Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa (12 page)

Implicit in the proposals that follow are financing solutions that have their roots in the free-market system. This invites the question: is it possible for a government to raise money in a free-market way and spend it on a socialist agenda (for example, provide free education and healthcare)? The answer is yes: Sweden, Denmark and Norway are just three examples. Whatever the social, political and economic ideology a country chooses, there is a menu of financial alternatives (all better than aid) that can finance its agenda.

Can a government use free-market tools and still maintain its core socialist values? The answer is not only yes, it can, but, perhaps more importantly, it has to. And even when a government finances itself using socialist-like tools (for example, high taxes), it must still rely on some market-based financing tools in order to successfully achieve its economic goals.

The fact of the matter is, governments need cash. This is true regardless of political leanings – whether a socialist government, which endeavours to provide all goods and services to its citizens, or a more market-driven government, which relies on the markets to provide some public goods (that is, goods and services for which there is a broad public benefit, but for which no one person bears the cost, like, again, a lamppost).

Perhaps nowhere is the role of government more crucial – as a strategist, as a coordinator and even, to some extent, as a financier – than in poor developing countries. For at the early stages of development, the nascent private sector is simply not large enough to assume a central developmental role. Traditionally, this is where aid stepped in. But, as this book has argued, aid has not delivered any meaningful or substantial economic performance. Even if it were true that aid had contributed to economic growth, there are two compelling reasons why Africa should seek alternatives to finance its development.

The donors are growing weary. As shown earlier, over the past twenty years foreign aid to Africa has been on the decline. Whether it is because donors don’t believe it works, they don’t have the cash or they simply don’t care, the fact remains that the donors’ African aid purse is slowly shrinking.

Despite the outpourings of Live 8, one survey found that the US public’s desire to reduce foreign aid outranked its fear of nuclear war. In a 1980 poll 82 per cent of respondents said foreign economic assistance should be cut.
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This may, at least in part, explain why, when it comes down to it, most donor countries have failed to meet their pledges of 0.7 per cent of GDP made in Monterrey in 2002.

Another reason for the decline in aid flows may be that donor countries are facing their own financial pressures. It has been estimated that Bush’s war on terror – being fought in Iraq, Afghanistan and Pakistan – will cost the US almost US$3 trillion.
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Demographic shifts are putting further strain on Western economies. Increasing numbers of retirees and fewer productive young people (owing to the ageing baby boomers and lower birth rates) means increasing health costs, lower tax revenues and less to give away. And of course it is worth remembering that the 2008 credit crisis has put immense pressure on the fiscal balances of rich (and rapidly emerging) countries; yet another stark reminder that foreign donor support is an unreliable if not dangerous palliative. For African policymakers to view aid as permanent (even with the noise made by aid proponents for it to be increased) is foolhardy.

Africa is addicted to aid. For the past sixty years it has been fed aid. Like any addict it needs and depends on its regular fix, finding it hard, if not impossible, to contemplate existence in an aid-less world. In Africa, the West has found its perfect client to deal to.

This book provides a blueprint, a road map, for Africa to wean itself off aid. This goal cannot be easily achieved without the cooperation of the donors. And like the challenges someone addicted to drugs might face, the withdrawal is bound to be painful. Drug-taker, or drug-pusher, in the end someone has to have the courage to say no.

What follows is a menu of alternatives to fund economic development across poor countries. If implemented in the most efficient way, each of these solutions will help to dramatically reduce Africa’s dependency on aid. The alternatives to aid are predicated on transparency, do not foster rampant corruption, and through their development provide the life-blood through which Africa’s social capital and economies can grow.

The
Dead Aid
proposal envisages a gradual (but uncompromising) reduction in systematic aid over a five- to ten-year period. However worthwhile the goal to reduce and even eliminate aid is, it would not be practical or realistic to see aid immediately drop to zero. Nor, in the interim, might it be desirable.

