The Hidden Costs of Development Aid

As many development aid projects fail to yield economic improvements, the multilateral institutions that carry out these projects have often been criticized for giving in to political influence. The World Bank claims that its development aid is no longer allocated based on political factors, stating recently that, “it is true that during the Cold War years aid was politically motivated. Now, however, aid is being delivered to countries most in need and to those who show they are determined to use it well.”

In “The Costs of Favoritism: Is Politically Driven Aid Less Effective?,” Dreher et.al. test this belief in the context of World Bank development projects, measuring the effectiveness and political motivations of approximately 6,000 World Bank projects over a 30-year period. The authors find that while only a fraction of World Bank projects appear to have been allocated based on political factors, those projects that did have political overtones yielded significantly worse evaluations when the recipient country was economically vulnerable.

Recent research suggests that politically important countries leverage their influence at the International Monetary Fund when they are economically vulnerable, leading to the authors’ hypothesis that these countries would act similarly towards the World Bank. The authors use ex-post performance ratings of World Bank projects as a proxy for effectiveness and temporary membership on the UN Security Council as a measure of political importance because it increases the number of World Bank projects for that country by 10 to 25 percent.

The authors identify and control for three ways through which donor interests can impact project initiation, implementation, and evaluation: countries on these committees could: (i) approve a higher number of projects, or specific types of projects, for approval to their own countries or countries in which they have a political interest; (ii) affect the speed of loan disbursement and reduced oversight and/or enforcement of project goals and conditions; and (iii) affect the evaluation of project outcomes, where donor countries use their positions to ensure the projects are evaluated positively.

Dreher et.al. address the inevitable difficulties in testing for political motivation. Despite controlling for donor and borrower factors in their sample, the data may be too rough to find any significant political influence. Specifically, they predict only around 10 percent of projects are likely to be politically motivated and, “[even] if these projects are of a lower quality, they might not reduce the average sufficiently to be detected amid the mass of other projects unaffected by political motives.” Indeed, when the authors test for political motivation in general for a project, there is no significant effect on project performance.

The authors then look at the countries that had politically-motivated projects and whether or not these countries were economically vulnerable at the time of project implementation, characterized by high short-term debt. They focus on loans to middle-income countries: because “vulnerable governments exploit their political capital when facing vulnerability, it stands to reason that the more powerful middle-income countries can mobilize more political capital than the poorest borrowers.” Surprisingly, the authors find that when an economically unstable country is a UNSC member and has a coinciding development project, these projects are much less likely to be satisfactory.

Specifically, there was a significant correlation between decline in project performance and short-term debt levels of 21 percent or more in countries with politically-motivated development projects. At 40 percent debt levels, the probability of the project receiving a satisfactory evaluation fell by nearly 15 percentage points.

These findings suggest that more consideration should be given when lending money to economically unstable countries. This could have implications for recipient countries that attempt to use the World Bank and similar multilateral institutions as a “quick-fix” when they are economically vulnerable. While this research focuses on a single multilateral institution, increasing financial interdependence and the global financial crisis necessitate further research into the effects of development aid projects.

Feature Photo/cc: (GHNI pics)