Foreign Aid: Who Benefits?

"Foreign aid is neither a failure nor a panacea.
It is, instead, an important tool of American policy
that can serve the interests of the United States and
the world if wisely administered."
~ Former Congressman Lee H. Hamilton

ST. LOUIS — An analysis by the Federal Reserve Bank of St. Louis suggests that the level of aid given to a country tends to increase along with the country's infant mortality rates, civil and political rights and government effectiveness, and decreases with its per capita GDP.

The analysis, by economists Subhayu Bandyopadhyay and Howard J. Wall, appears in the November/December issue of Review, the Reserve Bank's bimonthly journal of economic and business issues. The publication is also available online at the St. Louis Fed's web site: https://research.stlouisfed.org/publications/review.

Using data from the World Bank, Bandyopadhyay and Wall examined the post-Cold War era because it has not been the focus of substantial research.

"There are many reasons why we should be interested in the determinants of aid levels," they said. "First, because aid is an important means by which donor countries and agencies try to alleviate poverty, we should care whether the aid is being directed towards those most in need. Also, we should be interested whether the aid is going to those people and countries where it might be most effective, as measured by the effectiveness of the recipient governments in making use of that aid or in fostering economic growth for their citizens."

Bandyopadhyay and Wall reported that 13 countries that received more than $1 billion in aid per year, the top five of which were China, Poland, Congo, Indonesia and Russia. At the other extreme, four countries in their sample averaged less than $10 million in aid per year: Singapore, the Bahamas, St. Kitts (West Indies) and Kuwait.

The vast majority of the countries they studied have average per capita incomes around or below $10,000, although nine countries had average incomes above $15,000: Israel, Singapore, Kuwait, Malta, Slovenia, Bahrain, Seychelles, the Bahamas and the Czech Republic. "There was a general tendency for relatively poor countries to receive more aid per capita," said the economists, "but some countries' receipts were well in excess of the sample average." They noted that the latter also tended to have relatively low rates of infant mortality.

Bandyopadhyay and Wall theorized that while higher levels of infant mortality may indicate greater need, they might also indicate health-care systems that are less effective at making use of the aid they're receiving. "If so," they said, "donors might then be allocating more of their limited aid budgets to countries with better health-care systems, where each dollar of aid might have a larger impact on well-being."

To estimate the responsiveness of aid to changes in the needs of recipient countries, Bandyopadhyay and Wall followed a methodology from another study, which used fixed effects to control for the political, historic, cultural or political interest of donor countries.

They found that aid in the post-Cold War era tended to respond positively to a recipient country's infant mortality, its level of rights and its government's effectiveness in doling out money. Aid also tended to fall as a recipient country's GDP rose.

"The results of our analysis," they concluded, "run counter to much of the existing research, which, while tending to find a negative link between aid and per capita income, has been much more mixed regarding the other variables."

With branches in Little Rock, Louisville and Memphis, the Federal Reserve Bank of St. Louis serves the Eighth Federal Reserve District, which includes all of Arkansas, eastern Missouri, southern Indiana, southern Illinois, western Kentucky, western Tennessee and northern Mississippi. The St. Louis Fed is one of 12 regional Reserve banks that, along with the Board of Governors in Washington, D.C., comprise the Federal Reserve System. As the nation's central bank, the Federal Reserve System formulates U.S. monetary policy, regulates state-chartered member banks and bank holding companies, and provides payment services to financial institutions and the U.S. government.

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