A reasonable person could, for example, argue that aid in Africa has not worked precisely because it has not been constructed with the idea of promoting growth. The politically driven aid and tied-aid examples discussed in earlier chapters underscore the point that these types of aid flows do not promote development, and nor were they intended to in the first place. That, if executed in a moderate way, Botswana’s experience with aid (detailed earlier) is exactly what we would want to see: a country that began with a high ratio of aid to GDP uses the aid wisely to provide important public goods that help support good policies and sound governance that lays the foundation for robust growth. Over time, the ratio of aid to GDP would fall as a country developed. In this way, Botswana would seem like the poster-child for what aid can do in a well-managed country.

It might very well be the case that more-modest aid programmes that are actually designed to address the critical problems faced by African countries can deliver some economic value. The
Dead Aid
proposal does allow for this perspective, by leaving room for modest amounts of aid to be part of Africa’s development financing strategy. Systematic aid will be a component of the
Dead Aid
proposal, but only insofar as its presence decreases as other financing alternatives take hold. The ultimate aim is an aid-free world.

In September 2007, Ghana issued a US$750 million ten-year bond in the international capital markets. About a month later, the Gabonese Republic followed suit, issuing a US$1 billion ten-year bond. Could Dongo do the same?

Bonds are effectively loans or IOUs. On issuing a bond, the government promises to repay the money it borrows to the lender, plus an agreed amount of interest. However, as discussed earlier, bonds issued in the commercial marketplace are fundamentally different from aid given in loans in at least three ways: first, the interest rate charged on aid loans is below (often markedly so) the going market rate; second, aid loans tend to have much longer periods over which the borrowing country has to repay (some World Bank loans are for fifty years, whereas the longest maturities in the private markets rarely exceed thirty years); third, aid transfers tend to carry much more lenient terms in cases of default or non-payment than the relatively more punitive private bond markets.

There is a plentiful history of lesser developing countries issuing bonds – dating as far back as the 1820s. By 1860, for example, Argentina and Brazil were frequent users of the international bond markets, and since then many of the world’s poorest countries have, at one time or another, issued bonds. In a report, the rating agency Standard & Poor’s lists as many as thirty-five African economies as having had access to the bond markets in the 1970s and 1980s.

For many of these countries, the point of issuing these bonds to international investors was to help finance their development programmes, including infrastructure, education and healthcare. Monies raised by bonds could, however, also be used to fund governments’ day-to-day (current) expenditures such as on the military, civil service and trade imbalances.

Accessing the bond markets is not that hard. Having decided to raise money by issuing bonds rather than yet again taking aid (this might prompt the question of why an African government would choose to do this, but following the example set by South Africa and Botswana, a responsible government should see merit in this financing strategy), a country must go through a number of reasonably straightforward stages.

First, it must acquire a rating, very often obtained from reputable internationally recognized rating agencies. The rating might not be great, but it is nonetheless a rating. The rating is a guide to investors of the risk involved – the likelihood that a country will repay its loans – and therefore determines the country’s cost of borrowing.

Second, the country must woo the potential investors – those people willing to lend to it. Very often, a country will hire a bank to accompany its representatives on a roadshow to help make the case to an array of investors (institutions like pension funds and asset managers as well as private individuals) as to why they should lend their money to the country. It is also an opportunity to show that it can manage its borrowings in a credible way – after all, many of these countries were not able to keep the relatively low-interest-rate debt of the 1970s from piling up in an unsustainable way. There are good reasons to believe that the greater desire of many African leaders to see their countries excel should give investors the comfort that governments will fare better with private debt flows today than in the past.

Finally, assuming the country’s representatives make a compelling case for its credibility and intention to repay, and once the loan terms are agreed upon (the maturity or length of the bond, the cost of the bond, the currency it will be issued in), the country gets its cash.

