Absorptive Capacity for Increased Official Development Assistance Mick Foster

Definition of Absorptive Capacity Constraint? The full value of aid committed and available for spending within a given period can not be disbursed while achieving an acceptable level of benefits. Comments: No absolute limit on how much can be spent The problem is ensuring it achieves something Aid can always be absorbed by reducing taxes or borrowing- & sometimes that will be good use of aid

Aid and Local Costs

Evidence on Absorptive Capacity 1- Econometric Studies Most (but not all) studies find evidence of diminishing returns to aid at high aid:GDP ratios Some evidence that countries with better policy and institutional environments delay the onset of diminishing returns

Evidence on Absorptive Capacity 2- Country Experience Successful aid graduates grew out of high aid dependence while sustaining growth (e.g. Taiwan, Botswana) Mozambique, Uganda reconstruction cases combined high aid levels and rapid growth

Empirical Evidence 3- Aid has fallen! 1.Need 50% increase to restore 1990 real p.c. aid. 2.Terms of trade losses also increased need for aid. 3.Much higher aid could easily be absorbed in South Asia- where aid is low, has fallen steeply, there are more people living on less than $1 per day than in Africa, and will still be after 2015.

Potential Causes of Absorptive Capacity Constraints Donors Macro-economic constraints (Dutch Disease) Declining marginal returns to aid-financed public expenditure Limitations of management and administrative capacity Sustainability concerns Failing states (not discussed)

Donors Problems Solutions 1.Too many projects & donors 2.Parallel procedures 3.Conditions prevent disbursement 4.Unpredictability of donor support 1.GBS, SWAPs, donors specialise 2.Use Govt procedures 3.Use institutional assessments & track record, not promises 4.Provide disbursement schedule in advance

Good Aid Practice Strong in-house planning, budgeting, appraisal capacity Govt makes allocation decisions on domestic and foreign resources, strong central direction Examples: Taiwan, Botswana, Uganda Contrast with 7000 projects listed in Tanzania GBS/SWAPs & Govt procedures will help absorb aid sensibly- but also needs a light hand & room for Govt decision-making

Dutch Disease Problem: Aid inhibits growth in traded goods and services sectors. Cause: Increased aid without increased forex demand reduces international competitiveness, usually through real exchange rate appreciation. Consequences: may damage long-term development if traded sectors are particularly important e.g. because of technology transfer. Empirical evidence: some claimed in cross- country econometrics and country cases- but the evidence & the policy significance is disputed.

Policy Responses 1- Dutch Disease Innocent till proven guilty- monitor real exchange rate, relative price trends, growth Focus on relieving supply bottlenecks Offsetting tax and regulation measures Could reduce tax, reduce debt instead of increasing spending Trade off- but needs strong assumptions before refusing aid looks sensible

Diminishing Returns to Public Expenditure? IssuePossible Response 1.Marginal returns in short-run will usually be below average returns. 2.Govt crowds out private expenditure (credit, labour, non-tradeables). 3.Projects lead to unsustainable & unbalanced budget. 1.Inevitable. Use planning, appraisal, sequencing to ensure adequate returns. 2.Crowding in (education, infrastructure), phasing major infrastructure. 3.Broad-based budget with appropriate mix of donor instruments.

Limited Public Sector capacity 1.Human resources- especially in remote areas where the poor live 2.Weak institutions of accountability 3.Mobilising communities for sustainability, versus big push for Targeting dilemmas 1.Capacity Building, incentives, changed skill mix, partnerships 2. Transparency, community control, readiness criteria with independent verification 3.Real dilemmas on e.g. water & sanitation 4.Focus on narrow preventive & promotive health interventions for all?

Absorptive Capacity & Sustainability Little point in big boost for 2015 goals if benefits not then sustainable Countries reluctant to become more dependent on donors for e.g. salaries, consumables Donor support is volatile & fickle- so countries may choose not to use aid to build public sectors that will require long-term aid to maintain

Africa can sustain higher aid financed spending Stylised Illustration SSA GDP $Bn Population, mn Revenues,$bn Aid Doubles Aid $Bn Spending $bn Spend p.c.$67$91 $109

-but some major countries remain dependent: Ethiopia example GDP Popn Revenue Spending p.c Revenue p.c Aid p.c Aid $mn

Summary Conclusions 1.Much higher Aid p.c. achieved high returns in 1990s- so no reason for absorption constraint. 2.Proliferation of donors, projects, procedures fragmented in every sector is (the?) major cause. 3. Successful aid supports Govt plans & budgets. 4.Countries can raise absorption by better planning, management, prioritisation, capacity building, & procedures. 5.TA if needed should be under Govt control. 6.Sustainability needs credible long-term commitment.