Measuring Aid Flows: A New Approach

Abstract

Conventional measures of aid are not designed to estimate the overall aid content of financial flows. Furthermore, they typically overstate the grant elements of concessional loans, thus understating relative aid flows to recipients getting mostly grants and from donors giving mostly grants (and loans in high-yield currencies). A new approach to measuring aid flows-Effective Development Assistance-focuses on the overall grant equivalent of official financial flows and allows meaningful comparisons of recipients or donors. Debate about the effectiveness of foreign aid has intensified in recent years, as budgetary pressures on aid have increased in donor countries. Whatever the merits of opposing arguments, the question is: do conventional measures of aid (such as OECD's Net ODA), which lump together grants and loans, accurately reflect true aid flows? Chang, Fernandez-Arias, and Serven analyze the methodological shortcomings of conventional measures of aid and propose a new approach, which measures official aid flows as the sum of grants and the grant-equivalents of official loans (in a new aggregate they call Effective Development Assistance, or EDA). They show how results using this conceptually superior measure may differ significantly from conventional aggregates, providing a quite different view on major aid trends. They implement their approach empirically using data on some 40,000 official loans from the World Bank's DRS database-virtually all of the official loans to 133 developing countries from 1975 to 1995. The numerical results underscore several points: - The conventional approach has led to systematic overestimates of the concessionality of official loans. This overestimate has increased significantly since the mid-1980s. Conventional methods show a rising trend; the new method shows the opposite. - Net ODA increasingly overstates the true aid content of official flows, although the divergence between the two approaches is somewhat muted by the rising relative importance of grants over loans in total official flows. This paper - a product of Macroeconomics and Growth, Development Research Group - is part of a larger effort in the group to understand the effectiveness of development aid. The authors may be contacted at cchang6@worldbank.org or lserven@worldbank.org.