On the Investment-inducing Effect of ODA

SAWADA Yasuyuki
Faculty Fellow, RIETI

Not only a rapidly growing China but also those countries in South Asia and Africa that have long been considered to be trapped in poverty are beginning to see signs of steady growth. Against this backdrop, some people are questioning why Japan needs to provide official development assistance (ODA) at a time when the country is facing its own fiscal crisis. At the same time, however, the fact that 163 countries and regions offered assistance to Japan in the wake of the March 11, 2011 earthquake made many people re-appreciate the value of its overseas assistance to date. What should constitute Japan's ODA program in the coming years?

In his paper contributed to the American Economic Review in 1986, Professor William Baumol of New York University pointed to the coexistence of countries catching up with advanced economies and those lagging increasingly behind in the postwar world economy. Over the subsequent quarter-century, countries' relative economic positions have changed drastically. China, which was one of the poorest countries in the 1950s, has reached the level of middle income countries in terms of gross domestic product (GDP) per capita. The East Asia and Pacific (EAP) region has also achieved remarkable growth. In their paper published in the Quarterly Journal of Economics in 2010, Shaohua Chen and Martin Ravallion, both of the World Bank, showed that the poverty rate in the region dropped from about 80% to 20% in the past 25 years (see Figure).

Figure: Population living below $1.25 a day (%) Figure: Population living below $1.25 a day (%)

In Sub-Saharan Africa, there are signs of sustainable declines in the proportion of people living in poverty. According to the World Bank, Africa, a region that has been considered to be plagued with famine, conflicts, and corruptions, achieved 4.9% growth in 2011. Some attribute this to growing global demand for natural resources abundant in Africa, but non-resource-rich countries' growth is just as remarkable.

In their paper "Explaining African Economic Performance" published in 1999, Paul Collier and Jan Willem Gunning, then professors at the University of Oxford, cited "a lack of openness to trade," "deficient public services," and "high aid dependence" as the causes of slow growth in Africa. However, as Edward Miguel, professor at the University of California, Berkeley, pointed out in his book Africa's Turn? published in 2009, these problems were mitigated over the years and, as a result, foreign direct investments (FDIs) began to flow into African countries, invigorating their domestic economic activities.

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South Asia has also posted strong growth, 6.6% in 2011. Bangladesh, a country that has been ranked among the poorest in all social indicators including infant mortality, is a typical example showcasing such successful transformation. As a result of economic growth, the school attendance rate for girls at the primary and secondary levels exceeded that for boys, while the population growth rate, which used to be so high as to pose the risk of "population explosion," declined dramatically. According to a survey conducted in 2011, the total fertility rate (TFR)—i.e., the average number of births per woman—in Bangladesh stood at 2.3, compared to 5.1 in 1989.

Tetsushi Sonobe, professor at the National Graduate Institute for Policy Studies (GRIPS), and his co-author point to the garment industry for exports as the driver of high economic growth in Bangladesh, noting that the aggressive import of excellent human resources and technologies from overseas is what has supported the remarkable development of the industry. Research conducted by Mushfiq Mobarak, associate professor at Yale University, and his co-author also found that by offering an increasing number of jobs for women, the garment industry has effectively changed people's behavior in educational investment, resulting in a rapid increase in the school enrollment of girls.

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At a glance, such economic growth appears to be a private sector-led accomplishment. However, we cannot ignore the presence of physical infrastructure as a foundation for economic activities and the role of ODA that provides financial and technical support therefore. Do actual data support the view that ODA has been contributing to the economic growth of recipient countries?

In their paper published in 2000, Craig Burnside and David Dollar (both of the World Bank at the time) reported that ODA has a positive impact on growth in recipient countries only when their economic policies are good. This, however, sparked controversy, and their argument was subjected to rigorous reexamination and strong criticism by some other researchers including William Easterly, professor at New York University, and Raghuram Rajan, professor at the University of Chicago.

No consensus has since emerged on ODA's impact on economic growth, and there exist two conflicting sets of research findings, those that endorse the effectiveness of ODA and those that do not. This situation has been described as "anarchy" by David Roodman, senior fellow at the Center for Global Development, a think tank in the United States.

