Monday, August 18, 2008

Mind the Gap: The World Bank and the Financing Gap theory of Development

Since the establishment of the concept of aid for development after the Second World War, there have been roughly six failed methods that have been used to foster growth in the developing world. The first method was the financing gap theory which postulated that a recipient country needed project financing in order to develop.

Based on the Harrod-Domar economic model of 1946, the financing gap theory was used throughout the 1960s and 1970s as the method to calculate and deliver aid throughout Africa and Latin America. The main focus of this aid was the construction of large infrastructure projects.

The financing gap theory postulates that economic growth is proportional to investment. One could estimate the amount of growth one wants to achieve, and thus derive the amount of investment necessary in the country by comparing the difference between savings and investment. Since the target country for development was too poor to finance its own investment, and private capital flows to developing countries were at the time negligible, Western donors would step in to fill the gap.

This theory was lent further credence in 1960 by Walter Rostow in his influential work The Stages of Economic Growth. Rostow projected that increasing investment by five to ten percent of national income would launch a developing economy into “self-sustained growth.” The major drawback of Rostow’s projections are that they were heavily influenced by the apparent success of the Soviet Union’s attempts to industrialize at the time.

Using this theory the World Bank and others calculated the amount of aid necessary for a country’s economic growth and then financed large infrastructure projects in the developing world. Hydroelectric dams, new highways and industrial projects were funded across Africa and Latin America. The problem with this method is twofold.

First, the financing gap theory states that aid will encourage a government to increase its savings rate which will then be re-invested in the economy. This, however, has not been the case. The historical evidence demonstrates that the recipients of aid instead increase their government spending in light of the new found inflows of capital.

Secondly, aid for investment creates inverse incentives for growth. The greater the gap between savings and investment, the greater the financing gap and thus the greater amounts of foreign aid that will be received.

Despite the historical failure of the financing gap model, it is still in widespread use in many of the international financial institutions, namely the World Bank, to project the amounts of foreign aid necessary to create growth. A 2001 UN Report on development used the financing gap model to call for more aid for developing countries.

The World Bank is back at it again – only this time in Chad. In 2000 the World Bank financed the construction of a 1000 kilometer pipeline from landlocked Chad, across Cameroon to the Atlantic ocean. The idea was that the World Bank would finance the pipeline in exchange for an agreement with the Chadian government that 70% of of its revenue would be spent on poverty reduction.

In 2006, shortly after the pipeline became active, the government of Chad reneged on its agreement with the World Bank. Unusual for the World Bank, it froze the earmarked funds in what became a media sensation.

This being the World Bank, of course, it blinked first. Now Chad is only required to develop a new “poverty reduction strategy” in cooperation with the World Bank.

One has to wonder, what exactly is a “poverty reduction strategy?” Does it include the concept of “good governance and free and fair markets?” Nevermind – after the World Banks’ $4.1 billion investment, the World Bank now has over $300 million of additional projects in Chad.

Tuesday, August 12, 2008

Kenya Ports Work Slowdown: Government Meddling Hampers Free Trade

The election violence in Kenya earlier this year garnered a great deal of media attention for its suddeness as well as its shocking violence captured on video and splashed across television screens around the world. Wasn’t Kenya that romantic place of safari holidays and beach resorts?

The Kenyan election problems were simply one more manifestation of an endemic disease – that of gross governmental mismanagement. This disease is currently manifesting itself at the port of Mombasa, albeit in a way that does not make for splashy headlines or graphic film clips.

The Kenyan Ports Authority, a government controlled agency which manages the port of Mombasa, is in a labor dispute with the Mombasa port workers. These port workers are the ones who dock the ships, load and unload the cargo and ensure the smooth functioning of international trade and commerce. The majority of East Africa’s goods transit through the port of Mombasa. Rwanda, Uganda and Kenya export coffee, tea, and other agricultural commodities, and import petrol and other goods they do not manufacture themselves. Sudan and Somalia are heavily dependent on World Food Program aid shipments that transit through Mombasa.

In July the KPA mandated a seven day work week for the dock workers - without commissurate pay increases. The dock workers have responded with a dramatic work slowdown resulting in containers piled up and ships delayed – costing hundreds of thousands if not millions of dollars per day.

What does this really mean? This means higher costs for anyone who consumes goods that transit through the port of Mombasa – ie: everyone in East Africa from Sudan, Somalia, Uganda, Rwanda and Congo. Those lower on the economic ladder will be hit hardest.

The actions by the KPA are one more example of Kenyan fiscal mismanagement. Over the past thirty years Kenya has been the recepient of over $15 billion in aid through international institutions – namely the World Bank. The conditions on that aid was that the Kenyan government would have to reform its economic policies and liberalise its economy. Key to this was the privatisation of many state-owned entities. Again and again, Kenya did not fulfill its end of the bargain. Instead of cutting off aid, the World Bank accepted the excuses and ploughed more aid into the country, enriching its rulers and fostering endemic corruption.

As if the economic losses from the election violence were not enough for the Kenyan government, now they are mismanaging their main economic lifeline – the port of Mombasa. If Kenya wishes to pull itself out of poverty as opposed to being supported by the welfare of the World Bank and aid agencies it must reform its economic and fiscal policies.

Sunday, August 10, 2008

On Aid

Over the past fifty years the Western world has spent over $1.2 trillion attempting to help Africa lift itself out of poverty and launch into what economists call self sustaining growth.

Despite these efforts, the vast majority of Africa is mired in poverty while the majority of its wealth is concentrated in the hands of a relatively few kleptocrats. Recent economic research into the effects of aid on development has demonstrated that aid is not the mechanism to spur growth. Conversely, those countries who have not received any significant amount of aid over the past 50 years have significantly outperformed those that did.

In the early 1970s Kenya and Chile had vastly different conditions – Kenya was the star of Africa, with economic growth rates at 7% a year for over ten years. Chile was a basket case with growth of only 1.7%, large budget deficits and soaring inflation.

Over the ensuing thirty years Kenya, through the assistance of the World Bank, received over $15 billion of aid for development, while Chile received none, but instead focused on reforming its economic policies.

The results have been staggering – Kenya’s economy has grown at an average of 0.44% per year since the 1970s, while Chile has grown at 6% per year over the same period.

So what happened? Good economic policy or lack thereof, is what happened. Kenya has consistently refused to reform its fiscal policies and liberalise its economy and continues to tolerate cronyism and corruption. The World Bank has continued to turn a blind eye to its failures as it injects more and more cash into the economy. Chile, on the other hand, now has one of the fastest growing economies in South America.