IN DEPTH: Trade vs aid

Is trade better than aid in tackling poverty? Or is it just another excuse for low levels of government aid?

By Brett Parris, a World Vision Economic Policy Adviser based in Australia

Does trade or aid pack more punch in the fight against poverty? Brett Parris argues you can't have one without the other. Take action>>

It is often claimed that trade brings much larger benefits to the poor than aid does. The problem with this claim is that the economic models used for trade policy analysis assume that poorer countries already have well-functioning markets for goods, services, insurance and credit, a sound banking system, well-defined property rights, a skilled and healthy workforce, well-functioning legal and tax system, good infrastructure and so on.

In reality, for many of the poorest countries, these institutions are either dysfunctional or non-existent, the human capital base is poor and the infrastructure is sadly deficient. Aid has a critical role in strengthening all these vital capacities.

Over the last 30 years, governments around the world have downplayed the benefits of government aid or Official Development Assistance (ODA). The Australian Minister for Foreign Affairs, Alexander Downer, reinforced this approach in October last year, arguing that trade was the main game and that “aid…can only help at the margins” (Parkinson, 2002).

Unfortunately, this argument ignores the pervasive links between aid, good governance, political stability and a country’s capacity to trade. The ‘trade not aid’ mantra is strangely out of touch with what the poorest countries need for both economic development and trade expansion itself. Most simply do not have the necessary resources.

According to the United Nations Commission on Trade and Development, in the 49 poorest Least Developed Countries (LDCs): “Between 1995 and 1999, the average per capita income in the LDCs was US$0.72 a day and the average per capita consumption, US$0.57 a day… This would leave an average US$0.15 per person per day to spend on private capital formation, public investment in infrastructure and the running of vital public services, including health, education, administration and law and order.”

Infrastructure
Adequate infrastructure is obviously a precondition for strong economic development. Market opportunities are limited without roads and rail services, and rural roads can be an important factor in reducing poverty by providing the poor with greater access to markets, health centres and schools. Production is hindered by inadequate and unreliable power supplies and telecommunications, and trade is stifled with poor quality roads and inefficient port facilities. Aid can greatly accelerate a process of infrastructure improvement that may otherwise take decades longer.

How does New Zealand compare on overseas aid?

Human Capital
Aid to improve educational and skill levels, sanitation and health is essential for helping the poorest countries to reduce poverty and to build the skilled workforces needed to enable them to prosper. Without adequate investments in education, especially for women, countries risk becoming enmeshed in a low-skills, low-product-quality trap. Gallup and Sachs (2001) showed that, even allowing for differences in tropical location, colonial history and geographical isolation, countries with intensive malaria still had income levels in 1995 only 33% of countries without malaria. They also found that on average, incomes in countries with intensive malaria grew 1.3% less per person per year. Meanwhile, HIV/AIDS is devastating Sub-Saharan Africa and many countries in Asia. Investments in health, sanitation and a major international effort on ‘neglected’ diseases such as malaria and HIV/AIDS would bring enormous benefits to developing countries, significantly improving the quality of their workforces.

Institutions
In its statement at the UN’s Financing for Development Conference in Mexico in March 2002, Australia argued: “The continuing importance of ODA is undeniable. But it is only one of a number of interrelated responses that, together, contribute to development. Sound domestic economic policy settings and strong domestic institutions are crucial to attracting investment and sustaining growth. So is sound governance, both public and corporate.” This statement again ignores the fundamental links between aid and governance. Good governance and sound institutions are unquestionably essential for development, but they cost money, which most LDCs don’t have. Attracting and training competent officials, improving the rule of law, fighting corruption, reforming the police and army, building institutions, and raising technical standards all require major investments of time and money. The resources required for creating a favourable trade and investment environment do not come out of thin air.

Advocates of the ‘trade not aid’ view often have little appreciation for the institutional costs involved in participating in the World Trade Organisation system. Implementing WTO agreements can be enormously costly - sometimes more than an entire year’s development budget:
“ To gain acceptance for its meat, vegetables and fruits in industrial country markets, Argentina spent over $80 million to achieve higher levels of plant and animal sanitation. Hungary spent over $40 million to upgrade the level of sanitation of its slaughterhouses alone. Mexico spent over [US]$30 million to upgrade intellectual property laws and enforcement that began at a higher level than are in place in most least developed countries; customs reform projects can easily cost [US]$20 million. Those figures, for just three of the six Uruguay Round Agreements that involve restructuring of domestic regulations, come to [US]$130 million … more than the annual development budget for seven of the twelve least developed countries for which we could find a figure for that part of the budget.” (Finger and Schuler, 1999, p. 25)

Another fundamental role for institutions is in managing the conflicts that inevitably arise during processes of economic change - through good regulations, an independent judiciary, well-functioning courts and social safety nets such as unemployment benefits and pensions. Aid can also be exceptionally effective in reducing the risks of further conflict in post-conflict societies (Collier and Hoeffler, 2002). This disaster-prevention role for aid is woefully under-appreciated. Increased Australian government aid for conflict resolution and peace building, as a form of insurance against the risks of political instability and failed states in the Asia-Pacific region, could save Australian taxpayers billions of dollars over the long-term.

