Foreign Aid and Governance in Pakistan

Author:ADEEBA SARWAR, MUSHTAQ HASSAN and TAHIR MAHMOOD
 
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Abstract

This study analyzes the effect of foreign aid on governance in Pakistan by employing ARDL approach using annual data from 1984 to 2012. The study provides empirical evidence that foreign aid in Pakistan erodes the quality of governance, which has been measured by using indices of bureaucratic quality, corruption and rule of law in Pakistan. Aid dependence possibly damages the quality of governance by increasing corruption, weakening accountability, creating moral hazard, weakening policy learning, draining off talent and ability from the bureaucracy, and relieving burdens to restructure inefficient institutions and policies. Foreign aid programmes should be clearly understood and taken as a temporary and short-term development tool. There should be aid "exit strategy" and motivation for self-help.

Keywords: Foreign aid, Governance, Corruption, Rule of law, Bureaucratic quality, ARDL approach

  1. INTRODUCTION

    Foreign aid and governance have been widely discussed by economists over the last three decades. Both variables play a vital role in determining the economic prosperity in developing countries. Still the exact relationship between foreign aid and governance remains clouded and, hence, creates an interest for the researchers. Good governance creates conducive environment for sustained and high economic growth that enables a country to attain its goals and become prosper. There is low quality of governance in the most of the developing countries. There is a need to explore the main reasons that lead to worsen quality of governance and resultantly hamper the process of development.

    Pakistan is getting aid and also has become a victim of bad quality of governance. There is an immediate need to look for those hidden elements that are the causes of failure to attain our desired goal of sustainable development through foreign aid and quality of governance. This study tries to explore the effect of aid dependency on governance in Pakistan.

    Foreign aid is a key source of income in Pakistan like many developing countries. Foreign aid inflows fill saving and investment gap and increase productivity by transmitting modern technology that promotes growth. However, it has been observed that foreign aid has not benefited the country, as is evident from poor state of social indicators, like education, health and employment, etc. As the foreign aid inflows are not used for development of the economy, therefore, as a result the savings and investment gap is enlarged. Apparently, the aid is used in the vested interests of powerful people.

    Two views prevail about foreign aid. One view is that aid undermines government accountability to citizens because it goes into the pockets of corrupt bureaucrats and politicians. Foreign aid is used to import unsuitable technology, expand government bureaucracies and encourage a larger, unproductive and corrupt government in developing countries or it is just misused.

    The other view is that aid contributes to improve critical administrative and fiscal capacity that supports governments to better serve for their people. In fact, neither view is entirely right or wrong.

    International financial institutions, in particular the International Monetary Fund (IMF) and World Bank, emphasize much on issue of governance and mainly on corruption in developing countries. After the failure of structural adjustment programme initiated in 1988, importance of good governance was recognized to overcome the economic problems. The World Bank was the first to use the notion of good governance in its report "From Crisis to Sustainable Growth - Sub Saharan Africa: A Long-Term Perspective Study" (World Bank, 1989). In this report aid ineffectiveness is connected with governance issues. Later on, Africa became the center of discussions on governance related issues. In the next years, the Bank considered good governance as a main part of its development policy. However, the World Bank in its report "Assessing Aid: What Works, What Doesn't, and Why" (Dollar and Pritchett, 1998), considered good governance as a selectivity criterion for granting aid.

    In above-mentioned report, the Bank described the collaboration between developmental aid and the quality of governance. The report highlighted the importance of quality of institutions and claimed that the effect of foreign aid on economic growth depended on the effective institutions and sound economic management. The report recommended that policy performance and reform commitment should be taken as selectivity criteria for the disbursement of aid instead of the considering developmental wants or level of poverty of borrowing country. The report also recommended that the Bank should focus on giving more expertise and financial resources on governance issues to achieve developmental objectives in the fellow countries.

    Other important international financial institutions including IMF, OECD, UNDP, ADB, regional developmental and multilateral agencies etc. are also actively endorsing governance issues. The variety of World Bank's programmes of governance that are related to conditionalities include public sector restructuring, civil service reorganizations, transparency, reorganiza- tion of delivery system, and judicial and legal reforms.

