University of Kassel

Master of Arts thesis in Global Political Economy

Foreign aid and development: Success or failure in promoting Moldova`s

development?

Presented by

Valentin Lozovanu

31254320

valentin.lozovanu@student.uni-kassel.de

Supervisor: Prof. Dr. Aram Ziai

Prof. Dr. Christa Wichterich

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Statutory Declaration

I herewith formally declare that I have written the submitted dissertation independently. I did not

use any outside support except for the quoted literature and other sources mentioned in the paper.

I clearly marked and separately listed all of the literature and all of the other sources which I

employed when producing this academic work, either literally or in content.

I am aware that the violation of this regulation will lead to failure of the thesis.

Valentin Lozovanu x

Students name Students signature

31254320 15.01.2014

Matriculation number Kassel, date

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Contents

List of abbreviations 3

Chapter 1

1.1 Introduction 4

1.2 Conceptual framework

1.2.1 What is development? .............................................................................................................7

1.2.2 What is foreign aid? ..12

1.3 Literature review about foreign aid-development relation

1.3.1 Foreign aid as development cooperation (aid effectiveness) .14

1.3.1.1 Positive foreign aid development relationship .15

1.3.1.2 Negative foreign aid development relationship ...17

1.3.1.3 Conditional foreign aid development relationship ..19

1.3.2 Foreign aid as diplomacy ..21

Chapter 2

2.1. The overall context of intervention. Macroeconomic situation and development indicators for

the period studied ...27

2.2. Government`s development priorities .30

2.3. Donor`s assistance priorities ...34

2.4. The institutional framework of foreign aid management 43

Chapter 3

3.1. Analysis of foreign aid offered to Moldova (2004-2012) 49

3.2. The correlation of foreign aid with Moldova`s development priorities. Does aid promote

Moldova`s development? ..53

3.3. What are the constraints? 59

4. Conclusion ....68

5. Annexes .72

6. References .78

3

List of abbreviations

ADA Austrian Development Agency ATU Gagauzia Autonomous Territorial Unit Gagauzia (Moldova) CIB Comprehensive Institution Building CIS - Commonwealth of Independent States CEB Council of Europe Development Bank CBC Cross Border Cooperation CSP Country Strategy Paper CEFTA - Central European Free Trade Agreement CPIA - Country Policy and Institutional Assessment (CPIA) DCFTA Deep and Comprehensive Trade Agreement DFID - Department for International Development (UK) ENPI - European Neighborhood Partnership Instrument EBRD European bank for Reconstruction and Development EUBAM - European Union Border Assistance Mission EIDHR - European Initiative for Democracy and Human Rights EGPRS Economic Growth and Poverty Reduction Strategy ECA Europe and Central Asia region ESRP Economic Stabilization and Recovery Programme ENPAP - European Neighborhood Policy Action EIB European Investment Bank FP7 - Framework Programme 7 (EU) GIZ - Deutsche Gesellschaft fr Internationale Zusammenarbeit (German Society for International Cooperation, Ltd) INOGATE - Interstate Oil and Gas Transport to EuropeDAC OECD Development Assistance Committee of the Organization for Economic Cooperation and Development IFI International Financial Institutions INTERREG - Community initiative which aims to stimulate interregional cooperation IDA International Development Agency IFAD International Fund for Agriculture Development HDI Human Development Index MDG`s Millennium Development Goals MTEF - Medium-term budgetary framework MCC Millennium Challenge Corporation NCU National Coordination Unit NIP - National Indicative Programmes PRSP Poverty Reduction Strategy Paper PPP - Purchasing Power Parity PPIP - Partnership Principles Implementation Plan PIU`s - Project Implementation Unit PBA`s Programme Based Approach PCA Partnership Cooperation Agreement (EU) SDC Swiss Development Agency SIGMA - Support for Improvement in Governance and Management SWAP`s Sector Wide Approach Programmes ODA - Official Development Assistance UNICEF United Nations Children's Fund UNDP United Nations Development Programme UNSC United Nations Security Council UNCTAD - United Nations Conference on Trade and Development UNDAF - United Nations Development Assistance Framework UNDESA - United Nations Department of Economic and Social Affairs USAID - U.S. Agency for International Development TACIS - Technical Aid to the Commonwealth of Independent States TRACECA - Transport Corridor Europe-Caucasus-Asia TAIEX - Technical Assistance Information Exchange Twinning - Secondment of experts from the European Union institutions to a member state TIKA - Trk Isbirligi ve Kalkinma Idaresi Baskanligi (Turkish Cooperation and Development Agency) TTSIB - EU project Support to the State Chancellery Moldova KfW - Kreditanstalt Fr Wiederaufbau (German Development Bank) WTO World Trade Organization

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Introduction

Similarly with the other social sciences, the development concept has evolved as a highly contested

discipline combining different approaches and points of view about the meanings purposes and

ways of development. Currently, we assist in a long debate whether the development countries

constitute or not special case exception from the general rules guiding economic activity, are the

causes of failures originating from government or market, or maybe development is just a

system of knowledge originated in the West to impose a set of values, beliefs over the rest of the

world and not designed to bring any positive changes. What are the development paradigms

guiding the development and are these capable to improve the lives of people in poor countries?

Accordingly, the instrument of foreign aid designed to produce these changes in recipient countries

is assessed in terms of its effectiveness and purposes.

The persisting gap between the declared goals and present achievements during the decades of

development since its inauguration1 raises contrasting opinions about the effects of the foreign aid

on development. Though there are many cross country analysis trying to establish the effects of

foreign aid on development, these are often inaccurate given the variety of factors influencing the

process of development, but also different history and local circumstances which make each

country`s development story different. Therefore, I intend to examine the particular case of

Moldova, taking into consideration all these factors, define and explain both concepts of foreign

aid and development, institutional setting, specific approach followed by different donors and

measure whether foreign aid promotes development of Moldova. Is the disbursement of foreign

aid tied directly to country needs and follows developmental purposes? Or, contrarily, it is tied to

the interests of the donor countries and should be treated as a foreign policy instrument, or maybe

it is something in between?

Moldova is not selected as a random case study. Despite the fact that it had benefited already 22

years from Official Development Assistance (ODA) to support its development, its results are

doubtful. Although it had the highest per capita income in the Soviet Union, during independence

years since 1991 it has ended up with the lowest per capita in Europe23.This situation has

1 President Truman 1949 Inauguration speech http://www.youtube.com/watch?v=PXE-u4WanMI 2 http://www.globalpropertyguide.com/Europe/gdp-per-capita Moldova in 1994 had the highest domestic investment (55.8%) as a percentage of GDP (23.65% in 2010), and its HDI index in 1995 was 0.7 (in 2010 0.64). Source National Statistical Bureau and Human Development Index of Moldova publications. 3 This call into question both the effectiveness of the development efforts undertaken by both international donor community and Government`s. However, I will focus mostly on the analysis of foreign aid contribution for promotion of development efforts of Moldova fixed in its strategic planning documents.

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incited many development actors to extend their programs in Moldova and the level of their

assistance, but the question remain open: what effects does this assistance have for country`s

development given the questionable results from the previous rounds? Despite the growing

amounts of foreign aid, this field is mostly ignored by the academic scholarship in Moldova. The

works analyzing foreign aid are focused mostly on assessing it individually, in terms of

international aid effectiveness targets MDG`s (UN institutions), macroeconomic indicators fixed

in economic growth and poverty reduction (PRSPs of the WB, Memorandum of economic and

financial policies of IMF) or addressing the correlation of foreign aid with donor`s priorities

(bilateral aid), rather than assessing how overall the donor assistance is promoting the country`s

development strategy goals. No comprehensive assessment of how foreign aid promotes national

development priorities for a longer period (at least one decade) was done4. Moreover, the growing

international literature conclusions in this respect are divided and cannot alone provide answers as

there can be no one size fits all findings. It does not take into account the diversity of social,

political and historical contexts which makes each country development process story

different. Besides changing paradigms of development during different periods, there are

also various motivations guiding donor`s assistance for every case apart. The above-mentioned

gaps lead to the conclusion that foreign aid requires an examination for a better understanding

of its contribution to Moldova`s development process. Therefore, focusing on the particular case

of Moldova, I want to take into account all these particularities and reveal the role which it has for

development of Moldova.