There is no question that economic growth is essential for sustained poverty reduction. But growth takes time. Uganda, one of the better-governed nations in Africa, would take 150 years to reach Australian 1998 levels of income if it achieved 2% annual real per capita growth - better than the US average over last 100 years. In a world where rich-country TV programs are beamed into millions of poor villages, the poor today face a choice: shall I wait 100 years for growth to improve my family’s situation or should I try to cross a border?

Whereas many of our ancestors who migrated to Australia from poor villages were lucky enough to be born in a time of massed migration, those born today are not so fortunate. Between 1820 and 1914, some 60 million Europeans emigrated, helping Europe to manage the transition from an agrarian to an urban society. Poor countries today no longer have this pressure valve. There is no ‘New World’ for them and to expect them to manage with only token assistance from a rich world pulling up its drawbridges is to court disaster.

Some encouraging progress …
Thankfully, awareness of such links is growing. The EU has a target to reach an average ODA level of 0.39% of GNI (Gross National Income - formerly GNP) by 2006, with every member reaching at least 0.33% by 2006. Five European countries have increased ODA to at least 0.7% – including the Netherlands, Sweden, Denmark, Norway, and now Luxembourg. After four successive increases, Belgium is on track to reach its goal of 0.7% by 2010. Ireland’s goal is 0.7% by 2007 and in 2002 it increased ODA by 55% to reach 0.45% of GNI. The UK increased ODA by 35.6% in 2000 and has now reached 0.32% with a target of 0.4% by 2005-06. France announced a goal last year of 0.5% by 2007. The US has also embarked on an almost 50% increase over three years, eventually yielding an extra US$5 billion.

How does New Zealand compare on overseas aid?

...except from Australia
By contrast, Australia has made no commitments to increase ODA. For the last 30 years in real per capita terms, our ODA levels have remained virtually stagnant while we have been getting substantially richer. The average Australian is about 71.7% richer in real terms (taking into account inflation) than in 1972 ($19,381 per capita GDP in 1971-2, versus $33,281 in 2000-01 in 1999-2000 dollars), but our ODA per capita is 12.8% less than it was then ($92.16 per capita ODA in 1971-2, versus $80.38 in 2000-01). In 1971-2 we gave 0.48% of our GDP, compared with just 0.25% budgeted for 2002-03 – a decline of 48%.

Doubling Australia’s official aid from its 2001 level would cost each Australian adult about $2.15 per week, if it had to come entirely from new taxes (which it would not with other budget savings). Some cannot afford this, but most can and many can afford substantially more. To place this figure in context, Australians lost $14.37 billion in gambling in 2001 – an average of $988 (or $19 per week) per adult Australian (Campbell, 2002). We are also not a particularly highly taxed nation. In fact, in 1999 according to the OECD, Australia had the 5th lowest overall tax burden in the OECD, measured by total tax receipts as a percentage of GDP.

Conclusions
The ‘trade not aid’ mantra is a false dichotomy. There are multiple links between aid, economic development, growth and poverty reduction. The progressive decline in the level of Australia’s overall aid commitments does not reflect a serious effort to grapple with how and when poverty can be eradicated. Nor does it suggest an appreciation of the potential security threats and attendant costs resulting from increased inequality and political unrest over the next 50 years. Developing countries need vastly more help. Aid does work, and it makes a huge difference in the lives of poor people. But aside from its obvious humanitarian benefits, aid should be considered an investment in our future, not a cost.

References:
Campbell, D., (2002) “A Nation of Gamblers Ignores the Odds”, The Sunday Age, Melbourne, 18 August, p. 15.
Collier, P. and Hoeffler, A., (2002) “Aid, Policy and Growth in Post-Conflict Countries”, World Bank Working Paper No. 2902, World Bank, Washington DC, October, 24 pp.
Finger, J.M. and Schuler, P., (1999) “Implementation of Uruguay Round Commitments: The Development Challenge”, World Bank Working Paper No. 2215, Washington DC, World Bank, October, 53 pp.
Gallup, J.L. and Sachs, J.D., (2001) “The Economic Burden of Malaria”, CMH Working Paper No. WG1: 10, WHO Commission on Macroeconomics and Health, February, 27 pp.
Parkinson, T., (2002) “Give trade, not aid, says Downer”, The Age, Melbourne, 11 October, p. 4.
UNCTAD (2002) “Global Anti-Poverty Efforts Must Address Link Between Commodity Dependence and Extreme Poverty Says UNCTAD” Press Release, 18 June 2002, TAD/INF/PR45, p. 4.