277 privatesector P U B L I C P O L I C Y F O R T H E NUMBER NOTE 2004 Aid Agency Competition OCTOBER Tim Harford, Bita A Century of Entry, but No Exit Hadjimichael, and Michael Klein Critics of the aid industry have accused it of acting like a cartel (Easterly 2002). The accusation has some bite--globally the industry Tim Harford (tharford@ifc.org) is remains somewhat concentrated, and for the typical recipient an economist, and country, highly concentrated. Yet the most striking fact about the Bita Hadjimichael (bhadjimichael@world industry is how relentlessly competitive pressures are building. There bank.org) a senior PRESIDENCY has been a constant stream of new entrants, a steady fall in global economist, at the World and local concentration, and a clear tendency for donors to break out VICE Bank and International Finance Corporation of historical patterns of aid and compete with one another. Could (IFC). Michael Klein greater competition improve the efficiency of the aid system? (mklein@worldbank.org) is chief economist at IFC The postwar wave of modern aid agencies Entry to the market is continuing as new agencies DEVELOPMENT and joint World included the U.S. Agency for International Devel- find new business models--or new recipient coun- Bank­IFC vice president, opment (USAID), some export credit agencies, tries, in the case of the European Bank for Recon- private sector SECTOR and the Bretton Woods institutions, all in response struction and Development (EBRD). EBRD serves development. to the world's needs after World War II (figure 1). privatesectorclients,asdoitslargecontemporary,the This Note is part of a The second wave, arriving between 1955 and Multilateral Investment Guarantee Agency (MIGA), PRIVATE series exploring trends 1980, had a different character. True, the World and France's Proparco and Denmark's Investment in the aid industry, Bank agencies established--the International FundforCentralandEasternEurope(IFU).Recently including patterns of aid Development Association (IDA) and the Inter- two new agencies--the Global Fund to Fight AIDS, flows, competition, and national Finance Corporation (IFC)--were appar- Tuberculosis, and Malaria (GFAT) and the Millen- GROUP the effectiveness of ently a response to previously unmet needs. But nium Challenge Corporation (MCC)--started oper- different types of aid. many of the other agencies seemed to appear ations. They are expected to expand quickly in the BANK because there was money to spare rather than in next two or three years. In addition, emerging response to a change in the world's needs. The economies such as China and Slovenia have moved new agencies included Japan's huge Overseas Eco- to set up aid agencies. The prospects for continued nomic Cooperation Fund (OECF), the regional innovation and new entry seem good. Despite this, WORLD development banks in booming Europe and Asia, there has been very little exit. All the agencies created and several agencies funded by oil windfalls. since 1945 still exist. THE A I D A G E N C Y C O M P E T I T I O N A C E N T U R Y O F E N T R Y , B U T N O E X I T Figure The aid century 1 OPIC IFU EBRD Finance to private sector IFC Proparco FMO OECF USAID AusAID MCC Bilateral IMF EIB CAF MIGA 2 Multilateral IBRD IDB IsDB and others GFAT EHK IDA ADB France Germany Export credit Japan USExim Canada 1910 1930 1950 1970 1990 2010 Note: Agencies are shown in year of creation, with the area of the circles proportional to their most recent annual aid commitments in U.S. dollars. ADB is Asian Development Bank; CAF, Corporación Andina de Fomento; EHK, Euler Hermes Kreditversicherungs; EIB, European Investment Bank; FMO, Netherlands Development Finance Company; IDB, Inter-American Development Bank; IMF, International Monetary Fund; and OPIC, Overseas Private Investment Corporation. "IsDB and others" includes the Islamic Development Bank, the OPEC Fund, and the Arab Monetary Fund. For others, please see the text. Some organizations with annual commitments less than US$1.75 million are not labeled. Source: OECD Development Assistance Committee; authors' compilation. How much has competition increased? Competition between bilateral donors Even when studying a profit-making private Competition may take place between aid agen- industry it is not easy to measure the intensity of cies but also between donor countries. The competition. But it is possible to track concen- inherent competitiveness of the aid industry tration, the measure of how much market share seems to be increasing on both levels, because is in the hands of a few large players. Concen- besides establishing new agencies without clos- tration is not perfectly correlated with a lack of ing down