The failure of academic research to produce consistent findings may be attributable to the fact that the heterogeneity of ODA is often disregarded in statistical analysis underlying the findings. ODA is provided in three different forms—i.e., grants, loans, and technical assistance—and, presumably, each has a different impact. In addition, the degree of economic development in the recipient country and regional peculiarities also affect the effectiveness of assistance. Or it may be the case that it is difficult in the first place to measure the impact of ODA alone because it is just one of many types of capital and resource transfers from developed to developing countries, which also include foreign direct investments (FDIs) and remittances by migrant workers to their home countries as well as bank loans and indirect investments.

In this regard, a paper published in 2010 by Hidemi Kimura of the Ministry of Finance and Yasuyuki Todo, professor at the University of Tokyo, has interesting suggestions. By analyzing data on ODA and FDI flows, they found that Japanese ODA has what they call a "vanguard effect," meaning that Japanese aid promotes FDI from Japan to the recipient developing countries by enhancing information sharing and reducing investment risk through close cooperation between the government and the private sector. They suggested that the presence of such a mechanism might have accelerated the economic growth of recipient countries. Sung Jin Kang, professor at Korea University, and his fellow researchers conducted follow-up research using South Korean data. They found that South Korean ODA has an even greater FDI-promoting effect than Japanese ODA.

Another purpose of ODA is to help improve the productivity of recipient countries by transferring technologies and knowledge. Various kinds of assistance have been extended to assist developing countries in such areas as education, medical services, and administration, in addition to helping them increase production in the manufacturing and agricultural sectors. In my paper coauthored with Kimura and published earlier this year, we showed that, along with international trade and FDIs, such assistance contributed significantly to technological transfers.

These findings point to the importance of enhancing complementarity between ODA and private-sector funds and resources including FDIs. Thus, going forward, collaboration between the government and the private sector should be promoted in broad areas, particularly in infrastructure development.

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Since 2000, ODA has been implemented with an aim to achieve the Millennium Development Goals (MDGs; see the Keyword section), a set of development and poverty reduction goals, by the target year of 2015. However, over the course of those years, there has been a significant change in the world map of development. In 2010, South Korea became a member of the Development Assistance Committee (DAC) of the Organisation for Economic Co-operation and Development (OECD). Meanwhile, emerging economies such as China, India, and Brazil, which have yet to graduate from the list of ODA recipients, are increasingly acting as emerging donors (see the Keyword section), providing assistance to least developed countries (LDCs).

While various types of new "emerging" donors are rising in their presence, Japan, which was once the world's biggest donor, seems to be fast losing its presence due partly to its fiscal straits. However, now that Japan's ODA budget is shrinking, it is all the more important to take this opportunity to improve the quality of its assistance by selecting and focusing on such areas as the environment and disaster prevention where the country can capitalize on its own experience.

Japan has two keys to achieving success with its ODA in the future. First, ODA should be defined as a lubricant to facilitate economic growth and poverty reduction through private-sector investments, thereby serving as a means to bring benefits to both Japan and recipient countries. Second, ODA should function as a mechanism for avoiding the impact of various great risks that may arise in the world. For instance, ODA should be utilized to prevent the livelihood of poor people getting affected, for instance, by the ongoing economic crisis in Europe or climate changes and the resulting potential hazards such as the spread of infectious disease and/or natural disasters. Developing an effective strategy that can address these needs will be crucial if Japan is to take a lead in promoting development goals in the international community in the post-2015 process.

>> Original text in Japanese

* Translated by RIETI.


  • [Millennium Development Goals (MDGs)]
    This refers to the eight sets of global poverty reduction targets designed to materialize the United Nations Millennium Declaration adopted in September 2000. The MDGs include specific targets that must be achieved by 2015 in such areas as reducing the number of people living in poverty, achieving universal education, promoting gender equality, improving child and maternal health, and achieving environmental sustainability. With the target year of 2015 approaching, there have been active academic and policy debates on post-2015 targets.
  • [Emerging donors]
    Among the OECD members, Japan, the United States, and other advanced economies belonging to the DAC have been the primary providers of ODA. Emerging donors refer to those other than such traditional donors. They are not required to abide by such rules as those promoted by the OECD/DAC for harmonizing donor practices for effective aid delivery, and insufficient information disclosure by those non-traditional donors has been pointed out as a problem.

August 20, 2012 Nihon Keizai Shimbun

October 3, 2012

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