Saturday, October 20, 2007

Making foreign aid work better

While foreign aid works in some situations, it has two huge problems. First, there is never enough money to go around. Last year, the United States provided $23 billion of development aid to foreign countries. This was more than any other donor, but it still resulted in very little for the billion people who live on less than $1 per day.

The second problem is that the money that does get distributed doesn’t always reach the people who need it. As the economist Jeffrey Sachs has noted, of every dollar given to sub-Saharan Africa, only about 40 cents is actually directed toward economic development. The rest goes to debt service, consultants and humanitarian emergencies. And after those expenses are subtracted, the remaining money is further reduced by mismanagement and corruption. ...

Congress should provide a 39-cent tax credit for every dollar of American investment in developing countries. If Company X were to build a $100 million factory in Madagascar, its tax bill would be reduced by $39 million. The lost tax revenue would be offset by reducing direct foreign aid by the same amount. ... For the same cost to the federal government, Madagascar receives far more resources. ...

Using tax credits instead of traditional foreign aid also means that the money will be spent more prudently. Because for-profit companies are focused on the bottom line, they will be more protective than government agencies of the money they invest in developing countries.
--Justin Muzinich and Eric Werker, NYT, on how to make foreign aid more effective. Eric was in the Harvard economics Ph.D. program with me, and is now an assistant professor at HBS.

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