16 February, 2010

More Aid Wouldn't Necessarily Make Less Poverty

Jeffrey Sachs and His advocacy on More Development Aid

The world has agreed to bring prosperity to all people on earth as can be seen on Millennium Development Goals (MDGs). Sachs (2005a) examines the amount of ODA provided by the United States (U.S.) from 2002 to 2004 by analysing data from Organization for Economic Cooperation and Development (OECD) to understand the relevance of U.S. contribution providing global fund for MDGs achievement, particularly in comparison to other Development Assistance Committee (DAC) countries. He argues that U.S. ODA in proportion to Gross National Income (GNI) was insufficient and far from its commitment. He suggests U.S. to increase their ODA more than three times by 2006 and more than four times by 2015 compared to the level in 2003. He also suggests a rough structure of how the U.S. ODA must be allocated which mainly aims to increase its effectiveness. This paper will argue that, while more aid and better allocation is truly important for development in impoverished countries, but there are some more issues that have to be considered to make the aid effective in achieving the goals. Sachs maintains his line of thinking that more aid will create growth, and growth will result in less poverty. By maintaining that linier thinking, he will not convince his audiences, particularly the U.S. Government, to devote more development aid.

This paper will start by reviewing Sachs’s linier thinking which can be divided into two parts i.e. more aid creates growth, and growth makes less poverty. Followed by examination of those two parts of linier thinking by confronting with arguments from other experts. Before come to conclusion, this paper will discuss the broader perspective on understanding poverty, to contrast it to Sachs’s linier thinking.


Sachs’s Linier Thinking

The U.S. is one among other 191 MDGs signatory countries and one among 24 DAC countries who assist partners to alleviate poverty and achieve MDGs. The U.S. provided between 21 to 26 percent of total DAC ODA from 2002 to 2008 which made them the highest contributor (OECD 2008). However, the United Nations (U.N.) does not measure the donor countries contribution from its proportion to total ODA, it is measured by the proportion of ODA to the GNI of the respective donor country. The U.N. targets for developed countries to devote 0.7 percent of their GNI to ODA (OECD 2009). In this point Sachs argue that U.S. and DAC countries provide inadequate ODA from its commitment as well as from the actual need to achieve MDGs. According to his calculation, the world needs double amount of ODA by 2006 and almost triple by 2015 compared to the level in 2003.

Sachs believes more aid is needed to close the “financing gap” in impoverished countries, the aid would create growth which in the end will alleviate poverty (Sachs 2005a, pp.85-89). This typical way of thinking can be observed from other Sachs publications (e.g. 2009, 2007, 2005b). Sachs argues that poverty trap happened because impoverished countries are poor on human capital and infrastructure. However, their household and the government do not have sufficient funds to close the gap. They can barely ensure their survival and do not have addional funds to invest for the future. They face the problem of a “financing gap”, the development aid can fill that gap. The development aid can be used to close the financing gap for investment on infrastructure and human capital, that investment will empower people and create more economic opportunities which then will take poor households out of the poverty trap.


More Aid Doesn’t Necessarily Create Economic Growth

Sachs may make his point that investment in physical infrastructure will create growth. Studies conducted by Ghosh and De (1998) and their other publication (Ghosh and De 2004) tell us that physical infrastructure attract more factors of production to work to create higher level of outputs, income, and/or employment and it become highly significant factors in contributing to development. In economic theory, the higher level of output is identical to economic growth. Similar finding also come from Alicia H. Munnell who examined the impact of infrastructure on economic growth. She concludes that ‘public infrastructure investment has a significant, positive effect on output and growth’ (Munnell 1992, p.197).

However, an earlier study by Cassen (1986) which assessed the impact of development aid for World Bank and International Monetary Fund, concludes that different studies come to quite different conclusions. ‘They range from positive to strongly negative affects’ (Cassen 1986, p.25).

The sharpest critic to Sachs linier thinking on “aid creates growth” is probably William Easterly. Easterly (2001, pp.34-44) argued that the approach of “closing the financing gap” simply create perverse incentives for recipient country. They will not devote the aid inflow for investment, the recipient countries will just use aid to buy more consumption goods, and they will maintain the gap as it later on will be closed by donors any way. If the recipient countries would not make investment from their own resources then they will treat the aid inflow in the same way. Therefore the aid would not create growth because it would not be used for investment. The real challenge here is how to create right incentives to ensure that the aid inflow is used for investment.

