Aid has Failed in the Pacific.docVIP

1 aid has failed in the pacific emeritus prof h hughes australian national university and senior fellow center for independent studies submission to senate foreign affairs defence and trade references committee inquiry into australia s relationship with papua new guinea and other pacific island countries 28 march 2002 2 1 executive summmary national income has been growing at 1 to 2 per cent a year in the pacific for the past 25 years with some islands registering lower growth and even declines population has been growing at 2 5 per cent and more therefore per capita income is stagnating the benefits of the little growth that has taken place have gone to small political and urban elites in villages and towns standards of living have deteriorated with absolute poverty emerging in parts of papua new guinea and other melanesian states economic decline has been accompanied by unrest and violence these trends in our neighborhood must be of concern to our compassion and to our strategic interests since 1970 us 50 billion in 1998 dollars or a 100 billion has gone to the pacific in aid australia has been the largest donor growth and development have not resulted aid is thus not the solution to pacific development but a major part of the problem the lack of economic growth and development in the pacific does not arise from geographic social or cultural characteristics but is the result of inappropriate economic policies that have failed to deal with the negative economic effects of aid and mineral incomes only by understanding the economic implications can australia as a major aid donor seek to counterbalance the negative impact of aid on the pacific at independence the inappropriate institutional frameworks of the colonial area were extended rather than modified setting the stage for corruption aid flows enabled excessive public employment to be expanded at the cost of further employment creation the australian trade unions compassion unfortunately helped remuneration to run ahead of productivity making labour intensive private sector production impossible until the rabuka coup in fiji in effect freed that labour market enabling clothing production for export on a significant scale with some exceptions in tonga and samoa this has not been followed in the rest of the pacific high unemployment in urban areas and high underemployment in villages is the pacific s central problem it can not be solved by public sector employment in papua new guinea the inflated public sector employs 65 000 to 70 000 people the formal private sector employs about the same number leaving 100 000 42 per cent of the formal sector unemployed in urban areas with at least another 1 million people underemployed in the countryside this problem can not be solved by public sector unemployment the lack of employment is sustained by clan safety networks but their existence prevents entrepreneurial families from saving and investing retarding small scale business which could grow into large scale enterprises the lack of jobs encourages cargo cult mentalities with crime now spreading to the villages mirroring high level corruption restrictive use of land associated with communal ownership is a brake on rural development explaining the slow growth of agriculture and hence of low standards of living in the country in marginal areas traditional agriculture can no longer support the growing population whether the pacific chooses to move from communal to individual property rights is the choice of its peoples they have every right to retain a communal productive framework despite its lack of capacity for growth if they do so however they can not expect aid to sustain them indefinitely at a higher standard of living than communal production allows the fundamental problems of pacific societies can only be tackled in the pacific the first step is recognition that excess of population growth versus income growth indicates serious trouble it has not been and can not be overcome by muddling through with large aid inputs that has been tried for 25 years only when the economic problems that face the region are recognized in the pacific will a fruitful debate about the options for change emerge the discussion must be by pacific islanders in local forums including academics and media and within bureaucracies and parliaments australia has to face up to the inherent negative effects of aid not countered by effective economic policies we transformed our economy under labor and national liberal leadership in the last 20 3 years to become one of the soundest economies in the world we need to apply the same rigorous analysis to the effects of aid as we have to our domestic economy we can not rely as we had hoped on the world bank or the asian development bank to take the burden of conditionality to make aid effective experience of these two banks lending has shown that their main concern is with their own growth they have added grievously to the pacific economies problems by encouraging borrowing that was spent on consumption and hence creating unsustainable debt the solution most likely to succeed would be to suspend all aid to provide the catalyst needed for change this worked has worked elsewhere taiwan south korea india and chile but it would be a harsh step a softer alternative based on the understanding of the damaging effect of aid rents would be to empower ausaid to impose real aid conditionality under the principle of mutual obligation the destination of all aid would have to be mutually agreed and monitored with aid disbursements dependent on the meeting of mutually agreed and independently audited benchmarks this would mean removing all aid flows from pacific country budgets so that aid could and would be monitored the creation of labour intensive employment would be a priority area australia could also assist by making sure that pacific islanders take advantage of the access to australian labour markets albeit under