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A REVIEW OF FOREIGN AID EXIT STRATEGIES by ETHEL NGOMA submitted in accordance with the requirements for the degree of MASTER OF COMMERCE In the subject ECONOMICS at the UNIVERSITY OF SOUTH AFRICA SUPERVISOR: PROF P. LALTHAPERSAD-PILLAY JANUARY 2019 DECLARATION Name: ETHEL NGOMA Student number: 32046421 Degree: MASTER OF COMMERCE Title: A REVIEW OF FOREIGN AID EXIT STRATEGIES I declare that the above study is my own work and that all the sources that I have used or quoted have been indicated and acknowledged by means of complete references. 17th January 2019 _____________________ _____________________ SIGNATURE DATE ABSTRACT Foreign aid as an economic policy was previously widely accepted as a way to assist least developed economies to achieve economic growth. Over the years, aid effectiveness has been questioned, whilst aid dependency has continued to rise. To assist in aid reduction, various economists have proposed aid exit strategies that countries could adopt to reduce aid dependency. However, the adoption of these strategies has been rather slow. The purpose of this study was to review and assess the current literature on the different proposed foreign aid exit strategies, in terms of their feasibility and ease of implementation, taking into account the current state of African economies. The analysis focused on the exit strategies recommended by Tandon (2008), Moyo (2009) and Fee (2012). The main finding of this study suggests that the aforementioned exit strategies are feasible, but not necessarily easy to implement, due to the limitations faced by many least developed countries. Key terms: Foreign aid effectiveness; Foreign aid dependency; Economic growth; Foreign aid exit strategies; Official development assistance; Aid reduction; Foreign aid exit feasibility; Poverty eradication; Sustainable development; South Africa; Botswana; India. Table of Contents DECLARATION ii ABSTRACT iii CHAPTER 1: INTRODUCTION AND OVERVIEW OF STUDY 1 1.2 Background information 2 1.3 Problem statement 7 1.4 Aims of the study 8 1.5 Research questions 9 1.6 Justification and rationale for the study 9 1.8 Research methodology 9 1.9 Scope and limitations of the study 10 1.10 Structure of the study 10 CHAPTER 2: CONTEXTUALIZATION OF ECONOMIC DEVELOPMENT AND FOREIGN AID 2.1 Introduction 13 2.2 Definition of and types of foreign aid 14 2.3 Determinants of foreign aid 15 2.3.1 Ethical theories and approaches on aid giving 16 2.4 Economic growth theories and foreign aid 17 2.4.1 The Harrod and Domar model (1946) 18 2.4.2 Rostow’s stages of economic growth (1960) 18 2.4.3 Rosenstein-Rodan (1943 and 1961) The “Big Push” Theory 19 2.4.4 Chenery and Strout – Two-Gap Theory (1966) 20 2.4.5 Summing up the link between economic growth theories and foreign aid 20 2.5 The transformation phases of foreign aid 20 2.5.1 The Period 1900 – 1940: Initial stages of foreign aid 21 2.5.2 The Period 1955–1970s: The Golden Age of Development Aid/Decade of industrialisation 24 2.5.3 The 1980s – The lost age of development 26 2.5.4 The 1990s: governance, democracy and debt Relief 28 2.5.5 The 2000s – The era of development goals 29 2.6 Foreign aid framework 30 2.6.1 Aid organisations and donors 30 2.6.2 Levels of aid flows 32 2.6.5 Aid governance 35 2.7 Aid dependence 35 2.8 Conclusion 36 CHAPTER 3: LITERATURE REVIEW ON THE CURRENT STATE OF FOREIGN AID 39 3.1 Introduction 39 3.2 Trends in current foreign aid flows 40 3.2.1 Official development assistance disbursements 40 3.2.2 ODA allocation 44 3.2.3 Foreign aid dependency levels 45 3.2.4 The future of foreign aid 47 3.3 Impact of foreign aid on economic growth 47 3.3.1 Foreign aid and economic growth transmission 48 3.3.2 Favourable conditions for foreign aid 50 3.3.3 Transmission mechanisms 52 3.3.4 Exchange rate and taxes 55 3.3.5 Programme assistance 56 3.3.6 Review of the impact of foreign aid on economic growth 57 3.4 Factors that influence empirical research on foreign aid 58 3.5 Current constraints to foreign aid effectiveness 59 3.5.1 Donor led constraints 60 3.5.2 Recipient led constraints 61 3.6 Foreign aid criticisms 62 3.7 Proposed foreign aid reforms 63 3.8 Conclusion 64 CHAPTER 4: PROPOSED FOREIGN AID EXIT STRATEGIES 67 4.1 Introduction 67 4.2 Outline of proposed exit strategies 68 4.2.1 Brief outline of ending aid dependence: Yash Tandon’s proposed exit strategies 68 4.2.2 Brief outline of dead aid: Dambisa Moyo’s proposed exit strategies 72 4.2.3 Outline of Derek Fee’s proposed exit strategies 76 4.3 Critical analysis of Moyo’s, Fee’s and Tandon’s exit strategies 82 4.3.1 Institutional development 82 4.3.2 Mind-set adjustment 83 4.3.3 