The literature treats foreign aid differently by analyzing it mostly from the point of view of foreign

policy purposes or in terms of its effectiveness as a promoter of development. I intend to build a

common analytical framework which will examine both dimensions using Moldova as a specific

case. Given the participatory process through which the national development strategy is adopted,

it reflects not only the nationally agreed objectives but also Moldova`s international commitments

4 A first evaluation study published by a national think tank IDIS Viitorul only in 2010 http://www.viitorul.org/doc.php?l=en&idc=294&id=3525&t=/IDIS-Studies/Economy/Evaluation-of-Moldovasabsorption-capacity-of-external-assistance , two evaluation reports prepared by State Chancellery for 2011 and 2012 http://www.ncu.moldova.md/lib.php?l=en&idc=423 and periodical UN monitoring in accordance with aid efficiency DAC criteria (the last effectuated in 2010 http://www.un.md/donors/meetings/ . One chapter by Maia Sandu (pp. 311- 328) dedicated to foreign aid from Governance priorities 2009 http://www.e-democracy.md/files/prioritati-guvernare-2009.pdf (in Romanian).

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such as MDG`s5, European integration agreements of Moldova, IMF`s Memorandums and WB`s

Poverty reduction papers. At least formally, at the stage of commitments, donors are following

country`s development priorities due to ownership principles. Therefore, both of them - foreign

aid priorities and development paradigms of the donors and recipient will be examined. However,

given the limitation of research, I will focus on foreign aid alignment with development priorities

rather than the quality of the development strategies adopted. Using a qualitative approach I

analyze foreign aid for the last 10 years. I will examine foreign aid contribution by the extent to

which it has supported during the period the national priorities identified from 3 development

strategies - Economic growth and poverty reduction (20042006), National development strategy

(2008-2011), National development strategy Moldova 2020 (20122020) and priorities from

Government activity programme 2011-2014.

My working hypothesis is a) Foreign aid promotes the development priorities identified in these

documents and b) Aid reflects rather donor`s foreign concerns and therefore has moderate

achievements in addressing country`s development constraints. The theoretical framework

research is based on assumptions and conclusions advanced by different theories in respect to

foreign aid. I use the realist theory, as it is especially useful for analysis of foreign policy concerns

attached to bilateral aid and liberal theory, when assessing the economic dimension attached to the

principle of aid effectiveness. I divide the work in three chapters each with 2-3 subchapters. In the

first chapter, I begin with explanation of the method used, clarification of the concepts and the

literature review about foreign aid and development. In the second, I will provide an analysis of

the macroeconomic situation and development indicators, donor`s priorities and aid management

institutional setting. The third will assess amounts of foreign aid allocated for Moldova with data

about sectors assisted, terms of aid (credit/grant) and how the donor`s aid promotes development

targets in the national planning documents, the existing constraints for both donors and

Government. I will try to identify which aid is producing desirable changes and promotes

development, or seems reflecting mostly donor`s foreign policy objectives. Conclusion will

summarize and connect the findings from the previous chapters and will provide an answer to the

research question.

5 The internationally development objectives to which Moldova has committed such as MDGs and the commitments taken within EU integration, or IMF`s Memorandum and World Bank Poverty reduction documents are taken into consideration at the moment when the national development strategy is adopted.

7

K: Are you redoing the African thing? L: Yes. We had a version which is in the front office and we are redoing it some more. You can

look at what you have or wait for what is in the typewriter now. It will not be tremendously different. We gave you a draft about two days which was bounced back.

K: It was not much. L: We don't have much of a policy.

K: What would be a policy? L: That it is, I think, it is a sober, restrained.

K: I don't mind giving them what our intentions are. It is not always possible to do a hell of a lot L: Right. It is our lowest priority, but it cannot say that. But it is a fact of life.

K: We can say something about forthcoming aspirations. L: You mean for development?

K: Right6.

1.2. Conceptual framework

1.2.1. What is development?

Nowadays perhaps no policy maker would not be so cynical about the phenomenon of

development. However, despite the increased significance of the development process during the

last decades, as this excerpt illustrates, the notion is far from being as unambiguous. It can have

different perceptions and serve various purposes. There are different meanings attached by various

authors to the notion of development. I will refer to the most important paradigms of development

having influenced the concept and how these have changed during time. The analysis of the value

of the notion of development can be differentiated in three broad categories.

The first one is a historical arguably relatively value free and long term systemic vision of

development (major societal shift from traditional to modern characteristics). The second a

short to medium term policy evaluative value of judgment (development as PRSP, MDGs). The

third group is constituted from post-modernist approaches focusing on the analysis of the

ideological content of development discourse and looking for alternative system of values (Sumner

and Tribe 2008, p.11). Other approaches focus their attention on the means to attain economic

development and oppose different instruments of how to achieve it. The agency is developmental

state using active government policies to guide economic forces by treating market failures and

6 Kissinger: when you dont have a foreign policy, talk about development! A transcript of a 1975 telephone call between Henry Kissinger and his long-time aide Winston Lord on the knotty problem of what to say about Africa in an upcoming speech http://www.globaldashboard.org/2013/08/09/kissinger-when-you-dont-have-a-foreign-policy-talk-about-development/ .

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lifting the standards of life of peoples. Or using the neoliberal view, it can be the market. In this

case, the state interferences in the economy must be limited, as these are believed to produce

government failures (Gilpin 2001, pp. 305-312).

These conceptualizations of development evolved in different periods of time with a considerable

influence on the meaning of development and have reflected largely the changes occurred in social

sciences as economics, political science etc. It was a response to different necessities of society

such as problems of economic development, addressing the problems generated by progress,

overpopulation, urban squalor, job loss etc. later translated into necessity of political and social

modernization, colonial economics, human development or more radical approaches as

dependency and post-development theories (Pieterse 2010, pp. 5-8). Development encompasses

continuous change in a variety of aspects of human society and its dimensions are multiple:

economic, legal, politic and institutional structures, technologies, environment, religion, arts and

culture (Sumner and Tribe 2008, p. 11). The majority of works designate development as a

continuous change in various aspects of the human society for better, although the notion of good

change raises many questions. There is no univocal answer about what is good and what kind of

changes are needed, (Sumner and Tribe 2008, p. 11) or moving towards which modernity?

(Pieterse 2010, p.1)

From the very beginning, the focus of development was on the economic meaning. In the first

instance, the concept of development appeared with the works of the classics Adam Smith and

Karl Marx preoccupied with addressing the problems of economic development envisaging

structural long term transformation of the society. The meaning of development was focused on a

long term process of historical change, through industrialization, shifts of economy from rural

agricultural to urban industrialized society producing a transition from traditional to modern

society and involving structural changes such as capital accumulation regimes and propriety over

the means of production (Sumner and Tribe 2008, p. 12). In 19th century, economic development

has characterized the efforts of the latecomers (US, Japan, Germany) catching up strategies to

converge with developed world. In modern times, it has evolved into 1950-60 Big Push theory of

economic growth embraced by post-war decolonized world, as part of efforts to provide better

lives for their citizens and need to consolidate economic independence to their newly won political

freedom. The Keynesian economics emerged from deep Depression of 1920-21 were predominant

at that time, as states were preoccupied with postwar efforts to promote economic growth and

social welfare. Development was perceived as the agency of state in the process of modernization

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of society and rise of its income (Rapley 2007, pp. 1-4). The Lewis model, as one of the elements

of the Big Push plan, represented an economic growth based on a transfer of resources out of

traditional sector to a more performing through increasing investments in it. The main features of

this model in 1950-1960 were industrialization and import substitution with Government playing

the central role (Stern 2002, pp. 44-47). The least developed countries have used import

substitution strategies to stimulate the technological progress of their economies, as part of their

attempts to raise the value of their exports and avoid the primary resources export trap which

dominated their economies since colonial times. In their efforts, they have been guided by

dependency theory considerations to escape dependent accumulation, or development of

underdevelopment (Pieterse 2010, p. 6). Postwar developmentalism relied on national

accumulation (auto centric development) and the conviction that the less developed countries were

different from more advanced industrialized and their economies were functioning according to

different principles - represent a special case. By late 1970, the Keynesian economics entered in

crisis after a number of severe debt crises (oil shock 1973, Mexican crisis 1976 and 1982). The

neoclassical economics (neoliberalism) became more popular and prevailed in academic and

policy circles with the exception of several least developed countries and some organizations (such

as UNCTAD). The neoliberal theory has neglected the premises of developmentalist state as

special case and has instead insisted on reliance on market mechanisms. The state is not anymore

seen as an active actor in economic development, but rather this function is entrusted to market

forces. An active government intervention in this case means market distortion (Pieterse 2010, p.

