UK charity Action Aid has been getting quite a bit of press
today with its report
that only one-third of G7 overseas development assistance (ODA) is "real"
aid. The rest, they say, is "phantom aid". (If you’re interested,
the full report is here,
in PDF format.)
The thing that struck me about the report was where Action Aid said that debt
relief counts as "phantom aid". I think that debt relief is hugely
important for poverty reduction, and so I was rather angry abou that, especially
since Action Aid defines "phantom aid" as "aid which may have
achieved other goals, but did not help to fight poverty".
There are many, many things to take issue with in the Action Aid report –
for instance, since only 30% of the world’s poor live in middle-income countries,
Action Aid counts any aid to those countries beyond 30% of the total budget
as "phantom aid". This is profoundly silly: poverty-reduction programs
are, if anything, more effective in middle-income countries, because
those countries have better institutions.
But let’s stick with debt relief. Consider a highly-indebted country with a
poverty problem. It needs to spend money on providing clean water to its poor,
but it also needs to spend money on debt service. In this situation, by far
the most efficient way for a foreign government to get clean water to the people
who need it is to simply forgive that country’s debts. All the transaction costs
of the foreign government trying to provide the water itself – from consultants
to bureaucratic procurement procedures – disappear at a stroke. The local
government, which is certainly better placed to provide water than the foreign
government is, gets budget money freed up to be spent where it’s needed.
The local government can also, with its newfound creditworthiness, start to
finance projects which are needed for the long-term health and growth of the
nation, like building roads or ports. What’s more, it can quite easily reallocate
money where it’s needed when it’s needed, something a foreign government would
find almost impossible.
Now, debt relief on its own does not necessarily decrease poverty. If the money
saved in debt service is spent instead on private jets for the president and
kickbacks to his buddies, then the debt forgiveness will have done no good at
all. That’s one reason why the HIPC
program was so slow to get off the ground: it took a long time for governments
to prove that they were worthy of it. But when it’s done right, debt relief
is pretty much the most efficient way of delivering aid imaginable. Just think
of the costs involved with the average World Bank poverty reduction program,
complete with environmental impact assessments and whatnot, compared to the
cost of a local government simply going out and doing what is needed for its
poorest citizens. So I’m pretty upset that Action Aid simply declares that no
debt relief helps to fight poverty.
Then, however, I read the Action Aid report, and it does make some good points.
Here’s what it says:
All debt relief provided since 2002 has been counted as part of ODA,
despite the fact that the Monterrey Consensus agreed that year explicitly
stated that aid increases should be additional to debt relief.
Irrelevant. While the Monterrey Consensus never said that
debt relief should be excluded from ODA budgets, it did set a target for ODA
which explicitly excluded debt relief. To no one’s great surprise, many countries
are a very long way from reaching that target, even when you include
debt relief. But debt relief is a type of aid, and it is therefore perfectly
reasonable to consider it ODA. If Action Aid wants to castigate countries for
not meeting their Monterrey Consensus goals, that’s fine. But it does not mean
that debt relief is "phantom aid".
Cancelled debt stock – the principal and interest on the loan –
are counted as ODA in the year in which the relief is agreed, even though
any benefits are felt over several years.
Arguable. On its face, this is quite a strong argument. Let’s
say that Freedonia is paying $5 million a year on $100 million of debt, and
that Belgium then decides to forgive that debt. Suddenly, Belgium’s ODA expenditure
for that year has gone up by more than $100 million, while the amount of cashflow
freed up for poverty reduction is a mere $5 million. Clearly, Freedonia would
have been better off simply taking the $100 million from Belgium, using $5 million
of it to service the debt, and spending the rest on poverty reduction.
On the other hand, there are two reasons why debt relief is accounted for this
way. The main one is that this is simply the way that budgets in the OECD work.
Loans are assets, and accounted for as such. When a loan is written off, that’s
a line item in the country’s budget, and the full amount of money needs to be
found for it immediately.
Furthermore, Freedonia gets more than just a cashflow benefit from the write-off:
it also gets a significant decrease in its indebtedness. Without a write-off,
Freedonia will simply continue to pay interest on its loans and never pay down
the principal. With the write-off, Freedonia’s debt burden falls substantially,
making the country’s economy more stable and attractive to investors.
