The End of Aid?
Does foreign aid actually help countries? It's harder to say than you think.
The Big Push
For the longest time, both the World Bank and the IMF used the same methodology to forecast how much investment a country needs to grow at a target rate of X% - the idea is that poor countries need to invest more in capital to grow, and that they´re too poor to save, so international aid should fill in the gaps. This gap between required investment to grow sustainably with full employment and actual investment is known as the Financing Gap.
This model is based on an ancient, long-discredited (by its own creator, even) model of economic growth known as the Harrod-Domar model, later readapted by World Bank economists based on the weird, Soviet-inspired ideas of development economists during the 1960s. Empirically, it doesn’t check out. Out of hundreds of countries with this kind of programs, only a dozen or so presented the right sign on the correlation to begin with, and only Tunisia could be fully accounted for. To take an extreme example: had the model been correct, Zambia’s GDP per capita would have been nearly 20,000 dollars in 1994. Instead it was… little over 500.
Later research shows good policies (opennness to trade, fiscal prudency, etc) are a necessary but not sufficient condition for aid to increase economic growth. Nevertheless, exactly how to measure “goodness” of policies and how to treat it as an econometric variable is controversial at best. And it is not even clear that explicitly attaching policy demands to loans (like the IMF does) actually makes countries implement them.
At the heart of this problem lies a paradox of incentives: any poor countries with good conditions to invest won’t need aid, while poor countries with bad conditions will not actually invest their aid. Far-away bureaucrats, like the World Bank’s, don’t actually really know what the poor people of Rwanda and Myanmar need - and when their tyrannical governments only spend a fraction of their foreign aid on support, it would be utterly heartless to take them away.
William Easterly, professor of economics at NYU, has first hand experience with this. As a development economist at the World Bank itself, Easterly helped manage many of the kinds of projects we have described as ineffective. As an academic, he has staked his reputation on the ineffectiveness of foreign aid (most of the text above is based on his work), and its many weaknesses. He has written several high profile books and magazine articles to this tune.
The Sachs-Easterly War
Life in the poorest countries on the planet is hard. People there are exposed to horrific diseases, and they have bad diets without many vital nutrients. They don’t have access to clean water, electricity, or basically any government services. Whole families, even children, work entire days in unproductive farms to eke out their meager existence. Normally you wouldn’t expect them to have rich, powerful, influential advocates in the first world, but one such man has made it his life’s mission to lift them all out of extreme poverty: Jeffrey Sachs.
Jeffrey Sachs is one of the most influential economists on the planet. He was a key economic advisor to (somewhat successful) economic reform plans in Poland, Bolivia, and Russia; he’s advised basically all of the world’s most famous and powerful people on poverty reduction, and wrote many best-selling books on the matter.
After moonlighting as an economic reform guru to statist economies during the 90s (Bolivia, Poland, Czechia, Mongolia, and finally Russia) Sachs undertook another massive project: the Millennium Villages. They were (are) a group of 79 villages in 10 African countries, which are based around Sachs’ ideas about fighting poverty: spend money on people, through improvements to agriculture, sanitation, education, public health, and communications. Testing and monitoring the results of his interventions, Sachs intended the Millenium Villages Project (MVP) to be a test case for his proposal: that, by spending a couple hundred billion dollars a year, the world’s richest could erradicate global extreme poverty.
The MVP ended in 2015. Did it work? Maybe. On the one hand, Sachs’ own review seems to point to the project being a success, since “When grouped by major [Milennium Development Goals]-related category (poverty, nutrition, education, health, and infrastructure), significant impacts were found for every major category. The largest consistent gains were in health and agriculture.” (Sachs, 2018). To its critics, the projects have been a failure, with “… mostly small or null results including for core welfare indicators, such as monetary poverty, undernutrition and child mortality. (…) this was the combined result of: poor design and implementation, redundancy of the interventions, and overly optimistic expectations.” (Masset, García-Hombrados, & Acharya, 2020).
One of the key problems: bad accountability for its data. The MVP has been accused of poor transparency with its evaluation data, including “subjective choice of intervention sites”, “subjective choice of comparison sites”, “lack of baseline data on comparison sites”, “small sample size”, and for initial assesments, “short time horizon”.
What framework did Sachs even base his interventions on? His arguments have three “legs”. The first one is a simple moral case: the poorest people on the planet are suffering enormously, and we should help them somehow. The second and third ones are intertwined: poor countries are in a “poverty trap”, which means they can’t grow because they are poor and can’t save, and in the “financing gap”, which is the idea that, after they calculate how much they need to invest in every relevant area (education, healthcare, infrastructure, sanitation). His idea can be summarized by a “big push” approach: simultaneously tackling lots of problems using enormous amounts of money.