    The effectiveness of foreign aid is a debatable issue. There are many countries like Republic of Korea, Uganda, Indonesia, Vietnam, Ghana, Taiwan, Tanzania, Mozambique and Bolivia where foreign aid has played a substantial positive role in the development of the economy. There is also a list of several countries which received large amount of aid like Kenya, Papua New Guinea, Haiti, Somalia, Philippine, Congo but failed to use it for their development.

    According to recent Global Competitiveness Report, institutions of Pakistan are ranked at 115 out of 144 countries. Some indicators of institutions are given in Table 1.

    A clear picture of the government performance can be perceived from Table 1. All the above indicators show poor governance in Pakistan accord- ing to Global Competitiveness Report. The Pakistani business community has identified corruption as the most problematic factor in Pakistan. Inefficient governmental bureaucracy has been ranked as second problematic factor for doing business in the Pakistan.

    TABLE 1 Indicators of Institutions

    Pakistan's Ranking

    Indicators

    out of 144 countries

    Judicial independence 57

    Property rights 116

    Favouritism in decisions of government officials 129

    Irregular payments and bribes 119

    Organized crime 136

    Pakistan has been relying on foreign aid since 1947. Foreign aid is one of the key sources of income in Pakistan but foreign aid has not remained effective to improve the economic circumstances of Pakistan. The question arises that if foreign aid does not contribute to our developmental purpose then where does this foreign aid go? There is one view that foreign aid weakens quality of governance through high level of corruption, weak rule of law, weak institutions and absence of accountability, and leads to bad management; that's why foreign aid does not contribute to the process of growth. Durbarry (1998), Javid and Qayyum (2011), and Burnside and Dollar (2004) point out that foreign aid contributes to economic development in the environment of good policy or good governance otherwise it has no effect or otherwise this effect is negative.

    That's why this study has been planned to explore the impact of foreign aid on governance in Pakistan. Presently, there exists no such study that explores the connection between foreign aid and governance in case of Pakistan.

    OBJECTIVES OF THE STUDY

    The present study will analyze the relationship between foreign aid and governance in Pakistan. The objectives of study are:

    1. To empirically examine the effect of foreign aid on governance in Pakistan, and

    2. To explore the channels through which foreign aid influences governance.

    The present study attempts to analyze the relationship between foreign aid and governance in Pakistan. The rest of the study is organized as follows: the next Section provides an overview of the foreign aid in Pakistan, Section III gives a review of theoretical and empirical literature on the subject, and Section IV deals with model specification, description of the variables, data sources, and explains methodology. Section V discusses the results. Then concluding remarks and suggestions are provided in the last section.

  2. AN OVERVIEW OF FOREIGN AID IN PAKISTAN

    Pakistan has been the recipient of the foreign aid since 1947 and its volume has been increasing since then, however, with some periods of slow down. In 1960s and 1970s, this aid was available on easy terms and conditions. With the passage of time, Pakistan is facing difficulties in getting more aid.

    In 1960s, Pakistan received foreign aid equal to about 6.6 percent of the GNP. In early 1970s, Pakistan got foreign aid near to 4.2 percent of the GNP. The inflow of aid to Pakistan remained US $ 1.00 billion mark and the aid percentage to GNP was 5.5 percent in 1974-1975. The government started public investment programmes such as roads, social services, electric power and projects, like Pakistan Steel Mills and Indus Super Highway with the help these aid inflows. However, by late seventies (1977-78 and 1978-79), gross disbursements of foreign aid decreased as the United States cut down aid because of nuclear policy of Pakistan (Malik et al., 1994).

    Pakistan again got a huge amount of foreign aid (4.6 percent of GNP) during 1980s because of its frontline role in the America-Soviet Union clash over Afghanistan. In mid 1980s, the inflows of foreign aid touched US $ 2.0 billion mark per annum which boosted the credit worthiness of Pakistan (Le and Ataullah, 2006). Further, international aid sanctions, in particular by the Government of United States of America, were levied on Pakistan because of Pakistan's nuclear tests in 1998. As a result, other multilateral and bilateral aid also declined significantly during...

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