7).The paradigm shifted in late 1970 to microeconomic principles and to measurements of poverty

and inequality dimension. Then after, in 1980 attention was brought to structural adjustment and

debt reducing and in the 1990 focus shifted to institutions development especially those in charge

of rule of law and financial system. Social cohesion was seen as an important basis for sound

policies and growth. It was recognized that financing gaps is not working because the progress

was hindered by inadequate institutions and policy framework. The reform of these constraints

was a complex contingent upon more elaborate process than simple making foreign aid conditional

on concrete policy measures. Given that it was recognized that conditionality could not be forced

upon Governments, except when these policies could be accepted by them as necessary, ownership

principle emerged with the recognition that country must be in the driver seat, if the reform are to

succeed. Thus, must efforts of the foreign aid turned on building institution capacity as

prerequisites for development. (Stern 2002, pp. 44-47).

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Another approach, human development paradigm7 emerged in 1980` aims to expand the freedoms

and incapacitate the people. It`s is based on removal of different types of unfreedoms which hinder

the empowerment of people to exercise their agency (Sen 2000, p. 13). This concept is more

general than those pursuing some narrower views of development such as gross national product,

rise in personal incomes, industrialization, technological progress or social development. All this

particular aspects can be useful for development growth of incomes will expand the freedoms

enjoyed by particulars of society, but nevertheless, the whole process will depend also on other

factors such as social economic arrangements (access to education, health care etc.), political and

civil rights (liberty of participation in public discussion), industrialization and technological

progress etc. Therefore, if freedom is what development advances than it is important to

concentrate rather on this major objective than on particular means of advancement of

development (idem, p. 5).

A different view has the post developmental theory which rejects the concept of development

itself. Post-development thinking represents a different more radical thinking opposed to structural

theories of transformation of society, development itself, which is considered as a constructed

reality that does not exists outside of discourse. Post development criticizes the ahistorical model

of change of developmentalism which created the construct of Third world and the West that

doesn`t have a basis in historical reality, as the modernization paths followed by western countries

(early, late industrializers) differed according to periods and contexts from the ideology of

development (Pieterse 2010, p. 29). Development is a discourse which shapes and frames the

reality and power relations by valuing certain aspects over the others (Sumner and Tribe 2008,

p.10). Development was equated to modernity and with this it has constructed a discourse of

superiority. By constructing the term of developed and developing countries and the concept

of modernity this created a rationale for the interventions of the first into the affairs of the second

group (Pieterse 2010, pp.1-9). One of the reasons of this more pessimistic view about aid is due to

the fact that the struggle against poverty (which was the mantra of the development strategies),

elimination of social disparities and environmental degradation and others which were supposed

to be addressed with the help of aid to promote development has not succeeded. In many respects,

the situation is even worse in the countries of the South (with the exception of Southeast Asia)

than before when this assistance did not exist (Rist 2008, p. 239). By making poverty elimination

7 A paradigm on which MDGs are based and which guides the activity of such organizations as UN agencies

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their main goal the development agencies emphasize good governance principles, as a more

effective measure to achieve pro poor strategies of growth and eradicate poverty than just pooling

more and more resources. However, only by addressing the effects of poverty and not of its causes

they perpetuate the problem, proliferate the rationale and legitimize their intervention in every

domain of social life. For this reason, the problem is not the poverty but development itself which

is getting involved in all aspects of the life of society (Rist 2008, pp. 232-233, Peet 2009, pp. 229-

230).

Hence, development studies can be seen as a crisis prone science, a field of struggle which is a

subject to rethinking for alternative solutions and as an intellectual activity guided by political and

social forces (ibid., pp. 1-2). The question about the concept of development remains one of high

controversy and the academic debates most probably will continue in their quest for better

understanding the field and to propose improved or alternative solutions.

A more precise definition for reconciliation of different approaches is development as the

organized intervention in collective affairs according to a standard of improvement. (Pieterse

2010, p. 3). It is this definition of the concept of development which I will use in my analysis, in

particular the standards of improvement fixed in the development strategies (EGPRS 2004-2006,

NDS 2008-2011, NDS Moldova 2012-2020, Government Activity Program European

Integration: Freedom, Democracy, Welfare, 2011-2014) which included the national priorities

and international development commitments undertaken by the Government of Moldova (EU-

Moldova Action Plan 2005-2008, WB PRSP`s, IMF`s Memorandum of economic and financial

policies, MDG`s). Nowadays, development strategies followed by countries and donors doesn`t

follow a unique approach towards development, rather these can include several development

paradigms at the same time8. These aspects I will address in separate chapters describing

Government development and donor`s assistance priorities.

8 The donors compete advocating their agenda to be included in the country`s NDS (WB/IMF from one hand with a more economic growth and poverty reduction concept and UN family institutions pleading for human development centered approaches.

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1.2.2. What is foreign aid?

Foreign aid can have different forms and definitions. According to OECD foreign aid9 is delivered

through official bilateral and multilateral channels. The definition provided by the Development

Assistance Committee (DAC) of the Organization for Economic Cooperation and Development

(OECD) is Flows of official financing administered with the promotion of the economic

development and welfare of developing countries as the main objective, and which are

concessional10 in character with a grant element of at least 25 percent (using a fixed 10 percent

rate of discount). By convention, ODA flows comprise disbursements by bilateral donors and to

multilateral institutions. ODA receipts comprise disbursements by bilateral donors and multilateral

institutions11. ODA is considered as the amount of grants and loans offered to recipient countries

which satisfy these conditions. From different categories of aid technical assistance is considered

ODA while funds accorded for military, private transfers for individuals, donations from

international civil society organizations, commercial funds and foreign direct investments are not.

The purposes of aid are very diverse ranging from macro-financial stability, policy and

institutional capacity building support (good governance), civil society, private sector

development, sector support such as environmental, education, health, etc. or infrastructure

building and humanitarian emergencies (Tarp 2006, pp. 13-44). Further, in my analysis I will use

the meaning provided by OECD for ODA when describing foreign aid.

The official reasons for giving aid are developmental. Foreign aid is used to address a number of

constraints for the economic growth such low level of savings and investment, insufficient

amounts of foreign exchange or because of both. Foreign aid is considered to fill this gap by

supplementing the domestic savings and foreign exchanges which in turn increase investments and

spur growth. Therefore, after a period of help the economies of recipient countries would register

growth and the need for foreign aid would disappear. This approach was known as two gap model

of aid similar with the Harrod Domar growth model (Addison et all 2005, p. 1). The beginning

of the development theory emphasized the economic growth as contingent on capital formation

and large scale infrastructure building (Lewis, Nurkse). Later, it has evolved and aid was seen as

9 The criticism of foreign aid assistance has led to its rebranding into development cooperation (Pieterse 2010, p. 60). 10 Concessional loan - These are loans that are extended on terms substantially more generous than market loans. The concessionality is achieved either through interest rates below those available on the market or by grace periods, or a combination of these. Concessional loans typically have long grace periods. 11 OECD Glossary of terms http://www.oecd.org/site/dacsmpd11/glossary.htm, http://stats.oecd.org/glossary/detail.asp?ID=6043

