Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa (21 page)

The Indian experience is an example of how a government has successfully unlocked latent resources. Africa should take note and look for ways to bring the hidden money into the financial stream. Of course, Africans might not hoard gold to the same extent as Indians, but many of them do have access to (and nominal ownership of) the land they till. And this is de Soto’s main argument, that the inability of people across the developing world to secure their property rights is what prevents them from unlocking their vast capital. What is needed is a functioning and transparent legal framework so that Africans can convert that land into collateral against which they can borrow and invest.

It is not the case that African countries do not have legal frameworks (many inherited from their colonial past); it is, however, the case that in environments of rampant corruption the legal systems are often impotent.

Savings are a hugely important part of a country’s growth, and a country’s financial development. Domestic saving is the most important source of financing investment and thus boosting growth. Looking back at the Grameen Bank model, it too includes a component to encourage saving amongst its borrowers – in fact, they are required to save and invest. Customers must save US$0.02 per week, and new members are required to buy a share of stock
in Grameen for US$2; localized financial development at its best.

What Africa desperately needs is more innovation in the financial sector. We can put a man on the moon, so we can most certainly crack Africa’s financing puzzle, jump-start economic growth and drastically reduce poverty. But herein lies the key – innovation. Innovation means breaking out of the mould, and finding more-applicable ways for Africa to finance its development. There is a history of financial innovation to draw from: the Soft Banks of America’s Wild West and the Scottish Banks of the eighteenth century. Both catered to the unsecured and traditionally unbankable.

At the time of the gold rush in 1800s California, for example, one would have expected the well-established East Coast American banks to have simply migrated westwards, opening branches and setting up their lending shops on the West Coast to cater to the demand from those in search of yellow (and black) gold. Instead, what happened was that there emerged hybrid banking structures – a combination of venture capital, where the lenders would lend money with the prospect of a portion of the spoils when the borrower struck gold, and standard lending practices, where the borrower would have to pay back the principal plus some interest (in this case the lender got no share in the project). To illustrate, under a venture capital (VC) arrangement, the lender would give the collateral-less gold-seeker US$1,000 to invest in exploration and hiring all the staff he needed, and in return the lender would get 20 per cent of the gold project or all future profits emanating from the project. Naturally, this structure was very different to the standard banking practices which would have lent out the US$1,000 with an interest rate attached. But, of course, under standard banking practices most of the borrowers without collateral would have been excluded. In essence, as is the case in many places in Africa today, the gold-rushers of America’s Wild West had a good idea, but no collateral which standard bankers would feel happy to lend against.

The financing revolution of eighteenth-century Scotland was not much different in its innovative thinking. By essentially
becoming a fully fledged, all-service financial supermarket (providing all elements of banking – venture capital, standard commercial banking, investment banking, merchant banking, etc.), Scottish banks could customize the cash and liquidity needs of a whole range of businesses and individual entrepreneurs. Banking and finance are about risk – risk assessment, risk mitigation and risk estimation. Scottish financial engineers had figured it out. Even if a potential borrower did not meet a bank’s standard, prescribed risk profile (that is, had no collateral, no guarantees, no obvious ability to repay), rather than turn them away the bank would tailor a lending instrument to meet the risk profile of the borrower. Certainly, it might have meant infinite permutations to get the right structure, but there was never any doubt that a financing structure could be found.

There is a story, for example, of how two independent farm owners each applied for financing to invest in their individual farms. The lender could not see how to lend to each farm individually, but somehow if the two farms were merged, their risks pooled, and therefore mitigated, a loan arrangement could be struck.

It is this type of innovation, providing micro-loans as well offering hybrid venture capital structures (in addition to standard banking fare), that Africa should look to replicate in order to bring its masses into the global fold. No country has economically succeeded without finding a way to funnel the risk capital to finance its small and medium-sized enterprises. For Africa, this is an imperative that must be heeded.

After sixty years of dead aid, Dongo is regressing. Its finances stand as follows: roughly 75 per cent of the money coming into the economy is from foreign aid (essentially, all of which accrues to the government), capital markets 3 per cent, trade 5 per cent, foreign direct investment (including micro-finance) 5 per cent, and the rest from remittances and savings. This financing portfolio has been costly, and Dongo is going nowhere fast.

If Dongo is to survive, development finance demands a new way of thinking. It needs to abandon the obsession with aid and draw on proven financial solutions. Dongo should aim for just 5 per cent of its total development financing to come from aid, 30 per cent from trade (with China as the lead partner), 30 per cent from FDI, 10 per cent from the capital markets, and the 25 per cent that is left should emanate from remittances and harnessed domestic savings. The key is to wean countries off aid by putting them on a tight schedule instead of continuing to give them open-ended commitments.

Clearly, however, not all African countries are equal, and what might be right for Dongo may not be suitable for land-locked Zambia, Zimbabwe and Chad, versus oil-rich Sudan, Nigeria and Angola. But the point is that, in order to succeed and escape the mire of poverty and despair, they need a mix of each of these solutions and an end to aid-dependency.

It has been shown, from case to case and example to example, that this can be done. In fact, in many African countries some of this is already being done, but on nowhere near the scale that is needed. Implementation (as we shall see) will be challenging, but not impossible.

The transition from today’s low equilibrium to tomorrow’s economic promise requires proper and active management, as
challenges will inevitably arise. As described earlier, large capital inflows, whatever the source, can introduce the risk of Dutch disease (although Rajan and Subramanian have found no evidence that remittances hurt export competitiveness). But where private capital trumps aid every time is on the question of governance. You can steal aid every day of the week, whereas with private capital you only get one shot. If you steal the cash proceeds of an international bond issue, you most certainly will not be able to get more cash this way. The capital markets may be forgiving, but not so forgiving as to be fooled by the same culprit twice. And without cash to assuage the restlessness of an army, no despot can stand.

