During much of the 20th century, the dominant view among most economists and policymakers was that the key bottleneck to development in poorer countries was a lack of adequate financial capital. Development theorists believed that if countries were provided with more financial capital—mostly as loans, though sometimes as outright grants—the countries would then be able to buy the goods and services need to build up their stocks of human and manufactured capital. This would make their economies more productive, and they would then be able to pay back the loans out of their increased GDP. This was the guiding principle behind the founding of the World Bank after World War II – to provide capital to help less developed countries “catch up.”
| Table 1: Net Official Development Assistance,|
2005, Selected Countries
|Donor|| Amount Given|
Billions US $
| Amount Given in 2005|
as a Percentage of GDP
| Source: World Bank, 2006, Global Development Finance:|
The Development Potential of Surging Capital Flows,
Table 3.1, and World Development Indicators Database, 2006.
Many people—especially in the United States—are under the impression that rich countries give a great deal of money in "foreign aid." The amounts, however, are generally quite small as a percent of the GDP of the donor countries—generally only a fraction of 1% (see Table 1.) The uses of international aid vary both in intention, and in the kind of impact they have. Some bilateral aid is motivated by the donor’s wish to increase its own exports and is “tied” to requirements that the money be spent to make purchases from the donor country. Some has political motives, such as buying friends in countries that are important to the donor, because of their natural resources (such as oil), or for other reasons of geo-political advantage. While the category “development aid” is not supposed to include military aid, it may sometimes be used directly or indirectly to acquire weapons.
Some bilateral aid is crediting with achieving more clearly development-related objectives, such as increased school attendance, better health, and increased agricultural productivity. In other cases, aid serves primarily to promote the strategic interests of the donor nations, and may even create greater dependence rather than economic progress in the recipient nations.
Most multilateral support comes in the form of loans which must be repaid with interest. In fiscal 2005, the World Bank provided $22 billion in loans, of which $8.7 billion went to the poorest nations as “concessional” loans (loans on easy terms) or outright grants. Some of World Bank-financed investments have succeeded, but sometimes the projects promoted by multinational institutions have not been very beneficial to the countries involved. Regardless, the loans must still be repaid, and it is easy for countries to get heavily indebted.
Developing countries as a group currently have over $2 trillion in debt, on which they must pay over $300 billion in interest and principal repayment (debt service) each year. Of course, they can also receive new loans, but even taking this into account the net flows associated with the debt burden mean that developing nations are currently paying out more than they take in each year (as shown by the recently negative official flows in Figure 1). While more successfully developing countries can afford some debt service, it can be a crippling burden for the poorest nations. In 2005, Latin America, South Asia, and Sub-Saharan Africa, including some of the world’s poorest nations, together owed over a trillion dollars in outstanding debt.
In addition to bilateral and multilateral aid, funds from non-governmental organizations (NGOs), including church-related charities and independent medical groups, play an important role. These sources are usually smaller in volume than government funds, but they often finance “pilot” projects that demonstrate to potentially larger donors – rich nations and multilateral institutions – a variety of models of how development assistance can be applied in better ways.
Some loans and grants have truly supplied just the missing factor that was needed, at the right time, and have achieved significant success. In other cases, however, such interventions are made without sufficient attention to the many, complex factors that go into development, and are often far less effective than intended.
The failure of aid to stimulate sustained growth in many countries caused a great deal of frustration among policymakers. By the 1980s, the idea that countries should engage in “structural reforms” as a precondition for being granted aid gained ground. Multilateral institutions began to insist that all recipient governments undertake a broad swath of policy changes in order to qualify for further loans.
The set of favored policies came to be known as the “Washington Consensus”. The main principles of the Washington Consensus were:
- Fiscal discipline. Developing countries were urged to end fiscal deficits and balance government budgets by developing reliable sources of tax revenue and limiting spending.
- Market liberalization and privatization. Abolition of government-controlled industries, price controls and other forms of intervention in domestic markets were seen as essential to promoting growth.