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providing the necessary capital to fill the savings and foreign exchange gap and push the economy

into self-sustaining development (Harrod-Domar gap growth model). The model assumes that

there is an excess of labor, low levels of productivity and capital. In order for an economy to grow,

savings are necessary, a constraint which foreign aid can fix to produce higher investment,

productivity, savings and growth. Additionally, foreign aid can fill the gap created by insufficient

level of foreign exchange because of the low export earnings required for the import of capital for

investment. A third gap is the low fiscal capacity to collect the revenues to cover the required level

of investment. Therefore, aid is seen as capable to fill the gap in savings, foreign exchange and

domestic revenues which will result in higher level of savings, investment and growth. (Radelet

2006, p. 9). In many cases, official donors required that recipient countries pursue reforms or

policies that the donors consider should promote economic growth. In the case of multilateral

organizations such as WB, IMF the requirements are known as stabilization and adjustment

conditions. Some researchers affirm that the policy reforms suggested by these institutions have

been counterproductive and caused economic and social decline rather than growth. Others, insist

on the idea that the main causes of inefficiencies are laying in the bad implementation of reforms

and deficient governance of these countries unwilling to adopt the right approaches. However,

as the practice of aid has revealed later, the reform of these constraints was a complex process

contingent on a more elaborate process than simple making foreign aid conditional on a number

of policy measures (Tarp 2006, pp. 13-27).

Various ideas and motivations have led foreign aid especially as the changing conditions and

development paradigms evolved over time. Development is only one of its aims (Lancaster 2007,

p 2). Foreign aid was also often used to serve donor`s countries political interests by assisting

beneficiary policy and legal framework reforms or commercial as a modality to penetrate markets

and access resources (Tarp 2006, pp. 25-27). As Morgenthau has coined the famous expression

of the seeming and real innovations which the modern age has introduced into the practice of

foreign policy, none has proven more baffling to both understanding and action than foreign aid

(Morgenthau 1962, p 301).

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1.3 Literature review

Different theories gave diverse interpretations of the phenomenon of foreign aid. The realist theory

focuses on the purposes of aid as it sees as an instrument of diplomacy. Given its initial assumption

of states behaving in an anarchic environment, the realists see foreign aid as an instrument used to

ensure state security, protection of its political and economic interests. Therefore, taking into

consideration that aid in this case is given having donor`s interests at the core of motivation, its

capability to achieve developmental purposes are meagre. The Marxists school of thought and

postmodern tradition sees foreign aid through a dependency relationship between a group of

wealthy capital rich core and poor periphery countries. The first group of countries use their

position of dominance to control and exploit the resources of the second tying aid to policies,

services and goods for gaining access to markets and resources. The liberal strand of thought

concentrates on its economic dimension, in particular the effectiveness of development

cooperation to address the problems of globalization and interdependency such as environmental,

health etc. The constructivist theory interpret foreign aid as guided by normative principles, ideas

of humanity about the moral obligation of more affluent countries to help the poorer. Only in this

conditions an international order could prosper, when it is based on generosity and readiness to

cooperate in the interest of humanity (Lancaster 2007, pp. 3-4).

Nowadays, the debate in the literature about foreign aid is divided in two parts. One examines the

purposes of foreign aid and another focuses on the effectiveness of aid to achieve development.

During the last decades, the aid effectiveness aspect was more researched while the study of the

purposes of foreign aid was less prominent. Even after decades of study, currently, there is no

widely accepted consensus about the effects of foreign aid on development. The large literature on

this subject has not progressed in offering any hard conclusions.

I will start with the examination of the literature describing foreign aid as development cooperation

(aid effectiveness) which can be divided in several camps: positive, negative, and conditional

relationships with development. The first assumes that the allocation of aid will produce and

sustain the rates of growth. Foreign aid supplements the savings that a developing country is

lacking due to the poverty trap resources which invested lead to increasing savings and higher

growth. The long period and amounts of aid offered have not solved the problems of poverty and

underdevelopment and this has raised further questions about the effectiveness of this approach.

The second strand of thought findings are that aid is either displaced, has no impact on growth or

even harms fueling adverse processes. The third was introduced by the World Bank report

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Assessing Aid: What Works, What Doesnt and Why adding much controversy over the impact

of aid on growth as contingent on the policy regime of the country. It has been challenged by other

studies and now, the aid literature is split between those who consider that aid impact on growth

is depending on policy regime and those who contest this conclusion (Addison et all 2005, pp. 1-

2).

This strand of literature is added by another studying foreign aid purposes, considering aid as

representing an instrument of foreign policy. Bellow, I intend to present the literature explaining

the relationship of foreign aid with development, before I will proceed to the second chapter, where

I will analyze the macroeconomic situation of intervention and measure the development

indicators, present the donor`s and Government development priorities and the institutional

framework for aid management of Moldova.

1.3.1.1 Positive foreign aid-development relationships.

One of the main advocates of aid Jeffrey Sachs, campaigning for increasing financing of MDGs

finds that foreign aid helps to start capital accumulation, spurs economic growth, rise the incomes

of households and breaks the poverty trap in which the poor countries are caught. It can contribute

through three channels: a small part of it goes to households as humanitarian aid, the other finance

budgets to sustain public investments and private business through microfinance programs to

supply capital for small businesses. Where foreign aid is substantial and lasts enough it lifts the

revenues of households and break the poverty trap creating conditions for a self-sustaining growth

(Sachs 2005, p. 246).

Hansen and Tarp consider that cross-country analyses have failed to produce enough statistical

clarity of the relationship between aid and growth. However, the author argues that most studies

have produced the conclusion of a positive relationship between aid and growth. Foreign aid is

offered for many purposes and ways and the dilemma of aid is not whether aid works or not, but

how and when varied instrument can be made to work better in different country circumstances

(Hansen and Tarp 2000, pp. 19-20).

The study of Minoiu and Reddy argues that aid matters for growth and it can contribute

significantly, but only specific kinds of aid have this clear cut impact on growth and only in a long

term. Overall, foreign aid has a significant effect in those cases when it ranks high in the aid quality

index while geopolitical aid has been found with zero or negative effect on growth. Their

measurements did not show that aid is more effective in better policy environments, that there are

diminishing returns or income thresholds for the ability to use aid productively. Foreign aid matters

16

for growth and a change in composition of it (developmental rather than geopolitical) and an

increase of ODA will seemingly have substantial effects on the future growth of developing

countries (Minoiu and Reddy 2007, pp. 20-21).

Another study of Tarp argues that the cross country macroeconomic analysis shows positive effects

of aid on growth when longer time is taken into consideration. That does not imply that there are

no negative side effects or it can be inefficient, but that more work must be done in order to

improve it. Foreign aid effects are not as large as supposed initially and appear after a considerable

period of time 30 years of more. Therefore, alone, it cannot constitute itself a solution to poverty

(Tarp 2009, p.1). Tarp also considers that there are different purposes for which aid has been given

and the political motives guides the form and size of aid. If the priority of donor is not growth it is

obvious that the link between aid and growth will be weak. In addition, aid effectiveness factors

such as the lack of coordination between donors, conflicting assistance priorities, reduce the impact

of aid on growth (ibid., pp. 17-18).

Similarly, Radelet finds that the most important determinants of growth are foreign policy and

political relationships. Donors have a variety of motives to give aid and only some of them are

related to development. The bilateral aid is designed at least partially to serve the economic

interests of the donor countries (for example tied aid - to support certain objectives that support

specific groups in donors countries). Multilateral is less biased in this respect, although, it cannot

be judged immune to influences. However, overall, donors provide most of the concessional aid

to poorest countries. There was no simple relationship between aid and growth. Some countries

which received aid grew, others have had recorded slow or even negative results. Generally, aid

has a positive relationship with growth across countries, but not in each country and presents

diminishing results as the volume increases (Radelet 2006, pp. 6-8).

A study of Clemens at all points that the effects of aid on average are positive across countries, but

are limited in comparison with other factors of growth and negative in some countries. However,

on average, it has moderate positive effects on growth. To determine the correlation between aid

and growth it needs to be measured for a longer period of time and for those elements of aid which

can produce growth for this period (pp. 593-594). In this way, the divergence in findings of the

debate about the effects of aid might be solved and their findings might show a positive modest

effect of aid on growth. In addition, aid does not work everywhere and there are also countries

which have accomplished growth with relatively little aid (Clemens et all 2011, pp. 591-614).

