Money For Nothing: Overstating Official Development Assistance

Aid projects can help young children in Africa obtain access to fresh drinking water.
Aid projects can help young children in Africa obtain access to fresh drinking water.

Recently a report by The Guardian exposed the troubling reality that some nations overvalue their ODA. By exploiting the antiquated formula for calculating ODA, which calls for interest rates on foreign aid loans to be less than 10% (grants are held to a 25% rate), countries like Germany, France and Japan, are taking credit for more aid than they actually give. Just how much more? David Roodman, the author of the Guardian article, estimated that billions of dollars in ODA is tacked on each year by manipulating one simple calculation. Last April, former chairman of the DAC Richard Manning warned in a letter to the Financial Times that fewer and fewer loans given by OECD countries are “concessional in character.”

The 2008 Financial Crisis upset the ODA equilibrium.
The 2008 Financial Crisis upset the ODA equilibrium.

After the 2008 Financial Crisis, interest rates fell but the 10% discount benchmark rate for ODA loans stayed the same, causing the imbalance that upset the equilibrium of ODA calculations. Roodman writes, “Today, rich nations can borrow at 2% or 3%, lend at 4% or 5%, and make a profit while calling the loan aid.” Further compounding the problem, the profits made on these loans go back into the financial system of the lending country.  These interest repayments, as they are called, are not subtracted from net ODA like capital repayments, skewing the final figures. In the case of Japan, who in 2011 took in $2.6 billion in interest repayments, a nation can actually receive more money from developing countries than it gives to them in ODA.

But which nations are receiving these loans? Manning explains in his letter that “France, Germany and the European Investment Bank” give loans to the middle-incomes countries of Latin America and Asia. These loans count as concessional ODA, but in reality they do not reflect the “real cost of capital” and rake in huge profits for the lending countries. As more countries have discovered this type of loan practice, Manning writes, we have seen a recent surge in ODA to middle-income countries and a slight drop-off in ODA to sub-Saharan Africa. In their defense, some lending countries argue that the rates also must reflect default risk. And to be fair, default risk is always a factor when lending to countries in dire straits.

Thankfully, Roodman reports, nearly all of the DAC countries employ a more effective calculation method in their handling of export credit arrangements. This method uses calculated differentiated discount rates based on currency values and the rate at which each country pays to borrow money. Unlike the 10% benchmark, which has held steady since 1972, differentiated discount rates are updated yearly to reflect current market forces.  In applied, this could be an effected method of calculating rates for ODA as well. But no matter the ultimate solution, the fact remains that our fifty-year-old method of ODA calculation is in desperate need of an update.

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2 thoughts on “Money For Nothing: Overstating Official Development Assistance

  1. Simon Scott March 28, 2014 / 11:21 am

    Dear Matt,

    Thanks for this contribution of the ODA reform debate, where you identify some of the technical and political issues which are currently under discussion at the OECD Development Assistance Committee.

    Readers interested in this subject might like to look at an analysis of options recently considered by an Expert Reference Group convened to provide some external advice on this issue – it’s available here: http://www.oecd.org/dac/externalfinancingfordevelopment/documentupload/ERG%20S3%20Jan%202014%20-%20Discussion%20Paper%20on%20Options%20for%20Concessionality%202014%2001.pdf.

    My colleague William Hynes and I last year set out some broader suggestions in another paper here: http://www.oecd.org/dac/externalfinancingfordevelopment/documentupload/Scott%20Hynes%20ODA%20paper%20Nov%202013.pdf, and on the loans issue in particular also look for work by David Roodman, and Jeroen Kwakkenbos at Eurodad.

    Finally, those interested in the whole debate can follow the latest developments on our website here: http://www.oecd.org/dac/financing-development.htm

    Simon Scott, OECD

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