the same conditions as other immigrants with points for character knowledge of english and skills to avoid the creation of welfare dependent ghettoes of pacific immigrants in australian cities studying in australia is already a path to immigration that pacific island families are pursuing emigration to australia would increase remittances to the pacific and create savings and skills that would start business as some migrants return emeritus professor helen hughes australian national university is a senior fellow of the centre for independent studies her working career has mainly been focused on the economics of development and australian economic policies at the world bank 1968 1983 as consultant to the asian development bank 1983 1999 as member of the un committee for development planning 1987 1993 and as executive director of the national centre for development studies 1983 1993 of the national university she has worked in the pacific since 1963 when at the request of bob hawke then of the actu she undertook to assist the people of nauru to their claim to their phosphate and to independence at the national center of development studies she initiated a research program on the pacific that continues with the publication of the pacific economic bulletin research papers and economics updates 4 1 executive summmary 2 2 introduction 5 3 the economic theory of aid 6 4 pacific overview 8 5 causes of stagnation and decline 12 5 1 rich natural resources 12 5 2 cargo culture 13 5 3 communal land ownership and clan loyalty 13 5 4 legacy of the colonial era 13 5 5 inappropriate political and economic policies 14 5 6 inaproppriate industrial relations 15 5 7 corruption and crime 16 5 8 budget deficits 16 5 9 the economic debate in the pacific 16 6 aid to the pacific 17 6 1 bilateral donors 17 6 2 un agencies 18 6 3 the imf the world bank and the asian development bank 19 6 4 ngos in the pacific 21 6 5 debt in the pacific 22 7 conclusion 23 5 2 introduction although as australians we are naturally concerned with our own welfare we also pride ourselves on our egalitarian outlook and we are very conscious of our unique geographic location as a neighbor to pacific developing countries we are a compassionate people moved by the plight of the poor and conscious of colonial transgressions against developing countries in the past we hence wish to use our wealth and good fortune to help our neighbors strategically we are concerned with growth and stability in our neighborhood australia was an early participant in the western flow of aid to developing countries we were early aid donors to the pacific and we have remained a large donor to a region that at some 22o per capita per year has the highest aid receipts in the world but aid is inversely related to development sub saharan africa has received the highest aid but its growth has been the slowest with living standards falling in many african countries and more than 350 million people living in absolute poverty 1 pacific economies with the highest per capita aid in the world are following failing african states table 1 aid flows total and per capita by region total aid flows 1970 1999 us billion 1998 dollars average annual aid flows per capita 1995 1999 us 1998 dollars sub saharan africa416 60022 india85 0002 other south asia137 8009 china 41 2002 pacific 49 300220 other east asia152 6008 caribbean45 10034 latin america111 70010 middle east and north africa282 60015 source the development assistance committee development co operation reports 1971 2000 oecd paris the research on which this paper is based is supported by 40 years of involvement in the pacific starting in nauru in 1963 it is a response to the emergence of absolute poverty in lands where standards of living albeit at a simple level were high when european explorers first visited twenty five years of slower economic than population growth and the distortion of income in favor of small urban elites have reduced standards that traditional island societies were able to support the hopes for the high standards of living that people in the west enjoy have only been realized by miniscule proportions of pacific peoples these elites have benefited at the cost of the standards of living of the majority of pacific peoples in some melanesian islands notably in papua new guinea absolute deprivation marked by inadequate nutrition the spread of malaria tuberculosis and hiv aids is emerging throughout the melanesian islands all schooling is inadequate but girls are the most deprived averaging 2 to 3 years of schooling in part because they are in danger of being raped on the way to school women have always been and are the workers of the pacific yet they bear the brunt of emerging poverty and insecurity in villages and towns the economist has hailed the solomon islands as the pacific s first failed state conscious that instability is also endemic in bougainville and the papua new guinea southern highlands and 6 threatens elsewhere 2 australia s security is vitiated by the passage of drugs arms and ultimately terror and the flight of large numbers of economic refugees across the torres strait papua new guinea s population is expected to rise to some 10 million by 2025 unless there is a sharp change of direction in papua new guinea the prospect not merely of a failed state but of a rogue state like those of amin mobutu bokassa and mugabe in africa can not be lightly dismissed economic theory by showing counter intuitively that protection hurts employment enabled australia to adopt economic reforms that have made us economically strong economic theory again counter intuitively shows that the economic rents associated with aid impede the growth of developing countries aid policies have to counter the negative effects of aid rents if compassion and economics are not to be in conflict the pacific is not unique the combination of high mineral rents with large aid flows damaged a number of developing countries in latin america aid