Besides, whereas earnings from trade filter through to many thousands of exporters and remittances accrue to innumerable households, foreign aid almost exclusively lands up in the hands of a ‘lucky’ few. Quite simply, investment money is not as easy to steal.

Africa’s time is now. In the past five years there has been good economic and political news from the continent. Helped, in part, by soaring commodity prices, African countries are posting solid growth numbers, and, although nascent, positive political changes have swept across the continent. But these will count for little if the proposals set out here, essential for Africa’s growth trajectory, are not implemented. Opportunities abound; investment prospects lie all around, in every sector – agriculture, telecommunications, power, infrastructure, banking and finance, retail, property. How can they not? With roughly a billion people Africa is a big continent. This continent needs everything: roads, hospitals, schools, airports, food, houses, cars, trains, aeroplanes. There is inordinate demand, and supply is not coping.

In the near term, external forces like the Chinese can and should play a key role in jump-starting Africa’s renaissance. But African countries would be wise to prepare for the eventuality that China could pack up and leave – Africa may not always be the belle of the ball. Countries must after all face up to the reality that circumstances change – their resource endowments are not infinite, and commodity prices could tumble from the highs of today; but
the good news is that some countries are already hedging against this possibility by saving their commodity windfalls.

The
Dead Aid
strategies, if embraced wholeheartedly, will not only turn the economic tide in the short term, but also promise longer-term growth. And as the growth pie expands, so too does a country’s tax base – another reliable source of development finance.

Good governance trumps all. In a world of bad governance the cost of doing business is much higher, on every level. This is true even when investments are securitized (that is, backed by a specific asset), since the risk premium associated with the unpredictable behaviour of a bad government always looms large. As long as issues of bad governance linger overhead (guaranteed to be the case in a world of aid-dependency), the cost of investing in Africa will always be exorbitantly high even when the social benefits (such as skill transfer, education and infrastructure) are taken into account. Yet in a world of good governance, which will naturally emerge in the absence of the glut of aid, the cost (risk) of doing business in Africa will be lower (whether the investment is securitized or not).

The absolute imperative to make Africa’s positive growth trajectory stick is to rid the continent of aid-dependency, which has hindered good governance for so long.

It’s time to stop pretending that the aid-based development model currently in place will generate sustained economic growth in the world’s poorest countries. It will not.

The question is how do we get African countries to abandon foreign aid and embrace the
Dead Aid
proposal? They can do it voluntarily – as South Africa or Botswana have done – but what if they don’t, choosing the soft option of aid instead?

Let’s step back a bit. Recall the August 1982 phone call when the Mexican Finance Minister telephoned the IMF, the US Treasury, et al. to inform them that Mexico would be unable to pay its debt. What if, in Africa’s case, the scene were reversed?

What if, one by one, African countries each received a phone call (agreed upon by all their major aid donors – the World Bank, Western countries, etc.), telling them that in exactly five years the aid taps would be shut off – permanently? Although exceptions would be made for isolated emergency relief such as famine and natural disasters, aid would no longer attempt to address Africa’s generic economic plight.

What would happen?

Would many more millions in Africa die from poverty and hunger? Probably not – the reality is that Africa’s poverty-stricken don’t see the aid flows anyway. Would there be more wars, more coups, more despots? Doubtful – without aid, you are taking away a big incentive for conflict. Would roads, schools and hospitals cease being built? Unlikely.

What do you think Africans would do if aid were stopped, simply carry on as usual? Too many African countries have already hit rock bottom – ungoverned, poverty-stricken, and lagging further and further behind the rest of the world each day; there is nowhere further down to go.

Isn’t it more likely that in a world freed of aid, economic life for the majority of Africans might actually improve, that corruption would fall, entrepreneurs would rise, and Africa’s growth engine would start chugging? This is the most probable outcome – that where the real chance exists to make a better life for themselves, their children and Africa’s future generations, Africans would grab it and go.

If other countries around the developing world have done it
sans
aid (generated consistent growth, raised incomes and rescued billions from the brink of poverty), why not Africa? Remember that just thirty years ago Malawi, Burundi and Burkina Faso were economically ahead of China on a per capita income basis. A dramatic turnaround is always possible.

How do we put the
Dead Aid
proposals into practice, and help to ensure that Africa gains a firm economic footing? There are three interlinked stages after the phone call.

First comes an economic plan which reduces a country’s reliance on aid year on year. In Dongo’s case, aid would fall 14 per cent every year – taking it down from the 75 per cent of income it receives today to 5 per cent in five years’ time. For the first year, instead of 75 per cent, Dongo is now getting only 61 per cent of its income from aid. It now has to find the extra 14 per cent of money it requires from other
Dead Aid
means. In the second year, Dongo will have to find 28 per cent of its financial capital outside aid, and the year following, 42 per cent – nearly half of its needs.

We have offered an array of financing alternatives: trade, FDI, the capital markets, remittances, micro-finance and savings. It should come as no surprise that the
Dead Aid
prescriptions are market-based, since no economic ideology other than one rooted in the movement of capital and competition has succeeded in getting the greatest numbers of people out of poverty, in the fastest time.

Ultimately, where a country goes for its cash depends on its particular circumstances. For example, trade-oriented commodity-driven economies such as Zambia, Kenya and Uganda (actually the majority of African countries) should look at boosting trade with China and other emerging nations. And certainly the fifteen African countries which have recently acquired credit ratings should consider following Gabon and Ghana’s lead in drawing on the capital markets.