17

The first strand of literature seems to suggest that when it is allocated for developmental purposes,

assessed for a longer period of time and in sufficient amounts, using varied instruments and of

good quality (addressing the coordination problems, harmonization of procedures etc. ensuring its

efficiency) aid can promote development.

1.3.1.2 Negative foreign aid development relationship

Contradictory with the works mentioned above, this section identified that aid has a negative

impact on recipient countries and fuels corruption, stagnation and dependency.

One of the most ardent critics of aid Dambisa Moyo considers that foreign aid given to elites

encourage rent seeking behavior (because aid is fungible), hinder reforms and spurs corruption. It

interferes in the rule of law, the work of institutions and deteriorates the respect of civil rights

which makes country unattractive for domestic and foreign investments. Fewer investments reduce

growth and increase poverty levels and given the pressure to lend, donors allocate more aid which

is diverted, so that the process is continuing in the same vicious circle. It establishes a dependency,

encourages corruption which has repercussions for growth and perpetuates underdevelopment

(Moyo 2009, p. 49). There are other bad practices of aid which impedes development in recipient

countries (Africa) such as: the pressure to lend, unambiguous criteria and decisions regarding the

level of corruptibility when financing should stop, lack of accountability, weakening the

capabilities of local institutions by attracting the best and brightest to work for donor`s agencies,

rising local rivalry for the access to it, putting pressures on local prices, unproductive use of loans

because of low absorption capacity, large unproductive public sector and country ownership (ibid.,

pp. 54-67).

Another critical work written by Easterly finds that the goal of development is too broad and it

seems unattainable so far. It is a reason which makes difficult the task to hold aid agencies

accountable and process any feedback. Easterly suggests that interventions should be more focused

on specific tasks. Aid might be used to attain development specific targets by solving specific tasks

where there is big demand such as reducing the incidence of malaria by providing access to water,

building roads, providing scholarships etc. In other words to transform poor individuals rather than

poor societies. Easterly is a proponent of bottom up process for a focused effort which could solve

each problem separately, rather than within a more general framework of development assistance

at the macro level. He argues that development has not stopped from just happening in its own

18

way without much involvement of experts or contribution by foreign aid in places like China,

India, Turkey, Chile, Vietnam etc. (Easterly 2012, pp. 8-10).

The study of Doucouliagos and Paldam showed that foreign aid has no significant importance, as

on average, aggregate development and aid flows are ineffective to generate growth. Moreover,

their analysis shows a pattern in the correlation between foreign aid and growth which keeps

declining. Aid effectiveness has not increased despite the declared donor`s goal in this respect and

the marginal contribution of additional aid on growth estimate is minimal. That does not mean that

aid is never effective but that total aid does not generate growth. Moreover, aid seems to have

considerable fungibility, so that projects financed by aid are different from projects caused by aid.

If aid is at the discretion of the recipient government, the latter can feel free to seek rents from

these funds (Doucouliagos and Paldam 2011, p. 16).

The work of Bauer and Yamey (1982) affirms that foreign aid is likely to hinder development.

This is because the economic results depend on the conduct of people and their governments

efforts and the slow progress of these societies cannot be overcome by foreign aid, but rather will

reinforce it. They argue that foreign aid`s monopoly on compassion, so that nobody can criticize

these transfers of resources as ineffective or damaging, allows them to claim that poor results are

due to insufficiency of aid. During decades, sufficient amounts have flowed towards recipient

governments which did not performed well and created perverse incentives. The access to aid of

recipients has absolved them from the necessity to create necessary conditions for external inflows

of capital. The tax revenues are kept low, because of availability of aid money extends the power

of the existing political status quo and their control over the society which results in its

politicization. It inhibits private enterprise and therefore the inflow of foreign investments, creates

overvalued exchange rates, increases domestic money supply and inflation, balance of payments

difficulties and produces deficient fiscal policies. Foreign aid also creates perverse incentives such

as pauperization of the countries in order to be eligible for aid, de-skilling and increases of

dependency of these societies on donors (Bauer and Yamey 1982, pp. 302-310).

Moreover, the work of Djankov et al (2006) concludes that foreign aid has a negative impact on

economic growth and democratic achievements of developing countries, because it reduces

investment and increases spending. The effectiveness of aid is affected by the type of aid disbursed

grants or loans. Contrary with some opinions (such as Sachs) that more aid should be given as

grants, it is suggested that loans are a more effective measure to ensure the effectiveness of aid

(Djankov et all 2006, p. 2). The argument is that if aid comes as loans, there are stronger incentives

19

to use these resources efficiently. The recipient country will take care to obtain a good return on

the investment in order to pay back the loan. In the case of grants, these are mostly increasing

public consumption. Their research has shown that increasing ODA has no effect on investment,

but it has a significant effect on government consumption. Foreign aid has positive effects if the

ratio of grants in aid is small enough (ibid., p. 17).

A latest study (2013) which measured the degree of achievement of MDGs (in support of which

foreign aid is mobilized by UN organizations) has revealed that cross country analysis of data does

not support the hypothesis of a causal linkage between the initiation and the acceleration of

progress of MDGs indicators. The universal acceleration of MDG indicators happened in 2000, or

earlier which means that this could not have been caused by the MDG declaration. The study has

found a significant acceleration in 7 from 19 MDG indicators and from these 7 indicators only 1

had changed in 2011 or later. Only total debt indicator has indicated considerable acceleration in

progress after 2000 indicating that activities to debt financing by MDGs were successful. This

might happen because countries were already focusing on these indicators (such as health), prior

to their adoption and attempts to improve them (Friedman 2013, pp. 27-37).

This part of literature indicates that foreign aid is unable to eliminate the systemic constraints for

development, but rather reinforces these introducing various distortions in the recipient countries.

The role of aid compared with other factors is actually not so significant. Various authors described

different causes such as: approach followed is deficient (a micro is preferred), aid is fungible and

its role and contribution for growth is minimal, it does not generate growth and the type of aid

spurs rather consumption than investment.

1.3.1.3 Conditional foreign aid development relationship

This group of studies agree that foreign aid can produce development, but it is contingent on local

policy environment and for this to succeed a set of conditions must be fulfilled. One of the most

influential work in this respect, the Assessing aid report findings are that foreign aid works well,

but only in good government environment. At various time and places aid has manifested

differently from effective to ineffective or somewhere between (Dollar and Pritchett 1998, p. 2).

Aid agencies work in difficult environments and the early development thinking suggested that

bringing more capital will help to promote development. Nevertheless, as the evidence has

demonstrated this was not the case. Support must be directed to spur reforms, rather than just

allocate resources. These resources need to be given to reformers with long term vision to support

20

more systemic transformation than just pockets of reforms or project success which will not be

easy to extrapolate at the national level (ibid., p. 117).

Similarly, the study of Burnside and Dollar says that aid has positive effects on growth in good

policy environment. Strategic interests of donors plays a significant importance in their decisions

for allocation of aid, whereas commercial are not so important. The most biased channels are

bilateral aid, while multilateral is considered as being oriented to alleviate poverty and achieve

growth (pp. 31 - 32). On average, aid has little impact on growth, but when offered for countries

with good policy environment, it proved to have a positive effect on growth. Given that bilateral

aid is often offered with donor`s paying more attention to achieve its purposes rather than promote

the growth of the recipient country economy, it is positively correlated with government

consumption which can explain why its impact on growth is not more positive (Burnside and

Dollar 1999, p. 37).

In his analysis McGillivray concludes that aid works, but it depends on the policy environments

in different countries. The effectiveness of aid in promoting development is contingent on factors

such as conflict, political stability, and governance. The best situations, where foreign aid seems

to work, are post conflict and structurally vulnerable countries, as well as politically stable regimes

with good governance results. It can have negative returns when aid inflows reach from 15 and 45

per cent of GDP, the limit indicating limited absorption capacity. The allocation of aid, even if not

always, become increasingly more development oriented. Foreign aid is associated with increased

expenditures and fungibility, but nevertheless, it helps to diminish poverty through pro-poor

expenditures (McGillivray 2003, pp. 5-10).

