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Forum for the Future of Aid

Southern Voices for Change in the International Aid System Project

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Policy Coherence: Aid, Trade and Investment

Source: North South Institute

In principle aid is used to assist low-income countries evolve an appropriate mix of policies and institutions to support their development goals. The efficiency and effectiveness of this process could be enhanced by increased coherence within and across the aid, trade, and investment policies which feature prominently in the donor-recipient relationship. Policy coherence exists when the gap between policy intent and outcome is minimized by using mutually supportive approaches in related policy areas in pursuit of a common goal. Policy coherence is naturally more complicated where national policy is significantly influenced by policy-making at the supranational level. In this case policy coherence requires harmonization through international cooperation around jointly determined and voluntarily accepted common norms and approaches.

Central to the aid relationship is a common understanding of development as societal transformation for the purpose of enhancing the abilities of all members of the society to shape their own lives. In this context, the goals of development combine income growth with poverty eradication and human development, while the “drivers” of development include macroeconomic stability, openness, good governance, quality infrastructure and strong institutions. Among these, openness and institutions are the most contentious and constitute the main sources of policy incoherence. In both cases, no general consensus has emerged regarding the best approaches, the adjustment processes and time paths for generating sustainable growth through policy and institutional reforms.

The aid relationship presumes an understanding that both sides share a common interest in achieving certain development objectives. It is characterized, however, by policy coherence issues arising from ineffective partnership and collaboration which in turn reflect donor prescription of policy and institutional reforms considered unacceptable by recipients, and unwillingness by donors to accept experimentation in these reform areas. Similarly, standard donor prescription that trade openness enhances growth and poverty reduction often clashes with recipient-country perspectives that are more nuanced because in low-income countries supply response capacity is typically limited, the adjustment process is slow and, hence, the expected efficiency gains are limited and/or delayed while up-front costs of liberalization are real and can be substantive. Finally, with regard to investment policy where donors have tended to push aid recipients towards full liberalization, the latter seem to prefer a two-track approach which promotes export-oriented foreign direct investment (FDI) through liberalization and attracts market-seeking FDI through protection.

In addition to policy coherence within each of aid, trade, and investment policy area, coherence across the three policy areas is also critical for enhancing the positive impact of development assistance. For instance, aid disbursement conditioned upon trade liberalization will lack policy coherence where the aid recipient’s economy has limited supply-response capacity or is patently unable to defray the short-run costs. Similarly, the donor provision of aid to particular low-income countries may be more or less offset when the donors simultaneously erect trade barriers against their exports. There are many examples of this conflict. For instance, distortions to agriculture in several donor countries lead to significant reduction in the real income of many aid-recipient countries.

Across the aid, trade, and investment policy areas, there is a fundamental difference in the perspectives of aid donors and recipients. The former generally expect that aid disbursement should go hand-in-hand with the liberalization of the trade and investment regimes of the aid recipients; while the latter contend that building their supply response capacity should have priority and, hence, that trade and investment policies must be coordinated and strategically linked and involve gradual, selective and differentiated liberalization.

Enhancing policy coherence and, thus, effectiveness of aid requires an appropriate mechanism for reconciling and accommodating these differences. This should encourage the aid-recipient country to articulate a consistent development program with coherent policies for dealing with identified constraints and indicating how and where external assistance is required. It should then permit donors to evaluate the program’s coherence and feasibility and, in the process, coordinate donors’ activities with the program as a basis for establishing a constructive and mutually beneficial partnership.

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