In his book, Easterly calls this phenomenon “the financing gap forever”. Easterly’s argument on financing gap forever makes the case in Indonesia. Indonesia maintains its position in top five on DAC ODA recipient countries since 1986 to 2007 as can be seen from OECD statistical data (OECD 2009). Anis Chowdhury and Iman Sugema examined the impact of aid effectiveness in Indonesia. They found positive correlation between the aid inflows with the economic growth though it was low. However, Indonesia becomes an aid-dependence country that always wants to follow the balanced budget principle by seeking foreign aid to close the financing gap. The “closing financing gap” approach has made government lazy to be creative on domestic resources mobilization (Chowdury and Sugema 2005, p.186)

More evidence come from Kraay and Raddatz (2007) who examined the cause of poverty trap by testing the two canonical mechanisms: low saving and low levels of productivity at low levels of development in Africa. They found little evidence of the existence of poverty traps based on the two mechanisms. It tells us that the argument that more aid will create sustained increases in growth is doubtable.

It can be concluded here that it is true that growth need more investment on infrastructure and human capital. However, the development aid is not necessarily used for those productive investments if there is no right incentive for recipient countries to use it in a proper way.


Economic Growth Doesn’t Necessarily Make Less Poverty

In this second part of Sachs’s linier thinking of “economic growth makes less poverty”, Sachs has more supporters from development economist even including William Easterly. Although Easterly criticises “aid create economic growth” but he agrees very much with Sachs on “economic growth make less poverty”. Easterly influenced by data collection by his World Bank’s colleagues Martin Ravallion and Shaohua Chen on spells of economic growth and changes in poverty covering the years 1981 to 1999. After summarizing the data, Easterly concluded that ‘fast growth went with fast poverty reduction, and overall economic contraction went with increased poverty’ (2001, p.13).

Before having further discussion on “economic growth makes less poverty”, this paper will clarify the definition of “economic growth”. Encyclopaedia Britannica Online (2010) defines economic growth as the growth of total output of goods and services. Thus, if there are more goods and services produced and exchanged in the market, does that necessarily result in the less poor? Economic growth is something happening in the market while poverty is in the household. It is true that households are player in the market, but which households are in the market and which are still remining outside the market which means remaining poor?. It is very clear here that economic growth can not detect poverty.

Thus, how about the data examined by Easterly that convinces him that economic growth has correlation to less poverty, Paolo Verme has better explanation for this. Verme (2010) examined macro and micro regional data related to high rate economic growth and household income in Kazakhstan of 2001 and 2002. Verme distinguish between output growth which identical with economic growth and household income growth. He concluded that household income growth is the one that contribute to poverty alleviation, not the output growth. He found no positive and significant correlation between output growth and poverty reduction. Verme can come to this plausible conclusion because he didn’t rely to macro data of GDP only. He prepared GDP data disaggregation by sector and by regions as addition to micro data of household income. He argues that household income growth is the pro poor growth with contributing sectors that are different from contributing sectors to output growth. Pro poor growth means that the growth happened in household and it has been higher for poorer households, which explains why poverty has declined and why it has declined more for the poorest among the poor.

The concern of growth should no longer to “if” but rather to how the growth trickles down the poor, while output growth does not always trickle down the poor (Verme 2010, p. 19). The growth can happen without the poor involved in production and market, while the output can grow with or without the poor. Therefore, the future economic policy should not focus only to output growth. It should commit to the pro-poor growth policy.


Poverty Covers Multidimensional Spheres

Sachs (2005, p.88) emphasizes two major investments to achieve the MDGs, they are: infrastructure and human capital. It is nice that he mentions human capital and not too narrow to infrastructure. Sachs defines human capital as ‘healthy population with adequate levels of literacy, education, and job skills’ (2005, p.85). The explanation is very clear that infrastructure without human capital will not optimally work as production factors in economy, and after all, human capital is a basic human right.

However, poverty is not only about lack of human capital and lack of infrastructure. It is broader than that. The Nobel Prize-winning Amartya Sen has strong argument on this with his “capability” theory. Sen defines capability as ‘a person has, that is, the substantive freedoms he or she enjoys to lead the kind of life he or she has reason to value’ (Sen 1999, p.87). Therefore he defines poverty as capability deprivation rather than merely as lowness of incomes, let alone economic growth.

Goenner et al. (2007, pp.2-5) elaborate Sen’s capability theory combined with other model such as the sustainable livelihood approach (SLA) on multidimensional poverty assessment model called nested spheres of poverty (NESP). They argue that poverty is a lack of many things, starting from insufficient income, vulnerability in basic needs, up to the lack of freedom and options for a better future. In other sense, poverty can be very subjective such as the feeling of deprivation. The NESP’s spheres reflects causal link from the most out layer into the very core within its disc model. The bottom line is again that poverty cannot be handled only by economic growth and/or income improvement.


