Amidst the brouhaha over the Lancet article on aid fungibility, there’s one underlying question that seems not to have been addressed explicitly: what is the basis on which we expect funding (aid and domestic resources) to be allocated? I work in this field, and this basic problem has only been addressed with any quality in one place.
The comment on this topic is of sharply variable quality. Most of the voices critical of this evident of ‘fungibility’ deserve to be dismissed out of hand. Many suggest that by reducing own-funding to health the Governments concerned are committing a grave sin, based on absolutely no evidence on what the marginal return of the money moved was in the health sector compared to other sectors. These are single issue activists who lack the will or capacity to think more broadly than their specialism, and as Owen Barder has said, we should scorn them. Two contributions raise specific issues about resource allocation that we should explore further.
Not surprisingly, Owen’s is one of them, and his is the only contribution I would class as unreservedly useful, indeed excellent. He makes the most important point that we must hold in mind: the Lancet article actually does not address fungibility of aid. Aid would be fungible if the exact aid dollars that were earmarked for health could be used for education, transport or even private jets. What the Lancet article shows is that aid money in a sector can free up resources that the Government was always able to spend anywhere it wanted in a new area. That money was already fungible – it has simply been moved from one place to another in response to non-fungible funds. This is of crucial importance to this debate, because it means we can dismiss the question of fungibility altogether. What we are really talking about is resource allocation procedures governing the always-fungible Government resources.
Laura Freschi at Aid Watch makes the other contribution we should pay attention to, though I’m not uncritical of it. She says that donors use project support and earmarked funding to try and ‘force’ recipient Governments to use their resources ‘well’ by which she means ‘as the donors think they should’. This assumes that Governments will not change their own fungible resource allocation after the introduction of new, non-fungible resources by donors, so all aid money is purely additional to the sector it appears in. She says that if it doesn’t do this, then the argument for using earmarked funds disappears. This contribution is important, because it now introduces into the discussion the intentions of donor resource allocation and structure decisions, though I argue below this is an incomplete understanding of how it actually works.
So, how should resources for development be allocated, and how does the reality depart from this norm? Ideally, our resource allocation procedure would be entirely rational. Imagine a world in which no distinction is made between aid and local funds, and all money is fungible, the resource allocation procedure of Government should be straightforward. Looking at all the funds the Government has, it allocates a certain amount to core running costs (salaries, electricity bills and such) and then distributes the balance based on an analysis of the key constraints to the development of the country. If they have problems in health, education, infrastructure and private sector development, the rational resource allocation procedure would then address the constraining factors in each area. Given resources are scarce, we allocate them by looking at where the marginal benefit of each dollar is highest. If after we’ve spent $20 in health, we find that the marginal benefit in education is higher, we switch our attention there, and so on.
What we don’t do is just pour money in one sector until all the problems it faces disappear: doing this is counterintuitive, since after a point, each dollar would have a bigger impact in a different sector.
Now let’s complicate the picture with our first slice of reality. The donors provide some new funds, but they earmark them, so they are non-fungible. Say, originally, we had $100, and we gave $25 to each of the sectors I listed above. Now a donor comes in and gives us $25 that must be spent in health. Our decision of how to allocate the $100 has changed. We have $125, of which $25 is pre-committed to health. If our constraints and marginal benefit analysis tells us that marginal benefits are maximised by having equal funding in each area, then the new best approach is to use the $25 from the donor, and then increase this by $6.25 until we have $31.25 in this sector. Meanwhile, from our original $100 that was always fungible, we allocate $31.25 to each of the other three sectors. As such, we have now maximised the benefit of our spending by reducing our own health allocation, but increasing it overall.
Such is our ideal world. In reality, though neither Governments nor donors behave in this way. Take Governments first. Governments are political machines, and the incentives governing them are political. They use resources to strengthen patronage networks through the differential allocation of development projects, and even simple handouts. They also choose politically prestigious projects, such as fancy new buildings, roads or subsidies. Finally, they have a genuinely developmental incentive, since a better economy and country wins votes, too, though questions of ideology and politics can determine what kind of ‘better’ country this means.
These three incentives work in different ways, and mean that they don’t simply allocate resources according to the best marginal benefit. Instead, they pursue a number of objectives simultaneously, and this lends budgeting and resource allocation a chaotic feel. I’ve interacted with budgets in several African countries, and don’t think in any is it a fully or even largely rational allocation process. It’s very much a balancing act, with the real decisions taken far away from the technocrats (I’m not saying it’s a world different in the West, by the way).
This complicates things greatly: we are dealing with a mix of good intentions, bad ones and mixed ones. But it gets even more complicated when the donors’ own mixed up incentives. We saw that Freschi argued that earmarking was an attempt to fix Government allocations, one that was failing. This is only a small part of the story. In fact, earmarking has probably got more to do with the areas where a donor country office finds it acceptable to spend vis-à-vis its paymasters, be they Parliament, electorate or a Board. Most bilaterals spend in Health, HIV/AIDS, Water and Sanitation, and Education because these are easy sells – far more so than the unromantic realms of tax collection, private sector development and infrastructure development.
What’s more, when donors earmark they also don’t generally expect to peg the Governments’ domestic expenditures. When they do, they make this explicit. In Malawi, for example, under the conditions of the Health Sector Wide Approach the Government were compelled to maintain real funding levels to the health sector or donor funding would be reduced. This is easy enough to apply. If it isn’t, earmarking is probably motivated by a desire on the part of donors to protect a minimum expenditure in a given sector such as health (the level of their earmarked aid) rather than to influence Government resource allocation decisions – i.e. it assumes some level of reallocation of local resources.
As this makes clear, the donor’s incentives are not clean and simple to unbundled either: they gravitate towards certain sectors because they are more popular, and they design their aid modalities package based on a range of assumptions of Government behaviour.
What this leaves us with is a far knottier and scarier problem than fungibility of aid. It’s ultimately a question of the incentives facing both donor and Government agencies. These incentives are complicated, working in many ways at the same time, with results that are sometimes positive and sometimes negative. Solving this has nothing to do with fungibility questions. We need to improve resource allocation decisions by Governments by helping realign their incentives. Transparency and financial management is part of this, but it goes much deeper: the political settlements in most countries are a major part of the problem. Electorates captured in a web of patronage won’t want a more rational resource allocation procedure, they will wish to continue to reap the rewards they get. The ones in opposition search not for fairness, but their time in the sun. This is what needs to change.
On the donor side, marketization of aid may improve much, but ultimately, the decisions that lie behind developed country Governments giving aid at all are political. Not all uses of this money are equal, because of electoral pressures and political objectives. A better educated electorate and a clearer demarcation between aid and realpolitik-based state-building will go further in addressing these unhappy incentives.
What’s good about this whole controversy is that we can go beyond the shallow thinking that characterised many first responses and start thinking about what really needs change.