Pro-poor budgeting 84 4.3.4 Prioritising employment and decent wages 84 4.3.5 Creation and protection of domestic markets 85 4.3.6 Plugging the resource gap/reduction in expenditure 86 4.3.7 Limiting aid to national democratic priorities 87 4.3.8 Capital solutions and remittances 87 4.3.9 Domestic resource mobilisation 88 4.3.10 Bilateral relations with China 88 4.3.11 Financial solutions for the unbankable/ micro-financing 89 4.3.12 Economic diversification 90 4.3.13 Global fund model 90 4.4 General criticisms made against the proposed exit strategies 91 4.5 Conclusion 92 CHAPTER 5: COUNTRY CASE STUDIES 95 5.1 Introduction 95 5.2 Case study one: Botswana 96 5.2.1 Brief country background 96 5.2.2 Botswana’s foreign aid reduction management strategy 98 5.3 Case study two: South Africa 99 5.3.1 Brief country background 99 5.3.2 South Africa’s foreign aid reduction management strategy 100 5.4 Case study three: India 101 5.4.1 Brief country background 101 5.5 Consequences of aid reduction 103 5.6 Comparing Fee, Moyo and Tandon’s recommendations against the country case studies 104 5.7 Further lessons learned 109 5.7.1 Pre-exit assessment phase 110 5.7.2 Planning and Implementation Phase 110 5.7.3 Post exit phase 112 5.8 Conclusion 112 CHAPTER 6: SUMMARY, RECOMMENDATIONS AND CONCLUSIONS 116 6.1 Introduction 116 6.2 Summary of proposed exit strategies 119 6.3 Summary of the main findings 120 6.4 Policy recommendations 121 6.4.1 Trade reform 121 6.4.2 Improvement of the agricultural sector 122 6.4.3 Tax reform 123 6.4.4 Promotion of Small Medium Enterprises 123 6.4.5 Technology and infrastructure development 124 6.4.6 Good governance 124 6.4.7 Incentives to encourage FDI 125 6.4.8 Reduce the cost of remittances 125 6.5 Conclusion 126 BIBLIOGRAPHY 128 TABLE OF FIGURES Figure 2.1: Levels of net official development assistance in 2014 33 Figure 3.1: Net total ODA disbursements (2005-2014) 39 Figure 3.2: ODA Recipients by Region (USD million) 2013 – 2014 43 Figure 3.3: Foreign Aid and Economic Growth Transmission Analytical Framework 47 TABLE OF TABLES Table 2:1: Total number of countries receiving ODA, as per their per capita income level 31 Table 2.2: Levels of ODA - 2000 to date 32 Table 3.1: Net Total ODA Disbursements (2005 – 2014) 40 Table 3.2: DAC Members’ Net Official Development Assistance in 2014 41 Table 3.3: Allocation of ODA by sector 2013 – 2014 43 Table 3.4: ODA Dependency Trends/Levels for 2000/04 and 2011/15 44 LIST OF ACROYNMS AIDS Acquired Immunodeficiency Syndrome CIDA Canadian International Development Agency DAC Development Assistance Committee DFID Department for International Development EC European Commission EU European Union ERP European Recovery Programme FDI Foreign Direct Investment GDP Gross Domestic Product GNI Gross National Income HIV Human Immunodeficiency Virus HIPC Heavily Indebted Poor Country IFI International Financial Institution ILO International Labour Organisation IMF International Monetary Fund LDC Least Developed Country LIC Low Income Country MDG Millennium Development Goal MDRI Multilateral Debt Relief Initiative NGO Non-governmental Organisation OA Official Assistance ODA Official Development Assistance OECD Organisation for Economic Corporation and Development SIDA Swedish International Development Agency SME Small Medium Enterprise UN United Nations UNICEF United Nations Children’s Fund UNDP United Nations Development Programme USAID United States Agency for International Development WGI Worldwide Governance Index CHAPTER 1 INTRODUCTION AND OVERVIEW OF STUDY 1.1 Introduction Paul Kagame, President of Rwanda is of the view that foreign aid crippled self-reliance and defiled the dignity of his citizens (Lumu, 2016). Moyo (2009) argued that the main reason why only the continent of Africa has been locked in a cycle of economic dysfunction for many years is because of over-reliance on foreign aid. Furthermore, empirical studies have found that aid has had no impact on economic development or any poverty indicators (Boone, 1996; Svensson, 1999 and 2000; Knack, 2001; Brumm, 2003; Ovaska, 2003; Easterly et al., 2004; Djankov et al., 2008; Williamson, 2008). Despite this evidence and numerous calls to end foreign aid, aid has continued to flow into developing countries. For example, the Organisation of Economic Corporation and Development (OECD) reported that foreign aid increased by 4 per cent in real terms in 2017, with aid to sub-Saharan Africa rising by 3 per cent and humanitarian aid rising by 6.1 per cent (OECD, 2018). The OECD believes that this is still not enough and urges more donors to honor their 0.7 per cent target for official development assistance (ODA) (OECD, 2018).