These figures exaggerate the actual transfer being made to poor countries
because debt relief is valued at its full nominal value. Much of the debt
relief provided to poor countries simply closes the gap between what countries
were scheduled to repay and what they actually were able to repay, and has
often done little to relieve budgetary pressure on poor countries.
Fair. If Belgium had already agreed that Freedonia need only
pay $1 million a year on its debt, then claiming over $100 million in ODA upon
forgiveness seems even more exaggerated. Freedonia gets ony $1 million a year
in immediate cashflow benefits, while Belgium gets to crow about its enormous
ODA budget. There’s no way that Belgium’s action can be spun as meaning $100
million’s worth of poverty reduction.
What’s more, Action Aid shows that total debt service costs, especially in HIPC
countries, have actually been rising, rather than falling, even as large chunks
of their debt have been forgiven. It’s good that the debt has been forgiven,
of course. But without cashflow benefits, it’s not clear that there’s been much
poverty reduction as a result. And it certainly seems unlikely that even a small
fraction of the $9.4 billion cancelled in 2003 made its way to direct poverty-reduction
In the UK, debt cancellation has been presented as additional to aid
spending. This is double counting.
Unfair.The UK, as far as I know, has been quite upfront about
its debt relief activities and their place within the ODA budget. No one’s counted
debt relief on its own and then added it to an ODA total which already includes
it. Therefore, no double counting. The Action Aid methodology says that all
debt relief is "phantom aid", not just debt relief which is double-counted.
Funding debt relief from aid budgets is not only misleading. It also
risks penalising countries that are not indebted, as aid resources are diverted
towards heavily indebted countries. It also violates the principle that creditors
should carry some of the cost of debt relief, given the role that reckless
lending has played in the debt crisis, and the fact that much of the initial
lending was not supporting development-related expenditures.
Arguable. While it might be fair to include debt
relief within an ODA budget, it’s not fair to fund debt relief
with an ODA budget – and I daresay more than one country has
been doing that of late. In other words, certain countries might have spent
money directly on poverty reduction which they allocated instead to debt relief.
That’s a bad thing. The big question is the extent to which that behaviour goes
on, and since it’s all based on a hypothetical – "how big would your
ODA budget have been had you not done the debt relief?" – it’s very
difficult to answer.
Poor countries without debt have not necessarily been penalised – that’s
a strong word – but it’s true they haven’t had the same amount of attention
paid to them that the HIPC countries have had.
As for the "principle that creditors should carry some of the cost of debt
relief", aren’t the creditors carrying all of the cost of debt
relief? If they’re not, who is? I think I understand what Action Aid is trying
to say here, but it’s a very weak argument indeed.
Weirdly, after running through its arguments, Action Aid concedes my main point:
Debt relief can be a particularly effective form of resource transfer,
as it is untied, stable, predictable and flexible.
Well, exactly! The only argument seems to be whether it belongs in ODA budgets
– and if it does turn up there, whether it is "phantom aid".
My view is that any effective, stable, predictable and flexible form of resource
transfer is most definitely foreign aid, and not phantom aid.
I think the biggest problem with the Action Aid report is that there’s an unspoken
assumption running throughout it that we generally think that the amount of
poverty reduction is proportional to the amount of money that is spent on poverty
reduction. Action Aid gets halfway to the truth of the matter: that some parts
of the broad global poverty reduction program are much less cost-effective than
others. But the charity also confuses the matter by trying to draw a bright
clear line between "real aid" and "phantom aid".
In fact, all aid is useful to some degree, and there is no such bright clear
line. Countries spend money on ODA for many reasons, and some of that money
is always going to be more cost-effective, in terms of poverty reduction, than
other chunks of that money. The problem is that Action Aid spends a large amount
of space in the report comparing the amount actually spent on aid to the amount
that it thinks should be spent on aid. It’s confusing means (money) with ends
In fact, there’s no formula tying a certain number of billions of dollars to
a certain number of lives brought out of poverty. Action Aid shouldn’t be concentrating
on dollars, it should be concentrating on people. Scaring up a "scandal"
(cf the Guardian headline) over "phantom aid" doesn’t achieve that
in the slightest – if anything it reduces pressure on governments to spend
more and do more. After all, if two-thirds of the money is wasted, what’s the
point of spending the money at all?