Setting limits on aid

The Financial Times hosted an interesting debate recently on the possibility of setting an upper limit on aid, a summary of which appears in today's print edition. The debate was prompted by Adrian Wood, a professor of international development at Oxford, who wrote an article proposing that aid donors should limit the amount of aid to any particular country at 50 percent of tax revenue. Many chimed in, including the inveterate critic of aid William Easterly, Tony Addison, Robert Wade, and others.

The crux of Adrian's argument, I think, is that aid dependence results in poor governance since recipient governments have little incentive to pay attention to their (tax-paying) citizens. Without getting into the thicket of arguments (you can do that yourself at FT or get even more at the Center for Global Development), I'll just point out that almost all of the debate centered on how to reduce aid dependence by reducing or modifying aid. That seems to me to miss half the point.

If we think of aid dependence as the ratio of aid - the numerator - and tax revenues - the denominator - in theory both of these could be adjusted. Although Robert Wade pointed out the connection between taxation and state capacity, noone made the rather obvious point that aid dependence could also be addressed by increasing tax revenues. (William Easterly is particularly skeptical of reforming the current donor agencies, but his proposal is to make the taxpayers of donor countries more aware of the problem of aid dependency.) If we want a sustainable solution to the problem of aid dependency, we also have to look at how to increase tax receipts - and that means figuring out how to increase the formalization of enterprises and reducing the disincentives to firm creation.