How Financial Crises in Donor Countries Affect Aid

Review

Since 2007, after the global financial crisis, developing countries have suffered big time in terms of drying up of aids from donor countries like Japan & America. The reason being a steep decline in incomes of the donor countries have put massive pressure on aid budgets explain their reluctance to free up money.

If we look a little back into history we find out that in 1980s and 1990s, when five major donor countries (Finland, Japan, Norway, Sweden and United States) were hit by the banking crisis, the aid from these donors stagnated while the aid from other donors rose steadily. But these drops in aid due to crisis in countries could reflect other factors besides banking crisis like the fall in per capita income. So, authors tend to explore the relationship between banking crisis and aid econometrically.

The authors of the paper found out that donor-country banking crises can cause steep and sustained drop in aid disbursements which could go up to 17% lower in 5 years compared to the situation had there been no crisis (analysis based on a total of 23 systematic and non-systematic crisis in 17 countries). One percent decline in per capita GDP is associated with a drop of about 3 percent decrease in aid outflows: one of the effects which are in addition to the declining incomes effects on aid.

One likely channel is the fiscal effect of financial crisis. The fiscal channel explains why aid stagnates for so long after crisis; as the public debts increases and bailout plans are in place it is quite plausible that debt pressure lead governments to cut back growth in aid for years afterwards.

The study implies, taking in consideration the historical patterns that the likely bath of aid disbursements is going to go down! The global financial crises does reduce aid significantly over medium term. in the countries like America and united kingdom who have suffered the most severe of banking crises are expected to cut down the aid by fifth to a quarter. This study doesn't take into account any strategic interactions among donors so past is not necessarily a prologue here. So if donors coordinate they may be able to reduce the collateral damage to aid.

(Hai-Anh Dang, Steve Knack, and Halsey Rogers. 2009. "International Aid and Financial Crises in Donor Countries." Policy Research Working Paper 5162. World Bank, Washington, DC)