Empirically, there are many examples of this approach working, outside of his controversial projects: provision of mosquito nets has significantly reduced malaria levels; promotion of farming technologies yielded enormous improvements in food production; and, in an extreme case, the President’s Emergency Plan for AIDS Relief, or PEPFAR has isaved an estimated 18 million lives in its 15 year runtime. Targeting various human needs with monetary interventions seems to have helped, over and over again. Randomized controlled trials (basically, comparing a group that gets help with another similar one that doesn’t) of various Sachs-esque interventions has, for the past few decades, yielded promising results (more on this later).
Enter William Easterly, not a fan of Jeffrey Sachs or of global extreme poverty. Easterly’s argument is also tripartite. Firstly, as laid out above, he doesn’t believe in a financing gap. Secondly, he doesn’t believe in a poverty trap either - citing evidence that poorer nations grew just as fast as richer nations, and that aid recipients didn’t improve from the general trend. And thirdly, he believes this is centrally an issue of governance and incentives: poor countries have bad governments with bad incentives who implement bad policies, and foreign aid bureaucrats have no reason to punish them - both because of the cruelty of cutting off a poor nation and because their own careers could be hurt by handing out less money.
The disagreements between the two have not been pretty, with many heated op-eds and Twitter feuds - with Easterly comparing Sachs to the mobster Al Capone, and Sachs all but accusing Easterly of being on the side of malaria (one of the Sachs approach’s most resounding successes). Regardless, it does seem somewhat ironic that the former shock therapy economic reformer has turned into a staunch defender of localized technical fixed, and that the former World Bank development program desk jockey became a high profile advocate of economic reform over aid.
The Micro-Macro Paradox
Moving besides such petty (but highly entertaining) exchanges, this does actually point to an interesting trend. Micro-level studies of targeted foreign aid (i.e. individual projects) all show aid is highly effective, a big win for Team Sachs. A majority of micro-level projects in the dimensions tackled by Sachs improve the quality of life of the target population (with some distinctions based on project type) without much improvement to the overall poverty rate. The success of these projects is so resounding that even Easterly himself has conceded their effectiveness.
At the macro level, the question of whether foreign aid improves economic performance is as fraught as the exchanges of Easterly and Sachs themselves. The literature is so muddled and contradictory that not even a consensus about the consensus can be found. In general, good policies are a strong predictor for aid improving economic performance, but can’t be proven to be a necessary or sufficient condition for aid improving growth. And many of the factors that incentivize good policies, such as accountable and democratic governance and social cohesion, can even be predictors of the aid-growth pipeline without good economic policies. Some studies even seem to show that aid works exactly as well in basically all policy enviroments - it basically has no impact at all.
In the end, this proves that both sides lost. Team Sachs took “a big L” because, if ending poverty was just about spending money, it would have more or less ended anyways. But Team Easterly didn’t come on top either - the literature is just extremely muddled on his assertions (which ultimately boil down to “have better policies” and “be a democracy”) and his attacks on micro-interventions simply don’t check out.
Round 2: the Nobel Committee Weighs In
In 2019, the Nobel Prize in Economics was awarded to three economists: Abhijit Banerjee, Esther Duflo, and Michael Kremer. They received the field’s top accolade for their long-term, groundbreaking work in examining the impacts of various policies through randomized control trials. Their work has touched on education, healthcare, credit, gender, and more. A common thread has been foreign aid, and most of their work has been about what works and what doesn’t.
But let’s go back a bit. A big reason why countries are poor, in the first place, is that resources are used very poorly. State owned industries flounder while pretending to reach laughable targets, or autocrat-backed cronies get rich off fleecing the consumers. This is known as misallocation, and just using resources in slightly more productive ways can have a big impact on growth. The clearest example of this is Maoist China, where horrendous economic management by central planners had disastrous consequences. The reallocations of resources initiated by Deng Xiaoping were one reason the country started growing so quickly.
But misallocation is a low-hanging fruit, because it might hit a brick wall: markets (for capital, labor, and land) in developing countries can work very badly, so optimal outcomes are hard to reach. Then what?. In 2006, Nobel Laureate Michael Spence was tasked with forming a comission to find the answer to this question, and his results were… underwhelming. To quote William Easterly “After two years of work by the commission of 21 world leaders and experts, an 11-member working group, 300 academic experts, 12 workshops, 13 consultations, and a budget of $4m, the experts’ answer to the question of how to attain high growth was roughly: we do not know, but trust experts to figure it out.”.
Duflo, Banerjee, and Kremer proposed a solution. So far, development aid had been guided by what basically amounts to guesswork: what to invest in, how much, when, and how to structure it. For example, aid agencies had long recommended to charge farmers for their mosquito bednets, because it made them more likely to use them properly. Randomized control trials proved that this was precisely backwards: simply handing out the nets for free was much more effective.
