How Significant and Effective Has Foreign Aid to Indonesia Been?

Abstract

I. Introduction As the aid flow is becoming stringent and tied to policy reforms amidst growing or at best stagnant world poverty, the debate about the effectiveness of foreign aid has once again returned to the centre stage of development strategy. (1) After brief period of disillusion in the late 1960s and early 1970s about the effectiveness of aid, there was renewed hope that countries could be moved out of poverty through the allocation of aid. This saw rise in net aid flows to developing countries in real terms until the early 1990s (White 2004, pp. 235-36). However, disillusion about aid effectiveness again set in since the mid-1990s with little signs of world poverty disappearing (Hudson 2004). This has led to decline in net aid flows both in real terms and as percentage of donor countries' GNP. (2) Nonetheless aid is still regarded as essential for economic development and poverty reduction, especially for meeting the multilaterally agreed millennium development goals (MDGs). The need for increased aid flows has been highlighted at the March 2002 UN Summit on Finance and Development in Monterrey and the September 2002 UN Summit on Sustainable World Development in Johannesburg. Stern (2003, p. 14) has argued that meeting the challenges of the MDGs would depend on scaling up the international community's development efforts, which means not only increasing the quantities of aid, but also more importantly changing qualitatively from the past modes of doing business. Stern has also outlined the ways in which the World Bank and other donors are targeting and managing aid for improving efficiency or effectiveness of aid In short, donors have increasingly become selective in the allocation of aid to those countries with records of good policies and are attaching conditions on policy reforms and improving governance. Donors are now asking for detailed strategy for poverty reduction before agreeing to increased economic assistance. (3) However, recent work on aid effectiveness raised concerns about the manner in (and criteria by) which the reduced volume of aid is being allocated (Odedokun 2004, p. 229). Easterly (2003, p. 38) has expressed doubts about the effectiveness of selectivity in aid allocation. He has characterized the imposition of conditions as no than wistful hope, rather than policy with consequences in circumstances where a nation will selectively receive aid if it is 'good performer'--unless it is bad performer, in which case it will receive aid from the 'bad performer' fund. Easterly (2003) has also argued that donors are as much responsible for the past failure of aid as recipients. According to him, donors are judged by the amount of money spent and hence are driven by the desire to move money. (4) This creates potential moral hazard and incentive problems for both donors and recipients. He has, therefore, emphasized the need for independent evaluations of aid-funded projects as recommended by the Meltzler Commission (2000). Following the increase in aid-dependence (both in terms of volume and number of donors) in the wake of recent economic crisis, Indonesia has become almost test case for the issues pertaining to aid effectiveness, and both policy-makers and donors have devoted increased attention to aid effectiveness. It is widely believed that foreign assistance played significant role in Indonesia's success in terms of sustaining rapid growth for three decades until it was hit by the crisis in the late 1990s. Starting as an International Development Association (IDA) recipient in the late 1960s, Indonesia graduated to an International Bank for Reconstruction and Development (IBRD) client, and the bulk of its foreign financing since the early 1990s until the crisis was from commercial sources. (5) As matter of fact, Indonesia's graduation from one of the poorest countries to second-tier newly industrializing economy in less than three decades is in itself remarkable achievement matched by only handful of East and Southeast Asian countries. …