The analysis of Roodman (2004) alleges that foreign aid is probably not as decisive for

development as are domestic savings, inequality or governance. Some aid finances investments,

but this is done in an environment influenced by domestic policies, governance, external conditions

and other factors which influence productivity of investment. It is not homogeneous, has different

purposes and forms, and much of it is poorly used. Cross-country are not able to produce robust,

valid generalizations about when and whether aid works (Roodman 2004, pp. 274-275).

Finally, the study of Peter Boone (1995) argues that aid does not contribute to a significant rise in

investment, growth and human development indicators improvement, but it does increase

government consumption. Donor`s aid is highly variable, fungible and considerably politically

motivated. The efficiency of aid mechanisms depends on political regimes. Most of aid, in all

regimes, finance government spending and transfers to political supporters. However, in more

21

democratic regimes aid is more equally distributed within population because of people ability to

influence and mobilize support which depends on such factors as education, health and capacity

to organize. The main factors driving foreign aid are donor`s interests, rather than recipient needs.

Given the lack of correlation between increasing of aid and health sector indicators improvement,

the author concludes that aid does not introduce incentives to improve human development

indicators and that financing is not the main constraint for development. Foreign aid can be

effective when it is offered conditional on policy reforms and it is non-fungible. If reformist

regimes stay long enough in power to promote better education, health care, this can empower the

poor in the political system so that it could be self-sustaining (Boone 1995, pp. 1-28).

The last group of aid effectiveness studies affirm that the simple allocation of aid is not capable to

eliminate the constraints for development, that reforms must be carried to strengthen institutions

to allow efficient use of it. For this, foreign aid must have concrete conditionality contingent on

the policy environment, together with provision of more development oriented aid (multilateral

institutions are given as an example).

1.3.2 Foreign aid as diplomacy

This strand of literature is dominated by realist assumptions which considers foreign aid as an

instrument of foreign policy and has a more pessimistic view about its developmental potential. It

identifies different interests which guide donor`s policies of aid giving such as: geopolitical,

economic/commercial, humanitarian etc.

As the work of Finn Tarp (2009) acknowledges foreign aid is not just a transfer of resources, it has

often attached besides economic also policy strings. The effectiveness principle supposes that the

conditions tied to aid are for developmental purpose, but it also can contain commercial interests

of the donor. Bilateral aid is considered more biased in favor of donor`s interests than multilateral.

For multilateral aid such as WB and IMF the conditionality known as stabilization and

macroeconomic criteria has occasionally proved as counterproductive resulting in social and

economic distress, rather than progress in development. One cause why it might not be successful

is that it is given often in accordance with donor`s interest (Tarp 2009, p. 4).

The classic work of Hans Morgenthau indicates that foreign aid is by no way different than

diplomatic or military policy or propaganda. It is an instrument of the state interest. The expertise

is economic, but formulation and execution is political. In fact, development process depends on

internal factors such as existing intellectual, moral and political precondition and not so much on

22

the possibility of external manipulation to bring it. Its potential for successful change is much more

modest than generally accepted. Morgenthau distinguishes six policies which are pursued using

foreign aid: humanitarian, subsistence, military, bribery, prestige and economic development.

From all this types of policies only humanitarian is offered on non-political premises, but when

needed, it can also be used having diplomatic reasons. The economic development became an

ideology which legitimizes and rationalize the transfer of resources using an elaborate aid

apparatus. For instance, when subsistence aid is offered to purchase political favors or to help

maintain a status quo in the recipient country, it is always given as an assistance for economic

development, even if its real purposes are different. It is used to eliminate the deficit in the budget

of the recipient country, as an attempt to ensure stability, rather than promote some changes via

reforms. Similarly, prestige aid is made available using the same appearance that it intends to

improve economic situation of the recipient, even if it has other purposes. Usually, it is a piece

propagating recipient`s symbol of development to meet high expectations of the population and

serve a propagandistic role for elites. This kind of assistance is cheaper, faster and offers political

dividends for both donor and recipient. However, sometimes it is hardly distinguishable for donor

or recipient and produces errors in understanding what recipient actually needs, or what are the

real intentions of the donors. Therefore, in order to use it better, one must differentiate these 6

types of aid, choose the appropriate type of aid quantity and quality for each situation apart and

treat it as an integral part of political process (Morgenthau 1962, pp. 301-309).

Another work that of Berthlemy, analyzes foreign aid according to three variables: self-interests

of donors, recipient needs and their merits. The first is geopolitical or commercial and is specific

for bilateral donors. The estimation of the second is more complex, but most measure it by per

capita income of the recipient. The third, is a more general definition full of ambiguities and its

widely accepted as good governance criteria. The self-interest pursued by donors can reflect

several concerns such as geopolitical provided for political alliance, reflecting historical or

geographical factors (colonial past, proximity), or commercial (oriented to trade partners). The

author calculations showed that commercial interests have a big role in aid allocations in bilateral

aid which suggests that the motives of aid are rather egoistic than altruistic. Moreover, trade

linkages seem to matter more than geopolitical linkages. Bilateral donors do not behave similarly

and at least partially some of their aid is correlated with multilateral. The Nordic countries are

those who are least selfish from bilateral donors, but their aid constitutes rather an exception from

the general rule. Multilateral aid which is considered to follow more closely the principle of aid

23

effectiveness and that of EU is found to be influenced by commercial interests of US and Britain,

and also in a more limited extent by Japan. Recipient merits (governance) are only in the third

place after geopolitical, commercial interests and recipient needs, and it seems that it does not have

significant influence in donor allocation (Berthlemy 2006, pp. 79-99).

The study of Dreher et al (2008) finds a positive correlation between the status of non-permanent

member of UN Security Council and participation within IMF programs, even after accounting for

other influencing variables such as economic, political and country specific factors. The

international institutions seem to reflect the interests of the most powerful of its constituents and

the distribution of power within these reinforce the dominance of the key countries. The reason of

it is that using the institutions brings more legitimacy and lower costs than unilateral policy.

Therefore, besides economic variables guiding IMF policies politics matter as well. The non-

permanent members of UNSC in exchange of legitimacy are more likely to receive IMF loans and

with more favorable conditions than other countries (Dreher et al pp. 1-23). Similarly, an analysis

of Wittkopf (1973) says that states attempt to coerce one another to support their positions

in the UN under a threat of reducing foreign aid and this attempts are mostly characteristic to great

powers (Wittkopf 1973, pp. 869). Finally, a study of Kuziemko and Werker (2006) argues that

there is a large and positive effect of Security Council membership status on the foreign aid

receipts. An increase of approximately 59% in total aid from US and 8% from UN. Aid payments

sharply increase in the year in which a country is elected to the Security Council. These can get

significantly large especially during the key diplomatic years and recedes returning to previous

levels after the completion of the mandate. From UN agencies UNICEF and in a lesser extent

UNDP are those who allocate more aid after the countries from UNSC voted favorably for US

decision. Donor countries use aid strategically and do not prioritize humanitarian concerns when

designing their aid allocations (Kuziemko and Werker 2006, pp. 905-923).

For Mesquita and Alastair (2007) aid giving is a transaction in which donors purchase policy

support in exchange that parts of aid will be used to secure the recipient elites in power. It cannot

be expected from the leaders from developing countries to engage themselves in reforms, but rather

to follow a quid pro quo arrangement to back donors policy in exchange for aid sufficient for their

survival. Their selectorate theory says that the decisions of leaders with restricted exclusive

coalition are not to support the improvement of the welfare of the people. Only in a more broad

inclusive coalitions enhancing leader`s survival also means promoting public welfare (p. 225).

Foreign aid is more likely to favor big nations at the expense of small ones. Donors are more

24

induced to give aid for geographically proximal countries, than distant ones, although, the result

of measurements are not significant in this respect (de Mesquita and Alastair 2007, pp. 225 - 275).