Conclusion

More aid funding is important, but aid funds alone will not help to alleviate world poverty. Aid inflow can be simply used by recipient countries for consumption expenditures rather than investment without any clear incentive policy, which means that aid inflow would no create growth. However, even if it is used for investment and it creates growth, it does not necessarily means less poverty if we do not pay attention to the multidimensional spheres affecting poverty. Poverty alleviation and MDGs achievement in general need comprehensive intervention. An effective pro poor policy must be applied. Donors and recipient countries must understand the characteristic of the poor so they can design an effective policy which will provide turmendous opportunities for the poor to get out from the trap by them self. A searcher attitude is more useful than the planner.

Sachs will have more opportunity to convince his audiences, not only the U.S. government as his main target, but also his critics and peoples who work as grass roots development activists to support him to advocate for more development aid if he broadens his arguments on aid effectiveness and strategy to achieve MDGs and alleviate world poverty.

References

Cassen, R 1986, Does aid work?, Clarendon Press, Oxford.

Chowdhury, A & Sugema, I 2005, ‘How significat and effective has foreign aid to Indonesia been?’, ASEAN Economic Bulletin, vol. 22, no. 2, pp. 186-216.

Easterly, W 2001, The elusive quest for growth: economists' adventures and misadventures in the tropics, MIT Press, Massachusetts .

Encyclopaedia Britannica Online 2010, ‘Economic growth’, Encyclopaedia Britannica eb.com, viewed 14 February 2010,

<http://www.britannica.com/EBchecked/topic/178400/economic-growth>.

Ghosh, B & De, P 1998, ‘Role of infrastructure in regional development: a study over the plan period’, Economic and Political Weekly, vol. 20, no. 3, pp. 3039-3043.

Ghosh, B & De, P 2004, ’ How do different categories of infrastructure affect development? evidence from Indian States’, Economic and Political Weekly, vol. 39, no.3, pp. 4645-4657.

Gönner, C, Haug, M, Cahyat, A, Wollenberg, L, De Jong, W, Limberg, G, Cronkleton, P, Moeliono, M & Becker, M 2007, ‘Capturing nested spheres of poverty: a model for multidimensional poverty analysis and monitoring’, Occasional Paper No. 46, Center for International Forestry Research, Bogor.

Kraay, A & Raddatz, C 2007, ‘ Poverty traps, aid, and growth’, Journal of Development Economics, vol. 82, no. 2, pp. 315-347 .

Munnel, AH 1992, ‘Infrastructure investment and economic growth’, Journal of Economic Perspectives, vol. 6, no. 4, pp. 189-198.

OECD 2008, Net official development assistance in 2008: preliminary data for 2008, Organization for Economic Co-Operation and Development, viewed 13 February 2010,

<http://www.oecd.org/dataoecd/48/34/42459170.pdf>.

OECD 2009, OECD factbook 2009: economic, environmental and social statistics, Organization for Economic Co-Operation and Development, viewed 13 February 2010,

<http://lysander.sourceoecd.org/vl=4785723/cl=18/nw=1/rpsv/factbook2009/10/03/03/index.htm >.

Sachs, JD 2005a, ‘The development challenge’, Foreign Affairs, vol. 84, no. 2, pp.78-90.

Sachs, J 2005b, The end of poverty, Penguin Press, New York.

Sachs, JD 2007, ‘Take the guesswork out of aid to African countries’, Financial Times, 2 March, p.17.

Sachs, JD 2009, ‘Homegrown aid’, International Herald Tribune, 10 April, p.6.

Sen, A 1999, Development as freedom, Alfred A. Knopf, New York.

Verme, P 2010, ‘ A structural analysis of growth and poverty in the short-term’, The Journal of Developing Areas, vol. 43, no. 2, pp.19-39.