The market for African countries to issue bonds exists, but only for those countries seriously intent on transforming their economies for the better. The good news is that for countries considering the bond markets, investor interest in emerging countries is on the rise. Traditionally only designated emerging-markets
investors sought returns in underdeveloped markets. Over time, thanks to greater information and people being more at ease with the idea of globalization and cross-border linkages, other pools of money have turned their attention to emerging economies. This has broadened a previously narrow base to encompass an almost insatiable demand from mutual funds, pension schemes, hedge funds, insurance companies and private asset managers around the world.

Moreover, as economies have stabilized, and operate under better management, investors themselves have evolved from more short-term speculators (jumping in and out to garner short-term gains) into longer-term players happy to buy and hold developing-country assets for longer periods, and even up to maturity.

While it is true that the Asian crisis of 1997, the Russian debacle in 1998 and the Argentinian default of 2001 all led to a sudden outflow of capital from the emerging markets, these proved to be hiccups in what has been a strong and growing trend of emerging-market interest. And even in those countries where money flowed out on the back of crises, in just one decade investor money has returned.

The reasons for the rapidly growing interest in emerging economies are threefold:

For one thing, investors are always looking for the next, best opportunity. And emerging-market fundamentals make a strong case for being some of the best opportunities around. Countries that exhibit strong economic performance and are seen to be on a sound and credible footing will be rewarded. At a minimum, foreign investors will be willing to lend the country the cash. However, the beauty with bonds is that their very existence lends further credibility to the country seeking funds, thereby encouraging a broader range of high-quality private investment. More credibility equals more money, equals more credibility, equals more money and so on. As part of the macroeconomic improvements, being actively seen to be making strides away from aid, and in doing so shaking off the stigma of being an aid ‘basket-case’, is in itself an attractive proposition to potential investors.

Second, unsurprisingly, investors are attracted to the prospect of high returns. At the most elementary level, fund managers and commercial banks are themselves rewarded for a decent appreciation on their capital. In some cases, dedicated emerging-market fund managers (those only investing in these markets) look for net returns of at least 10 per cent per annum. By and large, thanks to their rapid growth, and the relative scarcity of investment capital, it is mainly assets in emerging markets and underdeveloped countries that can deliver these high returns.

For example, in 2006, emerging-market debt gave investors a return of around 12 per cent. The performance beat the 3 per cent return for US government bonds in the same year. Moreover, emerging-market debt has almost consistently outperformed international stocks over the past ten years. Whereas the average return for emerging-market bond funds over the past five years has been 40 per cent, US equity indices have only returned 20 per cent. In 2007, emerging-market bonds returned some 35 per cent and J. P. Morgan’s EMBI+ index of such bonds performed better against American government bonds by 15 per cent. Over a longer timeframe – say an eighteen-month to two-year window – experienced portfolio managers can make significant returns, averaging 25–30 per cent per annum.

More generally, historically, choosing to invest in the bonds of relatively underdeveloped economies instead of home bonds has paid off. The evidence of ten countries suggests that investors made higher returns on bond lending to foreign countries than in safer home governments; despite the former’s wars and recessions, foreign bondholders got a net return premium of 0.44 per cent per annum on all bonds outstanding at any time between 1850 and about 1970.

Third, investing in the broader class of emerging markets can enhance portfolio diversification. The notion of portfolio diversification is at the core of asset management. It pertains to the need to spread your risks and rewards across investments. In essence, you diversify a portfolio to garner the same amount of returns for a reduced amount of risk. A very basic example of the diversification
concept is illustrated by two separate islands, one that produces umbrellas and another that produces sunscreen. If you were to invest only in the island that produces umbrellas, you would make a fortune when it was unseasonably wet, but you would do poorly when it was a very dry year. Conversely, were you to only invest in the island that manufactures sunscreen, you would make a killing in the year when rainfall was extremely low, but would fare poorly if it were a very wet year. However, an investment in both islands could ensure you made money regardless of the climate, thereby reducing the risk to your investment (and, of course, to your expected return).