has been to place the same conditionality and dependence on loans as previously applied to aid, thereby removing the advantages.

In conclusion, the differences between aid and loans although distinct, are blurred through use of aid as an interchangeable term and the mechanisms of distribution. The mechanisms of distribution discussed highlight the importance of conditionality to both aid and loans; firstly through the success of aid when conditionality is removed, as in the example of the Marshall Plan; secondly, through the loss of advantage to the loan when conditions are rigorously imposed, as in the Structural Adjustment Loan. These outcomes each have implications for development connected to recipient government confidence and donor country interests which provide the agenda for development.

Questions generated by this essay concern the consequences of aid and loans on both macro and micro economic policy, relations between donor and recipient, and the effects of aid and loans on democracy and other state systems.

Bibliography

  • Black, M (2007) The No-Nonsense Guide to International Development, 2nd edition, Oxford, New Internationalist Publications.
  • Brown, C (2009) ‘Democracy's Friend or Foe? The Effects of Recent IMF Conditional Lending in Latin America’, International Political Science Review, Vol. 30:4 pp. 431–457 available at http://ips.sagepub.com/content/30/4/431 (Accessed on 3rd December 2010).
  • Burnell, P & Randall, V (2008) Politics in the Developing World, 2nd edition, Oxford, Oxford University Press.
  • Burnside, C & Dollar, D (2000) ‘Aid, Policies and Growth’, The American Economic Review, Vol. 90:4 pp. 847-868, available at www.jstor.org/stable/117311 (Accessed on 4th December 2010).

    *Easterly, W (2007) ‘Are Aid Agencies Improving?’, Economic Policy, Vol. 22:52 pp. 633-678, available at www.jstor.org/stable/4502212 (Accessed on 3rd December 2010)

  • Ghani, A & Lockhart, C (2009) Fixing Failed States: A Framework for Rebuilding a Fractured World, Oxford, Oxford University Press.
  • Knack, S (2004) ‘Does Foreign Aid Promote Democracy?’, International Studies Quarterly, Vol. 48:1 pp. 251-266, available at http://www.jstor.org/stable/3693571 (Accessed on 3rd December 2010).
  • McMichael, P (2004) Development and Social Change: A Global Perspective, 3rd edition, London, Sage Publications Ltd.
  • Moyo, D (2008) ‘The Myth of Aid’, Dead Aid: Why Aid is not Working and How there is Another Way for Africa, pp.3-9, London, Penguin.
  • Willis, K (2005) Theories and Practices of Development, Oxon, Routledge.
  • Wood, R.E (1980) ‘Foreign Aid and the Capitalist State in Underdeveloped

Countries’, Politics Society, Vol.10:1 pp. 1-35, available at http://pas.sagepub.com/content/10/1/1.citation (Accessed on 3rd December 2010).

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