- Trade liberalization and openness to foreign investment. Countries were pressured to remove tariffs and other barriers to trade, as well as capital controls and other restrictions on foreign investment flows.
Loans from the World Bank, IMF, and other institutions were made conditional on moving towards making such "structural reforms" or "structural adjustments" in a country's economy. The slogan “stabilize, privatize, and liberalize” governed the thinking of development policymakers. The implicit promise was that if these policies were followed, the conditions for rapid growth would be created.
The results of structural adjustment policies during the 1980s and 1990s were not nearly as positive as was hoped. Some countries progressed, but the countries that most strictly followed the World Bank’s market-oriented development path, including many of the formerly communist economies, suffered the most severe crises. In Africa, where investment in health and education is desperately needed, stringent financial policies often forced cutbacks in these areas of social investment. The idea of “fiscal discipline” made it impossible for countries to use fiscal policy for macroeconomic stabilization.
Meanwhile, countries such as China and India, which experienced high levels of economic growth during this period, generally did not follow the Washington Consensus policies. While these countries did increase their market-orientation, they combined this with high levels of trade protection, continued state control or guidance of important sectors of the economy, and divergent fiscal policies.
After two decades of Washington Consensus policies, overall rates of growth have generally been lower than in previous decades. The mixed results of the policies promoted by the World Bank and other international institution have led to an ongoing debate between critics and defenders of the Washington Consensus.
In 2005 the World Bank published a report, Economic Growth in the 1990s: Learning from a Decade of Reform, in which it accepted some of the arguments made by the critics of the Washington Consensus. Market reform, the report concluded, is not enough. Strengthening institutions, promoting greater social equity, and investing in human capital are also essential. Perhaps most importantly, the Bank acknowledged that there is no “one size fits all” set of policies for economic growth. Different countries have different needs, and policymakers in these countries have sometimes been more aware of these specific needs than World Bank economists seeking to impose a particular set of reforms. According to the report’s preface:
Unquestionably, macroeconomic stability, domestic liberalization, and openness lie at the heart of any sustained growth process. But the options for achieving these goals vary widely . . . In dealing with the growth process, economists have no formula. They have broad principles and tools . . . the manner and sequence in which economic principles and tools are used will determine whether specific country growth strategies will succeed or not.
Meanwhile, the International Monetary Fund (IMF) has replaced its "structural adjustment" policies with an emphasis on "poverty reduction" policies which are intended to give countries more voice in creating their own development plans.
For many critics, these reforms do not go far enough. They suggest that the policies of liberalization and openness advocated by the World Bank and IMF go in the wrong direction. For successful development, they say, countries need to engage in active industrial policy: promoting particular industries, using tariffs, subsidies, and other economic tools as needed, even when this implies active government modification of market outcomes. They point out that currently high-income economies all used such policies in earlier stages of growth; it is only now that they have grown wealthier that they preach free trade and fiscal reform to others. In addition, according to this alternative perspective, government policies aimed at improving the equity of income distribution should be an important element of development, balancing free-market forces which may tend to increase inequality.
Critics also point out that recent developments in the World Trade Organization (WTO) may further threaten—rather than encourage—growth in poor economies. WTO agreements increasingly forbid the sorts of tariffs and subsidies used by developed countries during their own industrializing periods. In addition, the "trade-related aspects of intellectual property rights" (TRIPS) provisions of the WTO increase enforcement of patents and copyrights held by rich-country corporations. This could make it more difficult for poor countries to access needed technology. Some analysts suggest that changes in trade regimes, such as reduced rich-country tariffs on poor-country products (and particularly, manufactured products), would go much farther in increasing poor country incomes than most programs of aid.
The debate on development continues. Undoubtedly, a combination of market and government-led policies will be used as countries continue to strive to develop. The unsettled question is how to determine the combination that will work best for a particular country, and how best to promote a combination of economic development and social goals.