Foreign aid can help strengthen the economies of donor countries by boosting business

Support for foreign aid is dwindling in many developed countries, including Canada. Reflecting this trend, a recent survey found 59 per cent of Canadians want to reduce foreign aid to developing countries.

This is striking, given that Canada’s foreign aid, amounting to 0.38 per cent of its gross national product, is already below the OECD’s target of 0.7 per cent, placing Canada in the middle of the spectrum of donor countries.

Cutting foreign aid from developed countries doesn’t just hinder international development; it also jeopardizes the international competitiveness of a donor country’s domestic businesses.

While foreign aid should always focus on tackling global disparities, alleviating poverty and enhancing the well-being of people in recipient countries, it’s also important to highlight the positive side effects aid can have on donor countries.

This can help legitimize and maintain support for foreign aid at a time when countries and their populations are becoming more inward-looking.

Not just an act of generosity

Despite the apparent foreign aid fatigue in the general population, the Canadian government pledged to increase it in the 2024 budget, following a 15 per cent cut the previous year that drew significant criticism from the aid sector.

It’s crucial to remember that foreign aid isn’t just an act of generosity; it can also benefit donor countries that provide aid.

Deputy Prime Minister and Minister of Finance Chrystia Freeland presents the federal budget in the House of Commons in Ottawa on April 16, 2024.

Many governments are now communicating the importance of foreign aid to their citizens. For instance, the Australian government introduced a new development policy in 2023 emphasizing the need to lift people out of poverty in developing countries to bring peace, stability and prosperity to Australia.

In the same vein, the Canadian government stressed the importance of Canada taking a more proactive role on the global stage in its 2024 budget announcement. Protecting national interests and promoting Canadian values require active participation and involvement in international affairs.

Foreign direct investment decisions

As researchers and experts in strategy, we were interested in whether foreign aid creates positive spillover effects for firms of donor countries.

If such positive effects exist, then reducing foreign aid could not just harm aid-recipient countries, but also harm the economic welfare of donor countries. Reducing foreign aid, for example, could result in Canadian businesses becoming less competitive abroad, which could lead to fewer job opportunities and reduced prosperity in Canada.

Our research examined the role of Japanese foreign aid in the foreign direct investment decisions of 1,451 Japanese firms in 76 developing countries from 1991 to 2002. Foreign direct investment refers to investments made by a company or entity from one country into another country.

We excluded infrastructure and construction firms, as their investment decisions could have been driven by the implementation of aid projects and not linked to aid spillovers.

Development aid was an important foreign policy tool for Japan, especially during the 1990s. In 1991, Japan was the world’s largest aid donor, but its aid budget was significantly cut in 2003.

Japan’s first Official Development Assistance Charter, enacted in 1992, favoured low tied aid — Japan largely ceased tying aid implementation to Japanese companies or products. When the charter was revised in 2003, it allowed for easier access to aid-related contracts for Japanese firms.

New insights from research

Our findings revealed that all forms of foreign aid can positively impact the foreign direct investment of donor nations in recipient countries. This includes economic and social infrastructure aid (for roads, telecommunications, education or health) and non-infrastructure aid (such as budget support or emergency assistance).

Both types of aid can reduce the costs and risks associated with foreign direct investment, which opens up new opportunities for donor country businesses in aid-recipient countries.

A Somali man in a suit gestures with his hands while speaking into a microphone to someone off camera
Minister of International Development Ahmed Hussen speaks in the Foyer of the House of Commons before Question Period on Parliament Hill in Ottawa, on Feb. 15, 2024.

Infrastructure aid improves access to information and networks in recipient countries, making the market environment better. Meanwhile, non-infrastructure aid can reduce market and political uncertainties, making it easier for businesses to operate.

For example, in Northern Vietnam, Japan supported the construction of highway and port facilities in the 1990s. Interviews by the Japan Bank for International
Cooperation suggest that, without the improved transportation infrastructure, most investments by Japanese firms would not have been made in the region. The use of these facilities was important to these firms because they relied on imported parts and material, making quick, affordable transportation to and from ports, as well as port handling, essential.

Our research also found that not all companies benefited equally from foreign aid. Some companies, like those with less experience in an aid-recipient country, were more dependent on foreign aid to overcome local challenges they could not handle on their own.

Jeopardizing national interests

Our research findings highlight that cutting foreign aid from developed countries doesn’t just hinder international development; it might also indirectly jeopardize national interests.

While the primary purpose of foreign aid should always be to increase the prosperity of those in developing countries, it’s important to remember the positive side effects aid can have on donor countries as well.

A more nuanced understanding of foreign aid is essential for Canadians as they assess how aid policies impact both Canada’s national economic welfare and its global influence.

Maintaining a robust foreign aid program is not only a moral imperative, but also a strategic necessity for countries like Canada. By continuing to support international development efforts, Canada can safeguard its economic interests while reinforcing its commitment to global equity and stability.

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