From the decline in export revenues and remittances to the fall in capital inflows, developing economies are being hammered by the global economic crisis.  At a time when an increase in aid is badly needed, it may well decline amid deteriorating fiscal conditions in donor countries. The poorest aid-recipient developing countries in Africa and elsewhere are particularly vulnerable to this possibility. In light of the potential fall in aid, development partners need to honor existing commitments and set up additional contingency funds, while vulnerable countries need to prepare for the possibility of decline.

Vulnerability in Sub-Saharan Africa

The global economic slowdown has further stressed the fiscal conditions of many developing countries, particularly in Africa. Real GDP in developing countries, excluding China and India, is expected to contract by 1.6 percent in 2009,  from an increase of 4.5 percent in 2008. In Sub-Saharan Africa, growth is expected to slow to a mere 1 percent in 2009,  down from 4.8 percent in 2008, and budget deficits as a share of GDP are now expected to rise by 4.7 percent on average in Africa in 2009.  Independent of any change in aid, these countries have clearly been hurt by the crisis.

Any fall in aid will only exacerbate these problems. Several African countries depend on foreign aid to finance basic needs and social protection programs. Aid accounted for 42 percent of GDP in Mozambique in 2008, and amounts to more than 10 percent in Burundi, Malawi, Guinea Bissau, and Rwanda. Official development assistance (ODA) is also the main source of funding for most UN agencies, which provide services to many of these same countries. It accounted for more than 70 percent of the UN Children’s Fund (UNICEF) budget in 2007.

Commitments Already Below Target

Donor countries already have several long-standing aid commitments to meet. Beginning in 1970, members of the OECD Development Assistance Committee (DAC) promised to provide 0.7 percent of their national incomes in aid annually. At Gleneagles in 2005, the G7 countries promised to double aid to Africa by 2010—an increase of about $21.5 billion.

At a time when an increase in aid is badly needed, it may well decline.

However, few countries have honored these commitments to date. OECD members gave only 0.3 percent of their national incomes in aid on average in 2008, well below the 0.7 percent target set by the UN. Only Sweden, Norway, Denmark, Luxembourg, and the Netherlands reached 0.7 percent or more. The OECD assessment of donors’ spending plans through 2010 indicates that, even if expected increases are taken into account, the 0.7 percent target will still not be reached (see graph). Similarly, by the end of 2008, only $7 billion had been added in aid to Africa, making the goal of a $21.5 billion increase by 2010 increasingly unlikely.

Aid to developing economies is needed now more than ever.  As fiscal conditions in donor nations deteriorate, evidence suggests that aid will soon fall, but existing aid  commitments must be honored to stave off catastrophe.

Aid Uncertain

While aid has yet to honor promised increases, aid flows in 2008 and 2009 did hold steady at pre-crisis levels. Because aid budgets were set prior to the financial crisis, a time lag is inevitable before they get squeezed.

However, the crisis did shift priorities dramatically and aid budgets, like any other budgets, will soon be subject to revision. Far from increasing aid to finally meet existing commitments, these potential disruptions would further decrease the already below-commitment flows.

To date, few countries have honored their foreign aid commitments.

Moreover, diminished growth in 2008 and economic contraction in 2009 will by definition reduce the value of aid commitments, which are often expressed as a percentage of the national income of donor countries. The overall GDP of advanced economies is set to decline by 3.8 percent in 2009.  Therefore, simply maintaining current levels of aid in real terms would require the unlikely allocation of an even greater share of GDP to aid in this time of crisis. 

Some countries have already cut their aid budgets. Ireland has cut nearly $315 million (a 22 percent decline) from its 2009 aid budget, and Italy announced aid cuts of 56 percent.

Aid Fell During Past Crises

Experience suggests that, in the years following a financial crisis, donor countries that were affected by the crisis respond by significantly reducing their aid budgets. For example, after the Nordic banking crisis of 1991, Finland’s aid contracted by more than 60 percent, and Norway and Sweden also reduced their aid budgets significantly.

Experience also suggests that ODA levels tend to recover very slowly after such reductions—it took Sweden six years and Norway nine to recover to their pre-crisis aid levels, while Finland still lags its pre-crisis flows. Using a sample of fifteen donor countries from 1980 to 2004, one study found that a 10 percent increase in the ratio of public sector debt to GDP is associated with a decline of 0.012 percent in the share of aid in GDP in the short run and 0.023 percent in the long run. This suggests that the full effect of an increase in public debt on aid is not seen in the short term, as the long-term impact is much larger.

The budget deficit is set to reach 11.2 percent of GDP and 13.9 percent of GDP in the United Sates and the UK, respectively, by the end of this year.1  These crisis-induced deficits, on top of concerns about long-term debt sustainability due to rising healthcare and other costs, are likely to deter higher spending on aid, particularly in the long run. 

Private Aid Hit Hard

Private aid has emerged as an increasingly important player in financing development in poor countries. U.S. international aid from corporations, foundations, charities, and individuals totaled about $36.9 billion in 2007—more than 1.5 times the aid provided by the government that year. However, the downturn in the economy has hammered private foundation endowments. U.S. charitable foundations lost $150 billion in assets in 2008. As a result, it is predicted that 100,000 non-profit organizations that depend on foundations for funding in the U.S. will disappear over the next two years.2  In addition, because of difficulties in operating oversees and worsening economic conditions at home, many foundations may choose to cut assistance abroad over cutting it at home.

The full effect of an increase in public debt on aid is not seen in the short term; the long-term impact is much larger.

Policy: Now is Not the Time to Reduce Aid

While the effects of the crisis on aid levels are still difficult to discern (the budgets being administered now were set previously and there are long reporting lags), econometric analysis, case studies, and anecdotal evidence suggest that aid will be hit soon.

Given the potentially dire consequences of such a fall, donors must work to honor their commitments. In addition, they must take special care to ensure that safety nets and humanitarian aid are sustained and, if possible, strengthened. Increasing aid would help address worsening poverty in poor countries that had no role in causing the crisis, and is justified on moral grounds. Furthermore, aid would also contribute to raising global aggregate demand, help protect investment and future growth in poor countries, lessen the pressure for migration, and limit the potential for civil unrest. Reducing aid, on the other hand, could prolong the crisis in the poorest countries—particularly in Africa—as the rest of the world recovers, thus setting back the global fight against poverty.

Recipient nations cannot simply depend on donors to make changes.

Responding to the crisis, the World Bank, the IMF and regional development banks have already stepped up their efforts. With the G20’s approval, the IMF is currently using gold sales to increase its lending capacity and to support additional financing to the world’s poorest economies. Though these efforts are helping to mitigate the effects of the crisis on aid right now, significant risks lie ahead. Because of spending and reporting lags, the true impact on aid may not be known until it is too late to respond. As a result, these organizations must continue to set up additional funds right now to meet the needs of vulnerable countries.

At the same time, recipient nations cannot simply depend on donors to make changes. They too have a heightened responsibility in this economic climate. African countries must step up their efforts to spend more efficiently and must better promote their exports through value addition, among other things. However, these adjustments must—and can—avoid cutting back on social spending. Clearly the choices will be hard, but they are necessary.

1 Country Data, Economist Intelligence Unit
2 “Charities move towards caution as recession bites,” Financial Times (April 12, 2009).