Akram (2003) points out that the pattern of disbursements does not seem to have any ties with the

needs in developing and transitional economies (p. 1351). The level of per capita income in a

country is not decisive factor for the decisions of donor. Therefore, he concludes that the flow of

aid is not oriented to those countries with the most urgent need. This misalignment between human

needs and actual allocations raise some doubts about the real interests of donors and efficacy of

international aid regime (Akram 2003, pp. 1351-1356).

The findings of the Nielsen`s (2010) assessment of need orientation of donors suggests that aid is

more responsive in countries that donor find strategically important. The norms and ideas matter

in allocation of aid in the same way, as the recipient needs, however, donors tend to meet them

when it is also in their interest. Nielsen asserts that the current debate is divided between the

constructivists and realist strand of thought. The first one believes that in countries with strong

traditions of domestic redistribution and poverty reduction, domestic norms dictate the necessity

to allocate more aid to developing countries for economic redistribution and poverty alleviation.

The second, assumes that foreign aid is just an instrument of foreign policy. He resumes that

between these two opinions there is a middle ground emphasized by strategic development of

(Bermeo model) which consider that donors have interest to maximize both diplomacy and

development. The need orientation is a strategic choice by donors, rather than evidence of norms

and domestic considerations regarding poverty reduction in donor countries. This is because the

economic development of strategic important allies represents a goal for donors and it must be

effective. This indicates to a softer realism, humanitarianism with instrumental reasons attached

to it (Nielsen 2010, pp.3-26).

A study of Dreher et al (2013) describes foreign aid as significantly less effective when aid has

been granted for political reasons. Given that it is granted for political reasons, other than

developmental when the donor is not so much concerned about how the recipient uses aid, it results

in meagre outcomes. However, there are cases when politically motivated aid can have remarkable

results such as Marshall Plan for European countries, South Korea and Japan. In this case, it might

not only curry favor but also help allies recover economically. Foreign aid granted for short-term

geopolitical motives is less effective. In this respect, the aid committed during the time when a

country gets a non-permanent membership in the UNSC is not effective in terms of helping to spur

economic growth (Dreher et all 2013, pp. 5-35).

25

Bermeo (2010) developed the concept of strategic development which implies that foreign aid is

targeted to countries were the benefits for donors are high. These are not necessary the states that

are most in need, but rather those which are important for donor countries due to such factors as

proximity, historical ties, and economic interconnectedness between a particular industrialized-

and developing country. In an increasingly interdependent world wealthy countries are forced to

pursue development abroad. Thus, a developed country interested to improve its own welfare will

concentrate its efforts in poorer countries where the degree of interdependence between them are

high. Strategic interventions also respond to humanitarian goals although not always as it also

depends on the importance of a country for donor.

Strategic development concept also gives an interpretation of different approaches for aid giving.

Poorly governed countries receive a greater percentage of their aid in the form of technical

assistance and through non-governmental organizations. Additionally, in these countries donors

focus more on providing humanitarian assistance and aid for social services. The better governed

countries receive more in form of cash transfers for infrastructure. The more marginalized

countries, some of which already suffer from poverty, are in this way excluded (Bermeo 2010, pp.

1-4).

Nye (2011) analyzed foreign aid and describes it as soft and hard power in the hands of states. The

first category includes the transfer of money, services, ideas, concessional loans12 and grants which

have the capacity to attract and enforce the dependency of one state on the other. The hard power

represents the use of foreign aid enacted when it is withdrawn, asking the repayment of debts (after

a generous period of giving) or harshening the conditions of aid. It contains an element of coercion

based on asymmetric relation of dependence between the recipient and donor. The purposes for

aid giving by donors are different. For instance US is seen as offering aid for Egypt and Israel,

Pakistan and Afghanistan for security reasons. China increases its aid in Africa to get access to

vast reserves of natural resources and ties its assistance to concession contracts. The new bilateral

donors (China in particular, India, Brazil, Russia) do not follow the OECD aid effectiveness

principles to which the traditional donors have subscribed. Nye doesn`t exclude such cases when

foreign aid can follow humanitarian purposes if it is properly managed and the donors have the

12 To qualify as ODA, a flow must among other things be concessional in character. It must also convey a grant element of at least 25 per cent (calculated at a rate of discount of 10 per cent). When interest rates are low, it is easy to satisfy the grant element test. http://search.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=DCD/DAC(2013)2&docLanguage=En

26

interest to provide such kind of help. It must be gradual, to involve participation and allow time

for results to appear (Nye 2011, pp. 32-33).

Finally to conclude, Gilpin`s work (2011) gives a more general explanation of the purposes of

foreign aid. He also finds that foreign aid is given for national security or economic interests, rather

than humanitarian reasons. According to him Robert Keohane and Joseph Nye`s analysis of

political power and aspects of economic interdependence distinguishes two forms of dependency

sensitivity and vulnerability. The first one refers for example to changes in the interest rate in

one country to influence interest rate in another one. The second to the possibility of political

exploitation of market interdependencies. Individual states can have preferences to decrease their

dependence from other states through trade protection and industrial policies, or increase other

state`s dependence using foreign aid and trade concessions. Therefore, international economic

relations are never pure economics, it implies consequences for economic autonomy and political

independence of national societies (Gilpin 2001, pp. 81-93).

27

Chapter 2

2.1. The overall context of intervention. Macroeconomic situation and development indicators for the period studied

Since its independence in 1991 from the Soviet Union, Moldova has confronted with a conflict at

its eastern borders when a number of rayons13 from the region (known as Transnistria) have auto-

proclaimed as an independent state. This conflict had a profound impact on Moldova, from both

political and economic dimensions, as Transnistria held approximately a third of total industrial

production of Moldova and accounted for almost its entire energy production at the time of

breakup. The conflict has also delayed economic reforms, increased the political vulnerability and

internal instability of the country. It amplified the already difficult situation in which Moldova

found itself after the collapse of the Soviet Union to which Moldova`s economy was increasingly

connected, producing a large economic recession that worsened social indicators and raised the

level of poverty (Government 2012, p. 10). Besides the negative effects enumerated above, the

economic crisis in Russia from 1998 has affected severely the economy of Moldova, because its

exports were dominated by agricultural products increasingly dependent on Russia`s market.

Therefore, between 1991 until 2000 due to different factors such as deficient transition from state

planned to market economy model, delay in reforms, vulnerability of Moldovan economy and

complex geopolitical context, it was registered a reduction of GDP by two thirds. The

transformation in which Moldova has engaged also included a series of deep and socially costly

reforms. The liberalization, privatization and stabilization of the economy was marked with

political instability and deep economic recession. Moldova has a small economy which is

vulnerable to external shocks and climate factors because of its poor diversification of exports and

high portion of agriculture in its economy. Between 2001-2005 period Moldova registered high

economic growth with approximately 7% of GDP. In 2005-2006 the country suffered from a

commercial ban from Russia on vegetables and wine. These negative effects have been

complemented by an increase of the prices on natural gas that led to a contraction in growth. By

2008, benefitting from increasing inflows of remittances, its economy grew by more than 8%. But

the progress has been reversed in 2009 when the economic crisis has affected the economy of the

destination countries for Moldovan exports, reduced employment opportunities for workers abroad

and decreased remittance inflows. In 2011 and 2012 efforts were made to stabilize the economy

and reduce budget deficits (Bassiouni et al 2011, p. 1).

13 Administrative unit in some countries from the former URSS

28

The country remains one of the poorest countries in Europe in terms of GDP per capita (PPP) with

3,368 (USD) in 2012 (Table nr. 1 of the Annex).

The implementation of national MDG`s has been a challenging development agenda for Moldova.

After it has committed in 2000 to Millennium Declaration, the country has registered progresses

in meeting most of the MDG`s targets (21 out of the 27 national targets are on track). The most

important improvement was the reducing of the infant and child mortality, while other targets

remained unmet in such areas as education, gender equality, combatting HIV/AIDS and TB, better

access to improved water sources and sewage (Government 2012 p. 10). There is a risk that the

remaining unmet targets could not be achieved by 2015. The Gini coefficient has registered a

slight improvement between the years 2004 - 2010 from 36 to 33 (in a range between 0 and 100).

