Dodging the Curse of Diamonds and Gold

PALO ALTO, California: The G-8 countries' recent announcement to cancel African debt and double foreign aid has occasioned a new discussion over the usefulness of aid. Critics argue against aid for corrupt countries, as it grants money to leaders who do not need to be accountable to their citizens. That judgment may, however, be hasty. Recent experience shows that with proper monitoring, aid to the states in the most trouble – those facing economic collapse and civil war – does work. The events of the last decades offer a crucial lesson about the usefulness of aid: While it is difficult to institute effective aid programs in resource-rich countries, aid can be successful in countries not endowed with resources like diamonds or oil. In either situation, however, aid cannot bring favorable results without proper monitoring.

A poster child of failed aid is the diamond-rich Democratic Republic of the Congo. The Congo (formerly Zaire) received aid from donors, like the World Bank, interested in reform; their efforts were unsuccessful. During the 1980s and 1990s, donors advocated policies to improve management of public resources and maximize confidence in the private sector. To this end, they sought to organize its tax and customs collection, reduce price controls, streamline its budget, and improve its infrastructure. But these reforms necessitated that Congolese President Mobutu Sese Seko, in power from 1965-1997, cede his private access to state wealth. Mobutu was unwilling. Instead, as Will Reno demonstrates in his book, Warlord Politics and African States, Mobutu used aid, along with profits from diamonds, to further amass his personal wealth. To defend his control over national resources, he financed a small military and bought loyalty from the Congo's most powerful people.

Due to Mobutu's manipulation of funds for personal enrichment, aid did not reach the intended recipients. Reno finds that, between 1972 and 1992, government expenditures on social services dropped from 17 percent to 0 percent, while government expenditures on the presidency increased from 28 percent to 95 percent. Meanwhile, the Congolese became poorer and died younger, as indicated by measures from the World Bank and the United Nations. This collapse in social well-being and public services parallels the Congo's economic collapse and recurring civil wars.

In spite of foreign aid, Congo has emerged as a textbook example of a failed state: a territory with internationally recognized boundaries that lacks domestic governance. The state doesn't (or can't) protect citizens from violence, and it doesn't (or can't) enforce contracts among them.

The reason for the failure in the Congo, and in resource-rich countries in general, is simple: Political leaders with alternative sources of revenue – namely, natural resources – are not dependent on the citizens who would benefit from reform. They also avoid reform because it demands that they build the very institutions that put their survival at risk. Thanks to profits from diamonds and oil, they have the luxury of foregoing aid and avoiding its conditionalities.

Are failed states like the Congo to be left for dead? Not necessarily. Resources seem less destructive when they're discovered within an already strong institutional environment, as in diamond-rich Botswana. Unlike the Congo, Botswana discovered diamonds after establishing post-colonial institutions. Today, donors emphasize transparent management of public resources, in the hopes of building strong institutional environments like that of Botswana. In oil-rich Nigeria, for instance, attempts at governmental revenue audits and contract disclosure are in progress. Other promising developments include programs that constrain the value of diamonds from civil-war zones, such as the UN-supported Kimberley Process, which attempts to certify diamond origins so that retailers avoid purchasing diamonds that fuel conflict. Nevertheless, the recent history of resource-rich states teaches us that their reform is extremely difficult.

Thus, while conventional wisdom about the inefficacy of aid seems true for resource-rich states, it could be much more effective in resource-poor countries. Recent studies by Shantayanan Deverajan and others at the World Bank suggest that aid could provide incentive for reform in resource-poor countries, but they don't tell us why. Leaders of failed states that lack resources need to find a steady source of income in order to survive. My ongoing research reveals that the need to secure aid flows has led these leaders to reform and to cooperate with political opponents. The more extensive the reform effort, the more investment they secure from donors, who are eager to support success stories.

Uganda illustrates this dynamic. When its president Yoweri Museveni took office in 1986, Uganda was a failed state. Museveni needed to fund his own survival – five out of the prior six regime changes in Uganda had occurred by force. Taxing would have been difficult since state institutions didn't function and Uganda's population was very poor. The economy for most citizens occurred through black markets, as it does in the Congo today. Furthermore, those with skills had left the country or been kicked out by Idi Amin, Uganda's ruler in the 1970s.

Museveni's first move was to request strategic bilateral aid from the Eastern bloc, which did not oblige. Next, he closed Uganda's economy, further eroding the economy. His final move was to accept multilateral aid from international financial institutions, including the World Bank. He developed strong relationships with these donors by reforming and taking responsibility for the reform program. He liberalized the economy, streamlined the civil service, implemented public finance management programs, and built roads. Growth rates and social indicators have steadily improved. In response to these results, Museveni secured a steady flow of aid, and is still in office.

Museveni's reforms were clearly motivated by a need to secure funding. But why hasn't Museveni's potential opposition challenged him? In such a situation, potential rivals choose not to overthrow the regime because they are uncertain of whether they will be better off if they replace their leader. By overthrowing him, they risk interrupting the flow of aid that he has established. Weighing this uncertainty against the more certain gains of aid benefits, opponents instead choose to seek positions in new institutions.

As Uganda shows us, donor leverage is strongest in resource-poor states. When donors are able to hold leaders accountable, aid can improve governance. The trouble is that donors have a weak record of monitoring. Sometimes they disburse aid in exchange for an alliance, as the US did in the late 1970s with Somalia and Sudan, or for basing rights, as in recent US assistance to Uzbekistan. In fact, strategic bilateral aid can be a resource like oil or diamonds – highly profitable, and requiring minimal labor. But even if the aid is meant for reform, as is aid from the World Bank or IMF, monitoring is often inconsistent. Former World Bank economist William Easterly points out that international financial institutions defend aid commitments based on a country's successes and failures at meeting demands. Kenya, he notes, received 21 loans between 1980 and 2000 - even though it failed to reform.

Concrete examples of how aid works in different countries should make critics more hesitant to condemn the effectiveness of aid. One rule may be that aid givers steer clear of countries brimming with oil and diamonds – and give assistance only to governments amenable to reform because of their dependence on domestic opinion and foreign money.