reasons for giving aid

Relationship Between Countries at Different Levels of Development – Reasons for Giving Aid

Objective

To explain why more‑developed (donor) countries provide aid to less‑developed (recipient) countries, to link these motives to wider macro‑economic concepts, and to evaluate the impacts on both donors and recipients (Cambridge International AS & A Level Economics 9708, 11.5.1).

1. Introduction

• International aid comprises financial transfers, goods and services, technical assistance, debt relief and budget support.
• Motives are a blend of altruistic (humanitarian) and self‑interested (strategic) considerations.
• Understanding these motives enables students to assess the effectiveness of aid and its relationship with trade, the balance‑of‑payments (BoP) and development indicators.

2. Economic Theories Underpinning Aid

1. Altruism / Moral Obligation – Aid is viewed as a global public good that corrects a market failure: poverty and disease generate negative externalities that spill over borders.
2. Self‑Interest (Strategic) Theory – Aid is used to achieve economic or political objectives, such as market access (strategic‑trade theory) or influence in international organisations.
3. Reciprocity / Trade‑Creation – By lowering transaction costs and improving infrastructure, aid can create future export markets for the donor.
4. Security Theory – Aid can promote stability, reducing the risk of conflict, migration and terrorism that affect the donor’s labour market and public‑finance position.
5. Soft‑Power / Global‑Governance Theory – Providing aid enhances a donor’s cultural, ideological and diplomatic standing, increasing its ability to shape global norms.

3. Forms of Aid (Syllabus Requirement 11.5.1a)

4. Main Reasons for Giving Aid (Syllabus Requirement 11.5.1b)

5. Linking Aid to Wider Macro‑Economic Concepts (Syllabus Requirement 11.5.1c)

5.1 Trade‑Creation Effect

• Aid that improves transport infrastructure or reduces tariff barriers lowers transaction costs for the donor’s exporters.
• Result: an increase in the donor’s exports and a right‑ward shift of the donor’s export‑supply curve.

5.2 Balance‑of‑Payments (BoP) Implications

• Grants and concessional loans are recorded as capital inflows in the recipient’s financial account.
• In the donor’s current account, aid appears as a transfer payment (debit), potentially widening the donor’s current‑account deficit.
• Debt‑relief improves the recipient’s BoP by removing future interest‑payment outflows.
• Aid inflows can cause an appreciation of the recipient’s real exchange rate – the “Dutch disease” effect – which may hurt export competitiveness.

5.3 Fiscal‑Balance and Inflation Effects

• Budget support and large grant inflows increase the recipient’s fiscal surplus or reduce deficits, allowing higher public‑sector spending.
• When aid is not sterilised, the additional money supply can generate upward pressure on domestic prices, especially in economies with limited productive capacity.

5.4 Development Indicators

Students should be able to relate aid flows to the following indicators:

• Human Development Index (HDI)
• GNI per capita (PPP)
• Gini coefficient (income inequality)
• Aid‑to‑GDP ratio (both donor and recipient)
• Current‑account balance as a % of GDP

5.5 Quantitative Example (AO2/AO3 practice)

Assume Country X receives a grant of US$2 billion in 2023. Its 2023 GDP is US$40 billion.

1. Calculate the aid‑to‑GDP ratio:
   Aid‑to‑GDP = (2 bn / 40 bn) × 100 = 5 %
2. If the grant is recorded as a capital inflow, the recipient’s current‑account balance improves by US$2 bn (ignoring other flows). With a 2023 current‑account deficit of US$1 bn, the new balance becomes a surplus of US$1 bn.
3. Discuss the possible exchange‑rate impact: the inflow may appreciate the real exchange rate, reducing export competitiveness unless offset by accompanying productivity‑enhancing projects.

6. Aid within the Wider Relationship Between High‑ and Low‑Income Countries (11.5.3)

Aid interacts with other channels that link richer and poorer nations:

• Trade – Infrastructure aid reduces transport costs, facilitating the export of primary commodities from the recipient and the import of manufactured goods from the donor.
• Foreign Direct Investment (FDI) – Development projects (e.g., power plants) improve the investment climate, attracting donor‑country firms.
• Migration and Remittances – Humanitarian aid that stabilises a country can reduce forced migration, while improved financial infrastructure can increase the flow of remittances back to the recipient.
• Capital Flows – Budget support and concessional loans appear as capital inflows, influencing the recipient’s financial account and exchange‑rate dynamics.

7. Globalisation and the Changing Nature of Aid (11.5.4)

• Globalisation has expanded the pool of donors to include private‑sector foundations, NGOs and emerging economies (South‑South cooperation).
• Digital platforms enable faster, more transparent transfers and the rise of “crowd‑funded” aid.
• Multilateral institutions now coordinate large‑scale programmes (e.g., Sustainable Development Goals) that integrate aid with trade, investment and migration policies.

8. Types of Aid and Their Connection to Motives

9. Benefits of Aid

9.1 To the Donor Country

• Enhanced political influence and voting power in international bodies.
• Access to new export markets and opportunities for foreign direct investment (FDI).
• Improved global reputation – “soft power”.
• Reduced risk of conflict, migration and trans‑national crime, protecting domestic labour markets and public‑finance stability.

9.2 To the Recipient Country

• Immediate relief from crises (food, health, shelter).
• Long‑term improvements in health, education and physical infrastructure.
• Capacity building that can lead to better governance, fiscal management and macro‑stability.
• Potential for increased FDI and export growth, improving the BoP.

10. Criticisms, Limitations and Evaluation (AO3)

• Dependency – Repeated aid can reduce incentives for domestic revenue mobilisation and structural reforms.
• Misallocation / Corruption – Weak institutions may divert aid away from intended projects, lowering effectiveness.
• Self‑interest of donors – When aid is primarily strategic, the altruistic narrative is weakened, potentially eroding legitimacy.
• Conditionalities – Policy conditions (e.g., structural‑adjustment programmes) can improve macro‑stability but may undermine national ownership and cause social unrest.
• Effectiveness of trade‑creation – Empirical studies give mixed results; some aid programmes have limited impact on the donor’s export volumes.
• Balance‑of‑Payments effects – Large inflows can appreciate the recipient’s real exchange rate (the “Dutch disease” effect), hurting export competitiveness.
• Inflationary pressure – Unsterilised aid can increase the money supply, leading to price rises in economies with spare capacity.

11. Summary Diagram (Suggested for Exam Practice)

12. Conclusion

Aid is rarely driven by a single motive. Humanitarian concerns coexist with strategic economic, political, security, cultural and soft‑power interests. By linking these motives to trade‑creation, balance‑of‑payments, exchange‑rate and development indicators, students can critically assess both the positive contributions and the limitations of aid within the broader framework of international economic relations.