old ones, donor countries seem to be competition but is highly suggestive of it. moving in on one another's "turf." Industrial economists measure concentra- That bilateral donations show geographical tion using the Herfindahl index, which ranges patterns and historical persistence is well from 0 (perfect competition) to 1 (monopoly).1 known. For example, France and the United Under U.S. competition policy a Federal Trade Kingdom send aid to former colonies; Australia Commission (FTC) investigation would regard concentrates on Asia, Oceania, and the Pacific an index of more than 0.18 as meaning "highly islands; and Japan's major beneficiaries are concentrated"--not proof of an uncompetitive large East Asian economies. One effect of such industry but certainly reason to be suspicious. patterns is to limit competition. Just as cartels Had the FTC been asked to investigate the always seek ways to divide up the market in a sta- international aid industry in the 1950s, it would ble fashion, donors might stick to historical part- have discovered an index of more than 0.5 (fig- ure 2). At the time the aid industry was domi- Competition grows in the aid industry nated by U.S. postwar aid flows. Now it has a 2 Herfindahl index Herfindahl index of around 0.1--"mildly con- 1.0 centrated" by FTC standards. 0.8 For comparison, figure 2 shows the range of Aid industry 0.6 concentration of primary commodities in the 1990s as estimated by Verleger (1993), with each 0.4 Primary commodities, 1990s producing country treated as a single entity. The 0.2 range is from 0.208 (rubber) to 0.085 (oil). Over 0 1948 1958 1968 1978 1988 1998 the years the aid industry has moved from well Source: OECD Development Assistance Committee; authors' calculations; Verleger 1993. above this range to near the bottom of it. ners if they were attempting to suppress compe- Figure Patterns of aid are shifting more quickly tition in the aid industry. 3 Yet the historical patterns are changing faster New entrants to list of top 15 recipients 15 than in the past. Donors' lists of favorite recipi- ents changed more in the 1990s than in the 1980s. For the major donors that make up the 10 Development Assistance Committee (DAC) of the Organisation for Economic Co-operation and Development (OECD), only 5 new entrants 5 3 made it to the list of the top 15 recipients in 1982­92, but 7 new entrants did in 1992­2002 (figure 3). The more rapidly shifting patterns of 0 aid do not support the contention that aid is 1982­92 1992­2002 increasingly cartelized. European Commission France Donors are also spreading their aid more United States Japan All DAC members thinly across the world. For nearly three-quarters Source: OECD Development Assistance Committee. of donors (14 of the 19 DAC members for which data were available) the share of aid flowing to the region that received the most declined everyone has abandoned the once widespread between 1982 and 2002. Thus the market is less belief that competition is wasteful and that a segmented, allowing more opportunity for centrally planned economy would do much bet- competition. ter. We now realize that any "waste" generated The corollary from the point of view of recip- by the competitive process is dwarfed by its abil- ient countries is that they receive aid from more ity to push firms to innovate, cut costs, and donors. The World Bank (2004, p. 172) recently respond to customer demand. published an index of donor fragmentation for But the aid system is at best a quasi-market. It recipient countries, which rose from an average is not always clear who the customers are. Thus for of 56 in 1975 to 67 in 2002. But while fragmen- the aid industry it is not so ridiculous to say that tation at the country level is rising, it is still quite competition is wasteful and should be managed. low. An index of 56 would be produced by three For example, Stephen Knack and Aminur Rah- donors alone, one providing 60 percent of aid man (2004), constructing a model in which com- flows and the other two 20 percent each. An peting donors poach the best local government index of 67 would be produced by three equal staff to run projects, find that donor fragmenta- donors. tion is associated with lower-quality bureaucracies in recipient countries. Impact on the World Bank Group The aid industry has attempted to limit these Multilateral aid agencies2 have been winning costs by calling for more cooperation. Such calls market share from bilateral and export credit have become more prevalent as competition has agencies for the past three decades, but the increased.3 But can this response be sustained in World Bank Group has been losing market the face of continued entry? Most cartels-- share