06 February, 2010

The Connectivity Policy and Its Relevance to East Kalimantan Context

When I was in GTZ national staff exchange to Himachal Pradesh (HP), India, I heard about “connectivity policy” applied by Indian government. It is the policy that aims to ensure all villages are connected to the capital of the state by road. I visited a small settlement located in the couple of hills behind the capital of HP, Shimla, which was connected by road. I should explain here that the level of difficulty of road construction is high as it is in the high side of hill, and interestingly, it is a small settlement where only few households are there, which we might think that it is not economically efficient for the road construction. However, the road is still constructed though it is just a gravel road.
At that time I thought that it is an interesting policy, particularly for East Kalimantan where some villages are even not connected to the capital of district. In terms of outcome based management, instead of keep talking about road construction only, let’s measured that effectiveness by counting the percentage of villages that connected by road to the capital of district.
Now I started to learn about economic in introductory program in ANU. The lesson is actually just the basic of economic way of thinking. But I just realized that I wasn’t aware about that before.
The main lessons is that when society create larger market which indicated by more quanityty demanded and supplied in ‘relatively’ free market, the benefit to society (or in economic jargon called as “total surplus”) will be increase although that the new equilibrium price may higher than the previous one. Why is it like that? The answer is simple: because more consumers who able purchase the products and services they need, and more producers who produce and able to sell their products and services. Both producers and consumers (society) are in better off.
Thus, how to make more demand and supply? The very basic theory of demand and supply said it is “price” that whill change the quantity demanded and supplied, and what they call as “non price determinant” that will change the demand and the supply. In demand, there are six non price determinant i.e. income, consumer taste, price of substitute, price expectation, price of complement, and number of customers. Meanwhile, there are five non price determinant factors in supply i.e. technology, price of factors, price of alternative goods, price expectation, and number of producers.
Now I come to the main point which is connectivity. I believe that connectivity is the most influencing factors to those non price determinants both for supply and demand. Connectivity as part of the public infrastructure outcome can create more investment, employment and private sector output (Munnell, 1990), and more public infrastructure can help to alleviate poverty (Buddhadeb & De, 1998). President Yudoyono also believe that if he make double spending in infrastructure, to $140 billion during his second presidency, it will help him boost economic growth to 7% by 2014 from an estimated 4.3% last year (Kate & Sukarsono, 2010). It means connectivity can create more income and more number of consumers, which at the end increase consumer demand. Connectivity can decrease the transport cost of producers (price of factors) and it can also increase the number of producers coming to the market, which at the end increase the supply.
If we look at the geographic of East Kalimantan connectivity can be achieved either by road, water or air. However, the most reliable and efficient way is road because it cost peoples less and relatively independent from the weather. Although road construction is more expensive in the investment but it will cost society less than air and water.
Public infrastructures such as roads and bridge demand a lot of money. However, East Kalimantan region has more than US$ 200 million per annum beside deconsentration and assistance fund from central government. Therefore, it is very difficult to accept the fact that from time to time local governments in East Kalimantan, included the province government, spent the budget much less than the plan. In 2007, governement spending was just 78% from its planned, while in 2009 most likely not reach 70% because the report per mid of December 09 shows the spending was just 65%. Whereas there are many villages are still not well-connected to the centre and the poverty is still more than 15% (I even beleive the figure is more than 30% particularly in districts). I would suggest to the governor and all mayors in East Kalimantan to prove to public that they are capable to spend the public budget wisely which means spend the planned amount for the strategic activities and programs which will bring the welfare to the society. Only by that way, East Kalimantan can push central government to review the fiscal decentralization policy in order to have more public budget in the region.

Bibliography
Buddhadeb, G., & De, P. (1998). Role of Infrastructure in Regional Development: A Study over the Plan Period. Economic and Political Weekly , Vol. 33, No. 47/48 , 3039-3043+3045-3048.
Kate, D. T., & Sukarsono, A. (2010). INDONESIA: UNFINISHED HIGHWAY TO GROWTH. New York: Business Week.
Munnell, A. H. (1990). How Does Public Infrastructure Affect Regional Economic Performance? New England Economic Review , 11-22.
Badan Pemeriksa Keuangan Republik Indonesia/Indonesia's Supreme Audit Institution (2008). Audit Report to Financial Statement of The Province Government of East Kalimatan Fiscal Year 2007.

02 February, 2010

The Development Challenge: A Summary

Sachs argued the role of United States wasn’t sufficient to help poor countries to meet their Millennium Development Goals (MDGs). It was not only because inadequate amount of Official Development Aid (ODA) fund provided, but also because the allocation didn’t support the MDGs directly. Sachs found that $11.8 billion out of $14.6 billion of total U.S. bilateral aid in 2003 were allocated for things that are not directly build long term economic change in impoverished countries. Of the remaining $2.8 billion very little used for transformational development that he believes would support poor countries to escape dependence on outside aid. Ironically, the perception of U.S. peoples about their development aid was much more than what actually they give. Moreover, the U.S. government often couldn’t meet their own promise to provide adequate amount of ODA fund.

Sachs argued that the poor countries will meet the MDGs if they invest more in infrastructure and human capital. However, the ability of their households and government budget is far from sufficient.

Sachs suggested four steps to make U.S. become the world leader on international development to achieve MDGs: make U.S. peoples realize the actual amount of money they spent for ODA, increase the U.S. fund to contribute to achieve MDGs according to international agreement, restructure the ODA allocation so the proportion is directly support MDGs, transformational development, and the Millennium Challenge Account scheme, and finally to adjust the U.S. development assistance program so they can synergize their development aid and national security concern.

Detail of paper:
Title: The Development Challenge
Author: Jeffrey D. Sachs
Journal: Foreign Affairs (March/April 2005)