Journal Article

IDS Bulletin Vol. 36 Nos. 3

Increased Aid Absorptive Capacity: Challenges and Opportunities Towards 2015

Published on 1 July 2005

The year 2005 promises to be an important year in the global struggle to fight poverty and underdevelopment.

In the run-up to the UN Conference in September, which will assess progress in reaching the Millennium Development Goals (MDGs), a number of policy initiatives are being discussed, such as the creation of an International Finance Facility (IFF) and proposals on global taxes to finance development. These will be at the top of the agenda for the UK’s presidency of the G8 and the European Union, with a specific focus on the problems faced by the African continent.

Since the MDGs were agreed to in 2000 by the General Assembly, increasing attention has been devoted to calculating and defining the level of resources needed to allow countries to reach them by 2015, and to mustering the necessary support from the international community. In the Monterrey Conference on Financing for Development, in 2002, rich countries renewed their pledge to increase development assistance towards the goal of 0.7 per cent of national income, provided poor countries took concrete steps to improve governance and adopt sound policies for growth. In the Rome Declaration on Harmonisation, signed in 2003, donor countries agreed to improve their levels of coordination, in order to enhance aid effectiveness and minimise the negative effects of fragmented and unpredictable aid flows.

Both the quantity and the quality of development assistance have received attention, on the premise that adequate, predictable and more effective aid flows are critical to reaching the MDGs. Estimates of necessary resources have varied substantially. The Zedillo Report, released before the Monterrey Conference, put the additional cost of achieving the MDGs at about US$68bn, roughly double the present level of aid, including humanitarian aid and the provision of“global public goods”. A study carried out by the World Bank in 2003 (Supporting Sound Policies with Adequate and Appropriate Financing) found that progress towards the MDGs at country level could be accelerated through a combination of better domestic policies and improved governance, higher aid levels, more effective aid delivery, and improved market access to developed country markets. The study estimated that an additional US$30bn was needed, which could be effectively spent by doubling aid to Asian countries with large shares of the population living in poverty (such as Bangladesh, India and Vietnam), and devoting sizeable, but smaller increases to more aid-dependent countries in Africa and elsewhere with less effective government systems.

The most recent of these assessments, which has received much public attention, is the UN Millennium Project Report (2005), coordinated by Jeffrey Sachs. It argues that substantial increases in aid-financed investment are needed to allow poor countries to break out of their “poverty traps” and create the conditions for self-sustaining economic growth. The report quantifies the amount of additional aid required to meet the MDGs on the basis of five country case studies where MDGneeds assessments were carried out. Their results ‘suggest that in a typical low-income country with an average per capita income of $300 in 2005, external financing of public interventions will be required on the order of 10–20 per cent of GNP’ (p. 55). Indicative figures put the projected aid needs at US$135bn in 2006, growing toUS$195bn in 2015 which represents 0.54 per cent of donor countries’ national income.

According to the report, aid needs to be tailored to specific country circumstances. Middle-income countries will mostly need further debt cancellation and access to rich world markets. Well governed low-income countries caught in poverty traps are the ones towards which additional aid flows can be most productively channelled, but assistance should also go to countries poorly governed due to weak public administrations. Special arrangements should be adopted for countries that have experienced conflict, that are of urgent geopolitical importance, and that have special needs, such as vulnerability to natural disasters. Where conditions allow, aid should be “scaled up”. The report identifies a number of countries that are already in a position for a massive “scale-up” on the basis of their good governance and absorptive capacity. These countries should qualify for “fasttrack” status in 2005, gaining access to substantial additional aid.

So far the promises made by donor countries in Monterrey and Rome have failed to concretise, even though some progress has been made. A number of countries, including the UK, France, Spain and Ireland, have adopted specific deadlines to reach the 0.7 per cent target, and recently published figures from the Organisation for Economic Co-operation andDevelopment/Development AssistanceCommittee (OECD/DAC) indicate that in 2003 aid increased substantially, reachingUS$69bn. The harmonisation and alignment agenda is less advanced, as donor countries struggle to turn their commitment to improved aid practices into concrete behavioural changes at international and country level.

The prospect of substantial additional amounts of aid therefore depends crucially on the ways in which the international community will decide how to react to the UN Millennium Project Report in the run-up to the September MDG Summit, and to the UK Chancellor’s efforts to convince donor countries to sign up for the IFF. This would allow for a significant front-loading of aid in the next few years, by raising funds on the international financial market against the promise of future commitments, and consequently for a substantial increase of aid flows, in particular to Africa. If this happens, the key question will be: ‘Under what circumstances can increased aid be most effective in promoting development in Africa?’

The existing literature on aid effectiveness (surveyed in McGillivray 2005), largely focuses on the impact of aid flows on growth rates in recipient countries and is consistent in finding positive evidence that aid increases growth, and that consequently, it may have a significant impact on poverty levels. Another consistent finding, at the base of new approaches to “selectivity”, is that aid’s impact on growth depends on the quality of the recipient country’s institutions and policies (Burnside and Dollar 2004). An interesting recent paper by the Center for Global Development (Clemens et al. 2004) also finds that particular types of aid, termed “short-impact aid” (which includes budget support, investments in infrastructure and aid to productive sectors), have a much stronger impact on growth than aid taken as a whole. This basic result, contrary to the selectivity arguments, does not depend on levels of income, strength of institutions or quality of policies. There are, however, clear indications that aid, like all other investments, has diminishing returns. Most studies indicate that an “aid saturation point” could be reached anywhere between 15 and 45 per cent of GDP, beyond which the marginal benefits of additional aid inflows become negative. This finding poses important questions about providing significant additional aid to Africa, where a number of countries are already highly aid-dependent (see Table 1). It is also reasonable to expect that the bigger and faster the increase in aid flows, the sooner diminishing returns will set in, as they will put additional strain on existing systems.

Related Content

This article comes from the IDS Bulletin 36.3 (2005) Increased Aid Absorptive Capacity: Challenges and Opportunities Towards 2015

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Renzio, P. (2005) Increased Aid Absorptive Capacity: Challenges and Opportunities Towards 2015. IDS Bulletin 36(3): 20-27

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Paolo de Renzio

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Institute of Development Studies
Renzio, Paolo