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Is Overseas Development Assistance (ODA) Dying or Just on a Life Support?

by Matthew Odedokun

Trend in the Volume of ODA

Overseas Development Assistance (ODA) refers to development-motivated official foreign grant or loans-that are concessional in the sense that the grant element, evaluated on the basis of 10 percent discount rate, is not less than 25 percent of the loans' face value. It is loosely and popularly referred to as 'foreign aid' and constitutes the main instrument of official finance from the developed to developing countries.

The volume of ODA has been on a steady decline, especially during the past decade. As shown in Table 1, the bulk-about 98 percent during 1991-2000 period-of ODA is provided by the members of the Development Assistance Committee (DAC) of the Organisation for Economic Co-operation and Development (OECD). But while the membership of the DAC has increased from 17 in the 1970s to 22 in the 1990s, the aggregate volume of ODA hardly kept pace.

In the 1970s, the nominal ODA volume witnessed a phenomenal increase, rising by over 14 percent per annum on average. This slowed to just over 8.4 percent average rate of annual growth in the 1980s while, in the 1990s, it contracted at an average rate of over 1 percent per year. Of 22 DAC-member donors, nominal ODA from 11 of them registered declining trend during the 1990s. But a clearer picture of the declining trend is portrayed by considering the aid generosity ratio, defined as the fraction of GDP given as ODA. As shown in Table 1, the aggregate generosity ratio of 0.31 percent in the 1970s rose marginally to 0.32 percent in the 1980s, only to fall substantially to 0.28 percent in the 1990s. While the UN-prescribed aid target is 0.7 percent of GDP, donors (except Denmark, Netherlands, Norway and Sweden) have observed the target only in breach. The US, which is the most parsimonious of the donors, gives only 0.13 of a cent as aid out of every dollar GDP earned during the 1990s, down from 0.25 of a cent given in the 1970s. In growth terms, the generosity ratio rose in the 1970s at an average of 0.7 percent per year but fell at an average of 0.3 percent per year in the 1980s and 4.7 percent per year in the 1990s. All donors (except five small ones, namely: Denmark, Greece, Ireland, Luxembourg and Ireland) recorded trend declines in their generosity propensity during 1990s while Australia and the US even recorded contractions in all the three decades.

Possible Causes of the Declining Trend in Aid Volume

Notwithstanding some recent attempts at identifying the factors responsible for the observed trend decline in donors' generosity as well as the reasons why some donors are less generous, at a point in time, than others, one could still only speculate as to the actual causes. In this regard, one possible factor was the end of the cold war that occurred in the early 1990s. This could have reduced international strategic and politics-motivated foreign aid, especially on the part of large donors like the US. Tight budgetary conditions in donor countries and regime changes between right and left wing governments are also possible causes. It is also likely that regimes in countries where there is great concern for the domestic population that are poor, like in the Scandinavian countries, would also be more generous in giving aid to developing countries. There could also be a peer pressure effect whereby the volume of aid given by a donor depends on what other (particularly, relatively large) donors are giving so that a reduction in aid volume by large donors like the US might generate a downward 'bandwagon' or spiral effect on total aid volume.

Non-conventional Ways of Reversing the Falling Trend in Aid Volume should be Explored

Irrespective of the factors responsible for the downward trends in aid volume and generosity ratio, there is the need for concerted efforts aimed at reversing the trend. This becomes more imperative in view of the increased number of recipient countries (which have, since the 1990s, included former communist countries) and increasing population size of each recipient country. More important, the scope of activities that foreign aid finances has been increasing, with inclusion of environmental issues in early 1990s and the more recent addition of poverty-reduction.

One way of boosting the aid volume and stemming the declining trend is for donors to consciously raise the volume through the conventional budgetary appropriations. But, as this is unlikely to achieve much within a limited period of time, other means should be found to enhance the aid volume. One such means is the quasi-multilateral institutional arrangement suggested recently by the British Government under the name of International Finance Facility (IFF). Under the proposed arrangement, the donor governments would make pledges to the IFF to contribute a certain sum to the IFF. On the strength and credibility of the pledges, the IFF would borrow from the international capital markets for onward transfer, as aid, to the recipient countries preferred by the donors. The loans are to be repaid when the pledges are redeemed.

In addition to the IFF mechanism, the issue of innovative sources of development financing should also be re-visited. Such innovative sources should be centrally collected by a multilateral institution that should disburse the proceeds in accordance with pre-determined allocation formulae. Several innovative sources of financing international development have been suggested in the literature. These include international currency transaction (so-called Tobin) tax; a general tax on the sum of exports and imports; carbon tax; international arms trade tax; international lottery tax; and charges on global commons (geostationary satellites, minerals mined and fishing in international waters; exploitation in Antarctica, etc.). Others are internet or bit tax; international aviation and shipping taxes; pollution charges; and additional issue of SDRs by the International Monetary Fund (IMF). Many of these sources can fetch huge and enormous sums of money -as in the case of Tobin tax, which has been fairly conservatively estimated to generate up to US$300 billion per year if the tax rate is 0.2 percent! However, due to opposition from some developed countries, particularly the USA, such proposals are yet to see the light of the day. But with renewed and ever-increasing interests in (and agitation for) them from the international community, the hope is bright that some of them would sail through in the near future.

Matthew Odedokun is the director of the WIDER research project The Sustainability of Development Financing', and editor of External Finance for Private Sector Development: Appraisals and Issues, published b Palgrave Macmillan, March 2004.