Short-term Benefits but Little Effect on Long-term Growth

Fast Facts:

• When oil prices have risen, OPEC’s Arab countries have given billions of dollars in foreign aid to poorer Muslim nations.
• The countries receiving this money have invested some of it in capital expenditures, but most of it has been spent on increased imports of consumer goods.
• This aid worked to raise the GDP of recipient countries in the short term, but had little long-term economic benefit.

Every year, wealthy countries provide billions of dollars in foreign aid to poorer countries around the world. According to the OECD, foreign aid totaled US$146.6 billion worldwide in 2017. This aid usually takes the shape of money for budget support or development projects, but can also include such things as food or technical support.

In theory, foreign aid should benefit the economies of recipient countries: if the money is invested or spent inside the country, it should raise aggregate demand and spur economic growth. Whether this occurs in practice, however, is the subject of much debate. One study covering the years 1965–1995 found that only six out of 88 countries showed positive economic growth due to increased investment resulting from foreign aid.

A research project conducted by Eric Werker, the William Saywell Professor at SFU’s Beedie School of Business, Faisal Ahmed of Princeton University, and Charles Cohen of the International Monetary Fund looked at the economic effect of one important but often overlooked type of foreign aid: that given by OPEC’s Arab nations to their poorer Muslim allies. The researchers wanted to know how this money is spent by the receiving countries.

Foreign aid by OPEC donor countries such as Saudi Arabia, Kuwait, and the United Arab Emirates is estimated to have totaled at least $240 billion between 1960 and 2004. Such aid closely tracks the price of oil. When oil prices skyrocketed during the oil crisis from 1973 to the early 80s, and again at the time of the first Gulf War (1990–1991) and after the 9/11 terrorist attacks in 2001, OPEC nations took a substantial portion of the windfall they received and gave it away as foreign aid. Although some of this money went to famines and other disasters around the world, the vast majority went to other Muslim nations. The motivation for this was largely political: the Gulf countries wanted to quell unrest due to the huge inequalities among fellow Muslim countries (between the oil “haves” and “have-nots”) and to secure their dominant position within the Muslim world.

In contrast to Western aid, which is often tied to contracts with the donor country, Arab aid usually took the form of unconditional block grants to recipient countries’ finance ministries. In other words, the receiving country was free to spend the money however it wanted. So how have the non-oil-producing Muslim nations spent the aid they have received from their richer Arab brothers?

Using data from the World Bank’s World Development Indicators database, Werker and his co-researchers found that most of this aid was spent on consumption, primarily in the form of increased imports of consumer goods and services. A smaller amount was funneled into imported capital expenditures and domestic investment. This use of foreign aid resulted some GDP growth in the short term: an increase in aid of 1% of GDP was found to raise economic growth by about 0.2% in the first year, but this effect was negligible over a longer 4-year period. Higher household consumption – in particular the consumption of imported goods and services – was identified as the primary driver of the initial jump in economic growth.

Spending foreign aid on increased imports is not necessarily a bad thing, especially if the imported goods include capital equipment to be used for productive purposes. But for the Muslim nation recipients of OPEC aid, “good” imports of capital goods decreased after the first year, giving way to a preference for “not-so-good” imports of consumer goods and services.

The researchers conclude that the popular critique that aid is “wasted” does not ring true; they found that every component of the domestic economy, including investment, was raised in the short run. Giving money to poor countries’ governments seems to be an effective way to stimulate the economy. The challenge is how to convert that temporary stimulus into lasting economic growth.