This approach had an extremely important core: the One Big Trick To Grow At 7% won’t be found for a while, but meanwhile we can use randomized experiments to make better policies. This is, uh, not uncontroversial.
The first, obvious caveat is that RCTs can’t actually answer why countries are poor. Take Latin America. Randomized experiments can show that transferring money to poor families if they vaccinate their children is effective at promoting vaccination. What they can’t show is why Latin America imploded so spectacularly in the 1980s - even if you time travelled Duflo & Co back in time. And you can obviously not run an RCT to check whether or not free trade or autarky or industrial policies are better. Another big concern is whether or not those results scale and can be translated. For example, paying impoverished Latin Americans to get vaccinated works. Will upper class American conservatives get vaccinated against COVID if you pay them? Who knows - they might not. And finally, the proposals themselves are limited to whatever the researchers can come up with. What if giving poor people food is more useful than paying them? What about giving them textbooks for their children, or a TV set, or a sticker congratulating them?. Plus, many people (such as Nobel Laureate and poverty studies legend Angus Deaton) have raised concerns about the RCT methodology itself.
The responses from Easterly and Sachs are not hard to imagine. The Easterlyites would argue that poverty won’t be ended by just making smart choices at some microscopic scale, but rather by actually finding macro policies and frameworks that work (whichever those are!). The Sachs Gang (he actually did respond to their points) would claim that we do know how to spur growth, that the big push works, and that the RCT approach understates knowledge that development experts already had (like, for example, that selling malaria nets was worse than simply handing them out).
Conclusion
In the end, poverty and underdevelopment won’t be eliminated with a silver bullet or a big push, but rather through slow, arduous work: stable macroeconomic policies, democratization, and investment in human and physical capital.
Regardless, all three perspectives acknowledge that enormous progress has been made in improving the conditions in which the world’s poorest live. Poverty in subsaharan Africa has remained constant, but due to population growth it has gone down as a percentage; the poverty headcount of most other impoverished regions has been reduced. And various targeted interventions has improved living conditions, meaning that aid (even if perhaps not the panacea) has already improved millions of lives for the better.
On a personal level, should we care?. To quote the philosopher Derek Parfit:
One thing that greatly matters is the failure of we rich people to prevent, as we so easily could, much of the suffering and many of the early deaths of the poorest people in the world. The money that we spend on an evening’s entertainment might instead save some poor person from death, blindness, or chronic and severe pain. If we believe that, in our treatment of these poorest people, we are not acting wrongly, we are like those who believed that they were justified in having slaves.
Some of us ask how much of our wealth we rich people ought to give to these poorest people. But that question wrongly assumes that our wealth is ours to give. This wealth is legally ours. But these poorest people have much stronger moral claims to some of this wealth. We ought to transfer to these people, in ways that I mention in a note, at least ten per cent of what we earn.
The 10% figure is not arbitrary, but rather, corresponds with the estimates by fellow philosopher Peter Singer in his book The Life You Can Save. Simply put, even a small amount of money could improve the living conditions of the world’s poorest people - if it is donated effectively. Both Singer’s website (linked above and here) and the organization GiveWell have researched which organizations are most effective at helping recipients of aid. So if you can, please help any of their top-rated charities.
Sources
Collier & Dollar (2002) “Aid allocation and poverty reduction”
“Jeffrey Sachs’s $200 Billion Dream”, Nina Munk (2007), Vanity Fair
Sachs (2018), “Lessons from the Millennium Villages Project: a personal perspective”
Miller (2011), “Sachs, Easterly and the Banality of the Aid Effectiveness Debate: Time to Move On”
IMF (2006) “The Macroeconomic Management of Foreign Aid” - Chapter 2 “Aid and Growth” by Radelet, Clemens, & Bhavnani.
“Does Foreign Aid Add Up?” (2008), William Easterly, Foreign Policy
“How Poverty Ends” (2020), Abihit Banerjee & Esther Duflo, Foreign Affairs
“Trials and Tribulations” (2020), Jeffrey Sachs, Foreign Affairs
Fauci & Eisinger (2018), “PEPFAR — 15 Years and Counting the Lives Saved”
“Global Extreme Poverty” (2019), Roser and Ortiz-Espina, OurWorldInData
I love your post! Just stumbled upon your substack on Twitter and I really like it. Keep it on!
I read this post for the first time over a year ago: the description of the two ideologies, and introducing Duflo's more nuanced (at least, incremental) approach is excellent! I added this post to the reading list for my Economics of Health (undergraduate) course for the talk about foreign aid.
Last year, students loved the Ace Attorney summary video. I'd love to feature it again. Would you still have it?