History Says Financial Crisis Will Suppress Aid

October 13, 2008

Though today's financial crisis began in the world's richest nation, there is good reason to worry about how it will affect the world's poor. A recent series of posts explores the implications. The contagions of freeze-up and slowdown will spread through many channels: trade, investment, migration, and more.In particular, as governments pour trillions of dollars and euros of aid into their banks, it will be unsurprising if their spending on aid for poor countries---currently about $80 billion/year---falls. (See Saturday's story in the Washington Post.) After each previous financial crisis in a donor country since 1970, the country's aid has declined. "Every" in this case refers to four instances: Japan after its real estate and stock bubble burst in 1990; and Finland, Norway, and Sweden after their shared crisis in 1991.How much the global aid total will go down is naturally hard to predict since donors as a group in 2008 are not some statistical blend of 1990s Japan and Sweden. Will the political consensus in Britain to raise aid to 0.7% of gross domestic product flag? In the United States, Democratic presidential candidate Barack Obama has already suggested that the crisis would slow his promised doubling of U.S. aid, while his Republican rival John McCain has proposed a one-year spending freeze on everything but defense, veteran affairs, and entitlement programs.Also unclear is how long a dip would last. Sweden's and Norway's aid totals recovered in 6-9 years. Finland's and Japan's still haven't. The latest developments offer hope that most industrial economies will snap back within a few years, as Norway and Sweden did, rather than entering a protracted slowdown like Japan's. And bureacratic and budgetary inertia in may muffle the effects until 2010, as my colleague Mead Over predicts. But a decline over the next 5 years seems possible, even probable.Here are the graphs and data. (Financial crisis dates are from Luc Laeven and Fabian Valencia's new IMF Working Paper. Aid totals are Net Aid Transfers.)After the Nordic crisis of 1991, Norway's aid fell 10%, Sweden's 17%, and Finland's 62%—from peak to trough after adjusting for inflation. Finland’s plummet apparently owed to a deeper economic contraction: its economy at the time depended heavily on timber exports to the former Soviet Union, whose own economy was collapsing. (Hat tip to Rilli Lappalainen.) Those were the days when a forest products company named Nokia saw the writing on the wall and went into mobile phones.Foreign Aid from Nordic Countries, Adjust for Inflation and Indexed to 1991=100Japan did not officially experience a banking crisis until 1997, but the financial squeeze clearly began after the bubble popped in 1990. Japan's aid fell 44% between 1990 and 1996, and has never returned to its pre-crisis level.Foreign Aid from Japan, Adjusted for Inflation (Trillion 2000 Yen)Supporting dataForeign Aid from Nordic Countries, Adjusted for InflationForeign Aid from Japan, Adjusted for Inflation


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