The World Bank takes the view that aid should be targeted at countries that have been pursuing ''good policies''. Writing in the June 2004 Economic Journal, Paul Mosley, John Hudson and Arjan Verschoor attack this position, questioning the definition of good policies and arguing that they must be extended to include the emphasis by governments in targeting expenditure to meet the needs of the poor.
Hence, these researchers contend, aid should not simply be targeted at poor countries, but the poorest inhabitants of those countries. It thus targets aid at the poorest of the poor rather than the more traditional scattergun approach, which sees aid benefiting everyone. They also argue the case for a return to ''conditionality'' – that is, the use of aid as a bargaining counter to generate policy reform. Work by World Bank economists David Burnside, Paul Collier and David Dollar has led to a major revaluation of the formerly widespread view that aid has failed to have a positive impact on growth and hence poverty. They argue that aid does work but only in a ''good policy environment'', the implication of which is that aid should be focused on low-income countries following good policies.
The paper by Mosley et al, in contrast with common practice, examines the effect of aid on poverty, rather than on economic growth. Apart from average living standards, a key impact on poverty is inequality. Also of importance is the composition of government expenditure, in particular the extent to which it is focused on the needs of the poor. Pro-poor expenditure (PPE) comprises elements such as spending on education, agriculture and health, which particularly benefits the poor and represents a significant new dimension in our thinking as to what constitutes ''good policies''.
Based on this analysis, an optimal allocation of aid is derived, which focuses on countries with high poverty and low inequality and also takes into account aid''s potential impact on PPE. This allocation contains significant differences from that derived using the World Bank''s approach and, for example, particularly benefits low-income, low-inequality countries such as Mozambique. Overall, this results in an improvement in aid''s impact of an estimated 12%, which year on year is not an inconsiderable amount.
However, Mosley et al believe that the impact of aid can be greater still if we fully take into account the potential to use it to influence policy reform. Conditionality has in the past got something of a bad name because of the frequent, almost ritualistic, process of developing countries reneging on agreed policy reform, with promises to do better in the future if given another tranche of aid, which duly materialises. Unlike the World Bank however, they argue that this necessitates a new approach to conditionality rather than its abandonment. In particular, they
argue for graduated penalties in future aid disbursements dependent on past policy reform slippage. Instead of an all or nothing approach by which developing countries either receive no punishment or are severely punished in
terms of their aid budget, a gradual approach is likely to secure much greater compliance in the same way as when the only penalty for stealing a sheep was hanging, many offenders were completely acquitted.
The law learned long ago that increasing penalties in line with the severity of the offence is the most efficient way to induce compliance with the law. The aid agencies need to take on board the same lesson. This ''new form conditionality'' also allows the opening up of a dialogue between donor and developing country, which enables the latter to develop a degree of ownership and commitment to policy reform and the former to gain greater understanding of the problems and constraints facing developing countries.
''Aid, Poverty Reduction and the ''New Conditionality'' by Paul Mosley, John Hudson and Arjan Verschoor is published in the June 2004 issue of the Economic Journal. Mosley is at the University of Sheffield; Hudson is at the University of Bath; and Verschoor is at the University of East Anglia.