14

The HDI prospective of Moldova is that it is one of the least advanced in terms of human

development in Europe and among transition countries. It has registered a decreasing level of

human development (HDI) compared with 1990 (0,650), only in 2010 it has registered a moderate

growth to 0,660 (Government 2010, p. 5).

In terms of poverty reduction, basing on the ECA regional poverty line of USD 5/day at PPP, 94%

of the population was poor in 2002, but their number declined to 55% by 2011. The incidence of

extreme poverty (based on the ECA poverty line of USD 2.5/day at PPP) has been significantly

reduced in the same period from 57 to 10%. The national poverty rate fell from 30.2% in 2006 to

17.5% in 2011. The observed poverty reduction has been produced by growth derived from

increasing transfers such as remittances, better employment opportunities and earnings (WB 2013,

pp. 13-14).

Given its European integration aspirations (the signature of Association Agreement) and the

closeness to European Union borders, Moldova can benefit from opportunities emanating from

this new enabling environment, but it also needs to undertake important efforts to manage the

external factor risks which it is confronting due to its vulnerabilities. The involvement of EU in

the resolution of Transnistrian conflict has increased during the last years, particularly after the

EU-Moldova neighborhood policy action plan was adopted. However, the slow progress in solving

the Transnistrian conflict continues to pose a silent threat for further stability and development of

Moldova (UNDAF 2011, p. 1).

14 WDI (WB) data set http://databank.worldbank.org/data/views/reports/tableview.aspx# . For 2011 and 2012 data are not available.

29

During the 2004-2012 period Moldova has promoted active foreign economic relations. It has

concluded free trade agreements with most of the member countries of the Commonwealth of

Independent States (CIS), it is a member of WTO from 2001, joined CEFTA in 2007, and

benefitted from EU`s autonomous trade preferences. In 2013 Moldova and EU sealed the

Association agreement which is expected to be signed at the end of the next year. However, despite

liberalization of the trade regime, the slow pace of reforms has not produced also a viable and

diversified economic structure which would allow it to benefit from opportunities on the new

markets. For the whole period 1991-2012 the imports prevailed over the exports worsening the

trade balance, current account and ration of savings (Table nr. 1 of the Annex). The global

economic crisis has affected Moldovan economy reducing the inflows of remittances, exports, FDI

and ODA, revealing its unsustainable fiscal situation. The resulted unemployment and the pre-

electoral spending in 2009 campaign has only increased the large fiscal gap created. The 2008

crisis has shown the necessity for fiscal consolidation and structural reform on both dimensions:

public revenues and expenditures. Therefore, the efforts of the authorities have concentrated on

improving the taxation administration and rationalization of the expenditures, to redirect more

funds to finance investments and fulfil increasing demands for social assistance (Quehaja 2012,

pp. 3-4). As a consequence, the general government's fiscal deficit decreased from 6.3 % of GDP

in 2009 to 2.1% in 2012 (WB 2013, p. 11). Moldova has recovered from 2008-2009 financial

crisis, severe drought in 2007 and a ban from Russia in 2006 and is approaching the level of middle

income country status with 6, 4 % of growth in 2011. However, this tendency is not sustainable as

in 2012 growth has slowed down to -1 because of lower external demand for its exports and

decreasing remittances15. The low amounts of foreign investment in 2008 (12% of GDP) continued

the downward trend from 4% (2011) to 2, 2% of GDP in 2012, while the current account improved

in 2012 from 11, 3% of GDP to 7%. Recently, the authorities have undertaken efforts to improve

the business environment and to make country more attractive for foreign investments. The Global

Competitiveness report for 2012-2013 has reflected a better ranking for Moldova (87 position from

144 states assessed). In 2008-2009 Moldova was ranked 103rd out of 181 countries in the World

Bank Doing Business ranking and for 2014 the rank shows an improvement of 8 positions from

86 (2013) to 78. At the same time, the CPIA average measured by WB reflecting the quality of

institutions has improved from 3 in 2005 to 4 in 2012 from 616. The remittances will continue to

15 WDI (WB) http://databank.worldbank.org/data/views/reports/tableview.aspx 16 Data taken from WDI (WB) dataset http://databank.worldbank.org/data/views/reports/tableview.aspx#

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play a significant role (approximately 1, 2 billion in 2012), especially considering their effects for

poverty reduction and a source of foreign currency for the state. Improvements in fiscal

performance and growth in 2010-2011 have reduced public and publicly-guaranteed debt from 31

% of GDP in 2009 to 28% in 2011 and in 2012 constituted 23.8% of GDP. The debt percentage is

expected to continue to decrease (State Chancellery 2012, pp. 9-10, State Chancellery 2013, pp.

12-14, EU 2013, pp. 13-14). It is lower than the standard threshold and so far there are no signs

for concerns regarding the debt sustainability. Nevertheless, it should be managed careful, because

Moldova`s public debt servicing remains low. The situation with the private debt is more fragile,

as it was around 44% of GDP in 2009 2011 and is projected to grow over the medium term,

mostly as short term debt (European Commission 2013, pp. 33-34).

As the NDS Moldova 2020 reveals, without a concerted effort to change the development

paradigm, the potential of growth for the next 10 years is limited at maximum 4, 5%-5% annually.

This scenario is based on such assumptions that the labor outflows will be stopped and remittances

will remain at the current levels which cannot be guaranteed at all. Besides the fact that the inflows

of remittances are expected to diminish in the next decade, predictions show this increase is not

sufficient to converge with the comparable countries, even less European levels. Moldova is

penultimate country ranked with countries in the region in terms of GDP per capita at PPP after

Kirgizstan. Another paradigm of development based on exports and investment is necessary which

would allow Moldovan economy to continue to grow (NDS Moldova 2020 p. 6).

2.2. Government`s development priorities

In 2004 the first Poverty Reduction Strategy Paper was succeeded by a strategy for economic

growth and poverty reduction paper. It was built on three pillars: sustainable economic growth,

human development and social protection and inclusion. Deriving from these, the medium-term

objectives were focused on sustainable and inclusive economic growth, poverty and inequality

reduction, increased participation of the poor in economic development and human resources

development (Picard et al 2012, p. 18). The EGPRS was preceded by the signature in 2005 of the

EU Moldova Action Plan which gave a start for reforms to bring Moldova economically and

politically closer to EU. The EU Moldova Action Plan provides the basis for economic integration

contributing to adoption of economic and trade rules and standards to enhance trade, investment

and growth. It has also the objective to support development policies via social cohesion, poverty

reduction and protection of environment. There was a synergy between these two documents.

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EGPRS reflected European integration priority and was the main planning document, while EU

Moldova Action Plan was seen as guiding more closely the relations between Moldova and the

European community. Before the adoption of EGPRS, the planning process was considerably

complicated by a high number of sectorial level strategies, when Government found itself in a

situation to monitor and report simultaneously on approximately 50 various strategies. By adoption

of EGPRS, it was achieved a more coherent and strategic approach towards development. For

Moldova it was the first experience to elaborate such a development strategy and this caused some

difficulties. The mid-term expenditures framework did not manage to reflect fully the EGPRS

priorities, the progress indicators were broad and the weak administrative capacities have

precluded from obtaining better results in the sectorial level. Also, because of the lack of more

precise progress indicators, it was difficult to monitor more closely the progress and control the

efficiency of spending (Government 2012, pp. 13-15). As a consequence, the EGPRS monitoring

was sporadic, politicized and the results of the EGPRS did not achieve what was proposed. The

program contained an amalgam of different objectives and priority domains which has denaturized

the principle of priority17 (Sandu 2009 p, 317)18. There were lessons to be drawn from this

experience for the next development strategy (NDS 2008-2011). when Government learned to

focus more on cross cutting issues, rather than on policy sector priorities (Government 2012 pp.

13-15). In addition, given the country`s European integration aspirations, it was considered

necessary that the next strategy would incorporate the objectives of the EU-Moldova Plan in a

more holistic way (PPIP p. 2). Therefore, in 2007, the work on the elaboration of th