since the mid-1980s (figure 4). The whether predatory or altruistic--attract entry International Bank for Reconstruction and and are not resilient when it happens. Development (IBRD) was smaller in 2002 than An alternative strategy is to embrace the in any year since 1985, even before adjusting for increasing competitiveness of the aid "market" inflation. and use it to make the market work better. There is no reason that the agencies that set pri- Consequences and responses orities and donate money need to be the agen- In well-functioning markets an increase in com- cies that use the money to deliver services. petition is almost always good news for cus- Should aid agencies "make aid" or simply "buy tomers and bad news for incumbents. Almost aid?" Since competition would probably be A I D A G E N C Y C O M P E T I T I O N A C E N T U R Y O F E N T R Y , B U T N O E X I T Figure Multilaterals grow in importance, but the World Bank Group shrinks 4 Distribution of market share Aid commitments (US$ billions) among multilaterals (percent) 160 100 viewpoint 120 75 Export credit agencies Multilaterals excluding Bilateral agencies World Bank Group 80 50 Other international financial IFC is an open forum to institutions and multilaterals IDA encourage dissemination of 40 World Bank Group 25 IBRD public policy innovations for private sector­led and 0 0 market-based solutions for 1970 1980 1990 2002 1970 1980 1990 2002 development. The views Source: OECD Development Assistance Committee. published are those of the authors and should not be attributed to the World much more productive between service delivery funds through the agencies that produce the Bank or any other affiliated organizations than between donor organiza- best results. organizations. Nor do any of tions, this split has some attractions. There are the conclusions represent several ways in which it might happen: official policy of the World Effective outsourcing of aid to "execution Bank or of its Executive agencies" would need to be based on better Notes Directors or the countries monitoring and benchmarking of agencies' 1. The Herfindahl index is the sum of the squares of they represent. performance. Donors would be able to the market shares of industry players. achieve desired results more effectively if 2. Including the World Bank Group, the United To order additional copies they knew which agencies deserved their Nations, the regional development banks, and the contact Suzanne Smith, money. European Commission. managing editor, Existing agencies could be split up to make Room F 4K-206, 3. One way to get a sense of this trend is to survey the such outsourcing easier. The Commonwealth The World Bank, titles of papers presented to the Bank-Fund Development 1818 H Street, NW, Development Corporation in the United Committee since its founding in 1974. No titles mentioned Washington, DC 20433. Kingdom was split into an agency that gives partnership, joint programs, or harmonization before 1985, but money and a government-owned limited lia- 14 have since then, 10 of them in the past five years. Telephone: bility company that delivers services. It is 001 202 458 7281 quite possible to conceive of a market for cor- References Fax: porate control emerging between service Easterly, William. 2002. "The Cartel of Good Inten- 001 202 522 3480 delivery agencies, and for-profit companies tions." Foreign Policy (July­August): 40­49. Email: freely entering the business. Knack, Stephen, and Aminur Rahman. 2004. "Donor ssmith7@worldbank.org Going further, poor people could be given Fragmentation and Bureaucratic Quality in Aid Recipi- aid vouchers so they could purchase services ents." Policy Research Working Paper 3186. World Bank, Produced by Grammarians, directly, an idea floated by William Easterly Development Research Group, Washington, D.C. Inc. (2002). Of course, both the economic and Verleger, P. K. 1993. Adjusting to Volatile Energy Prices. the political obstacles to this proposal are for- Washington, D.C.: Institute for International Economics. Printed on recycled paper midable. World Bank. 2004. Global Monitoring Report 2004: Policies The competitive pressures faced by aid agen- and Actions for Achieving the Millennium Development Goals and cies can be exaggerated, but they are real and Related Outcomes. Washington, D.C. growing. It is therefore worth exploring ways to turn this trend to the advantage of the poor. In the short term the most promising way to do so is to improve the monitoring and benchmark- ing of aid agencies, enabling donors to channel T h i s N o t e i s a v a i l a b l e o n l i n e : h t t p : / / r r u . w o r l d b a n k . o r g / P u b l i c P o l i c y J o u r n a l