and mineral rents have created havoc in more than 30 sub saharan states lessons must be learned from those countries like chile in latin america after many vicissitudes and botswana and mauritius in sub saharan africa that have achieved positive growth and development botswana has shown that traditional tribal societies can grow strongly mauritius with a similar ethnic heritage to that of fiji has prospered twenty five years ago botswana and mauritius had lower per capita incomes than papua new guinea and fiji to day they have respectively more than twice the per capita income of the two pacific countries table 2 comparison of economies of african and pacific countries population gross national income per capita us purchasing power parity dollars botswana2 000 0007 300 papua new guinea5 000 0002 180 mauritius1 000 0009 940 fiji800 0004 480 source world bank world development indicators 2002 washington dc purchasing power parity are econometrically derived not directly estimated figures 3 the economic theory of aid in economic terms aid is a windfall unearned income or an economic rent milton friedman anticipated the analysis of aid as damaging recipient countries 3 but the principal exponent of the counterproductive economic rent aspects of aid was peter bauer 4 bauer saw fungibility that is the substitutability of capital as the most counterproductive aspect of aid even if aid is small in relation to budgets it enables governments to spend on their own objectives rather than on projects or programs agreed with donors in small countries where aid represents large components of budgets it makes possible swollen political and bureaucratic establishments entrepreneurship is deflected from making money through business activities to earning public service and parliamentary salaries consumption takes the place of investment budgets are drained to enable large personal accounts to be accumulated by political leaders bureaucrats their crony contractors and expatriate helpers bauer elaborated the insights of neo classical economics and anticipated developments in the theory of rents and institutional economics to explain that even when aid projects and programs have positive outcomes aid has a negative impact overall 7 economic theory indicates that mineral rents attract resources disproportionately to mining mineral rents lead to exchange rate appreciation appropriately for mineral exports but exchange rates become overvalued for import substitution and non mineral exports investment becomes unprofitable in agriculture and manufacturing labor intensive export industries fail to develop aid has similar effects because aid flows to governments it attracts investment and employment to the public sector and biases incentive away from employment the expectation of aid as of mineral incomes discourages the build up of foreign reserves and encourages fiscal and monetary irresponsibility with inadequate taxation budget deficits and borrowing leading to inflation and capital flight and so further undermining private investment waste and corruption at the top combine with low employment creation leading to crime on the streets so that business can not operate import substitution and other regulations are used to offset appreciated exchange rates increasing the regulatory role of government and further biasing the economy away from markets to the advantage of elites financial repression price controls and other regulations follow they are maintained by aid long after their high costs damage to employment creation and contribution to fiscal and balance of payments crises become evident dirigiste regulations become the principal sources of patronage intensifying the struggle for power particularly in multi ethnic communities the large bureaucracies that implement dirigisme are a dead weight on society but support the parliamentary elites with whom they share the spoils dirigiste economic management undermines the evolution of the institutions essential to growth and development 5 clan loyalties characteristic of less developed societies o not lead to new internal institutions such as civil and business morality modern internal institutions such as respect for the rights of the individual are essential to savings entrepreneurship investment and rising output and productivity they have often been ignored in economic analysis but neo classical harrod domar models of economic growth do not work without them external institutions such as police legal systems and economic rules for the conduct of an economy have become clearly recognized as essential components of growth and development bauer already saw in the 1960s that the adoption of marxist development 6rather than market economics would create institutional frameworks that would not only retard development but that once entrenched would be very difficult to reform if redistribution takes place when production and productivity are low when there are only aid and mineral rents to distribute consumption levels for those benefiting from the rents become high but the rest of society does not benefit from increased incomes particularly when population growth exceeds job creation savings and investment are lacking further undercutting growth the pacific economies illustrate the validity of bauer s predictions and their elaboration in economic theory the failure of aid and mineral incomes to lead to growth thus does not arise from ill will but from the failure to understand the economics of aid and mineral rents the understanding of the effects of aid has been retarded by the very understandable desire for australia and particularly for ausaid and its predecessors not to appear in a colonial role in the pacific australian policy relied on international financial organizations notably the imf and the world bank to take on the management of conditionality and policy dialogues with developing countries on behalf of other multilateral agencies and bilateral donors so that the nega