The Effectiveness of Foreign Aid in Bolivia

During the last five years, Bolivia received more than $US 3,000 million in foreign aid and more than $US 3,500 million in Foreign Direct Investment (FDI). The country also received debt relief with a net present value of $US 1,300 million and implemented a National Poverty Reduction Strategy. During the same period, however, the GDP growth rate fell from an average level of 4.7% between 1993 and 1998 to an average level of 1.7% between 1999 and 2002, relative and absolute poverty increased, and the fiscal deficit increased to 8.7% of GDP in 2002. These numbers suggest that neither foreign aid, nor debt relief, nor FDI has the capacity to increase growth rates and reduce poverty in Bolivia. This, however, is not necessarily true. It could be the case that without these positive shocks, the situation would have been even worse due to other negative shocks. The only way to separate the effects of different shocks is to use a Computable General Equilibrium (CGE) model, where the effects of changes in one variable can be analyzed while holding all other exogenous variables constant. The model used for this project contains a variety of sectors and household types which permits the analysis of aggregate effects on the GDP growth rate, the balance of payments, the fiscal deficit, etc, as well as distributional effects indicating who benefits and who is hurt by different policies. The distributional analysis is of particular importance when poverty is a main concern since aggregate GDP growth does not necessarily reduce poverty. Estimations by UDAPE indicate that the elasticities of poverty with respect to changes in GDP are extremely low in Bolivia: Only 0.3% in rural areas and 0.6% in urban areas. This means that during the last decade, growth in Bolivia has clearly not been pro-poor, despite the stated emphasis on poverty reduction. During the period 1998-2002, Bolivia received on average $614 million in foreign aid per year. For the period 2003-2006, there are commitments implying that this amount will increase to $872 million per year, which means an increase in the level of annual foreign aid of $258 million. This report used the CGE model to simulate the effect of additional foreign donations of $258 million per year for four years, after which the level of aid returns to its “normal” level. Such a simulation allows us to see the effects of the initial expansion, the effect of the subsequent contraction, as well as the long run effects after the temporary increase in foreign aid. The effects of this extra aid will obviously depend on how the money is used. Applying the combination of public spending and public investment that we consider most likely, the simulations show an increase in the GDP growth rate of approximately 1 percentage point per year during the four years of extra aid, but when the extra aid disappears, the growth rates return to their normal levels. It is important to stress that public investment in the model is assumed to produce public goods, which increase the productivity of everybody.