Will this time be different? Financial crises and aid collapses over the last 30 years.

March 11, 2010

     By Duncan Green     

What impact do financial crises in rich countries have on their aid budgets? You would probably expect them to lead to a big bank bailout, producing a debt burden and a fiscal hangover, triggering bouts of cabinet infighting over public spending with aid coming off worst (after all, aid beneficiaries aren’t voters, at least in the donor country). Now some World Bank researchers have run the numbers from past financial crises and unfortunately (for aid), they agree.

‘This paper estimates how donor-country banking crises have affected aid flows in the past, using panel data from 24 donor countries between 1977 and 2007. The analysis finds that banking crises in donor countries are associated with a substantial additional fall in aid flows, beyond any income-related effects, perhaps because of the high fiscal costs of crisis and the debt hangover in the post-crisis periods. In most specifications, aid flows from crisis-affected countries fall by an average of 20 to 25 percent (relative to the counterfactual) and bottom out only about a decade after the banking crisis hits.’aid flows after a banking crisis 1977-2007

Here’s what the typical aid trajectory post crisis looks like. On average, aid keeps rising for 2-3 years after the start of the crisis, then goes into freefall for a decade and doesn’t recover its pre-crisis levels until 17 years after the start of the crisis.

In the UK at least, the good news is that both major parties have pledged to stick to ambitious targets for increasing aid despite the crisis. But governments everywhere will need plenty of scrutiny and public pressure if we’re to prove that (as they used to say during the boom years), ‘this time is different’.