1885. Aid, Taxation, and Development: Analytical Perspectives on Aid Effectiveness in Sub-Saharan Africa

Christopher S. Adam and Stephen A. O'Connell
(February 1998)

Designing effective aid programs requires accurately diagnosing problems. Under current donor efforts to promote democratization and institutional development, the shift from policy to institutional conditionality reflects an attempt by Africa's donors to recast the aid relationship from one that at best secures temporary policy changes to one that permanently alters institutions in favor of sustained growth and development.

The design of effective aid programs depends on the diagnosis of the problem. To say that institutional failures are central to Africa's poor economic performance is not to repudiate early interpretations based on policy failures and capital shortages. Institutional failures produce policy failures that in turn produce capital shortages or the equivalent.

Adam and O'Connell focus on the core of the evolving (mainly external) diagnosis of the African development problem, making these main points, among others:

• Tax and taxlike distortions tend to be high and volatile in Africa. These influence the allocation of national wealth and can reduce both the level and productivity of domestic investment. The composition of domestic investment seems to be more important in explaining poor African growth than the level of domestic investment.
• Policy-generated uncertainty (under-emphasized in the literature) can activate socially inefficient self-insurance mechanisms that reduce growth. When leaders have substantial discretion about policy, as they do in most African countries, executive transitions become a major source of uncertainty.
• Patronage is heavily used in African systems of personal rule. Governments use distortionary taxes to finance transfers to politically powerful groups.
• A government that is captive to a favored group will trade off growth for transfers, if the group is small enough relative to the government's disposable resources. In such a case, conditional aid can be ineffective in spurring growth and investment, even when the potential gains from aid are great.
• Conditionality is required to secure the gains from aid when nonrepresentative political structures generate a conflict of interest between donors and recipient governments. When donors are in a strong bargaining position, conditionality agreements that mandate a reduction in distortionary taxes will also require that some part of lost revenues be made up by cuts in politically motivated transfers. But policy conditionality is difficult to enforce and even when perfectly enforceable is subject to the problem of aid dependency.
• To avoid aid dependency, donors must focus on conditionality that shifts the "no aid" point. Under current donor efforts to promote democratization and institutional development, the shift from policy to institutional conditionality reflects an attempt by Africa's donors to recast the aid relationship from one that at best secures temporary policy changes to one that permanently alters institutions in favor of sustained growth and development.

This paper—a product of the Development Research Group—is part of the research project "Analytical Perspectives on Aid Effectiveness in Sub-Saharan Africa" (RPO 680-18). The study was funded by the Bank's Research Support Budget. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Kari Labrie, room MC3-347, telephone 202-473-1001, fax 202-522-3518, Internet address klabrie@worldbank.org. (46 pages)

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