2. ii
CONTENTS
DECLARATION
ACKNOWLEDGEMENT
CHAPTER 1
INTRODUCTION AND BACKGROUND
1.1 BACKGROUND OF THE STUDY..........................................................................................................5
1.2 STATEMENT OF THE PROBLEM.........................................................................................................8
1.3 OBJECTIVES OF THE STUDY ...........................................................................................................10
1.3.1 Broad Objective of the Study…………………………………………………….................12
1.3.2 Specific Objectives of the Study…………………………………………………………....12
1.4 RESEARCH QUESTIONS ..................................................................................................................11
1.5 RESEARCH HYPOTHESIS.................................................................................................................11
1.6 SCOPE AND LIMITATION OF THE STUDY ........................................................................................12
1.7 SIGNIFICANCE OF THE STUDY ........................................................................................................12
CHAPTER 2
LITERATURE REVIEW
2.1 THEORETICAL AND EMPIRICAL LITERATURE REVIEW...................................................................13
2.2 THE CONCEPTUAL FRAMEWORK ...................................................................................................22
2.2.1 THEORIES OF FOREIGN AID .......................................................................................................22
2.2.2 SAVING GAP MODEL .................................................................................................................23
2.2.3 FOREIGN EXCHANGE GAP MODEL ............................................................................................24
2.2.4 FOREIGN AID IN TANZANIA.......................................................................................................25
2.2.5 EMPIRICAL EVIDENCE ...............................................................................................................25
2.2.6 CURRENT STATUS ON PARTNERSHIP, AID COORDINATION AND HARMONIZATION ..................26
2.2.7 INTEGRATING DONOR FUNDS INTO THE GOVERNMENT BUDGET SYSTEM ...............................27
2.2.8 FOREIGN AID IN THE LONG RUN ...............................................................................................28
2.2.9 SUSTAINABILITY........................................................................................................................29
2.2.10 CAPACITY BUILDING FOR AID COORDINATION AND EXTERNAL RESOURCE MANAGEMENT...30
2.2.11 NATIONAL DEVELOPMENT POLICY FRAMEWORK.....................................................................31
2.2.12 SOURCES AND RECIPIENTS OF AID ............................................................................................33
2.2.13 INSTITUTIONAL SET-UP FOR PROMOTING DONOR/AID COORDINATION AND HARMONIZATION
33
2.2.14 CONSTRAINTS, CHALLENGES AND THE WAY FORWARD...........................................................34
2.2.15 KEY CHARACTERISTICS OF BUDGET SUPPORT..........................................................................38
3. iii
2.2.16 EXPECTATIONS FROM THE BUDGET SUPPORT ...........................................................................39
2.2.17 THE RATIONALE FOR GENERAL BUDGET SUPPORT...................................................................40
2.2.18 FOREIGN AID IN TANZANIA.......................................................................................................41
2.2.19 CAPACITY BUILDING .................................................................................................................43
CHAPTER 3
RESEARCH METHODOLOGY AND WORKING DATA
3.1 RESEARCH METHODOLOGY ...........................................................................................................44
3.1.1 RESEARCH DESIGN ....................................................................................................................44
3.1.2 REASONS OF CHOOSING A CASE STUDY DESIGN .......................................................................44
3.1.3 AREA OF STUDY .........................................................................................................................45
3.1.4 POPULATION ..............................................................................................................................45
3.1.5 WORKING DATA ........................................................................................................................45
3.1.6 METHODS OF DATA COLLECTION .............................................................................................45
3.1.7 PARTICIPATORY OBSERVATION.................................................................................................46
3.1.8 IN-DEPTH INTERVIEWS...............................................................................................................46
3.1.9 QUESTIONNAIRES ......................................................................................................................46
3.1.10 REVIEW OF DOCUMENTS ...........................................................................................................46
3.1.11 DATA PROCESSING AND ANALYSIS ...........................................................................................47
3.1.12 THEORETICAL MODEL ...............................................................................................................47
3.1.13 CONCEPTUAL FRAMEWORK.......................................................................................................48
3.1.14 VARIABLES AND MEASUREMENTS (DEFINITION OF VARIABLES) .............................................49
CHAPTER 4
EMPIRICAL RESULTS
CHAPTER 5
CONCLUSION AND POLICY IMPLICATIONS
5.1 INTRODUCTION...............................................................................................................................58
5.2 SUMMARY OF THE FINDINGS..........................................................................................................58
5.3 POLICY IMPLICATIONS ...................................................................................................................58
5.4 CONCLUDING REMARKS ................................................................................................................60
REFERENCES: ..........................................................................................................................................61
APPENDIX……………………………………………………………………………………..................63
4. iv
DECLARATION
I, Handley Mpoki Mafwenga, do hereby declare that I am the sole author of this dissertation, that
during the period of registered study I have not been registered for other academic award or
quantification, nor has any of the material been submitted wholly or partly for any other award.
This dissertation is a result of my own research work, and where other people‟s research was
used, they have been dully acknowledged.
Date…………………………………………………………….Signature…………………………
CANDIDATE
Date ……………………………………………………………Name………………………….....
SUPERVISOR
5. v
ACKNOWLEDGEMENT
In writing this Research paper, I owe intellectual debt to the Eastern and Southern African
Management Institute which examined, reviewed, and commented on the entire manuscript and
sought the importance of the Research work for the MBA degree and therefore provided the
preliminaries and necessary directives to go about doing this Research. Special thanks are due to
the Country Coordinator Mr. Morrel S.J.K, ESAMI Business School Administrator Fredrick
Majariwa and Gloria Mdenye who enabled the speedy completion of this work. I would like to
thank the Management of the Ministry of Finance that facilitated accessibility of information.
Another special thanks are hereby extended to my family particularly my wife Bertha and my
sons Alvin Handley, Clerick Handley, Malcom Handley, and Issack Handley for their moral
support towards the completion of this Research. Ultimately and foremost, I would like to thank
God for spiritual support during the entire period of my research work.
6. 5
CHAPTER 1
INTRODUCTION AND BACKGROUND
1.1 Background of the Study
The Foreign aid is one of the major policy instruments of international cooperation that aims at
transferring critical development oriented resources from the North to the South. Large amounts
of aid have been disbursed and long traditions of aid dependency have been established.
The government receives foreign aid under modalities of threefold; namely i) General Budget
Support (GBS), ii) basket funding and iii) direct project funding. GBS goes directly into national
budget, while basket funds are set aside by Developing Partners for a particular sector or
programme. Project funds support specific, often donor-led projects, which are sometimes
outside normal government budget processes. It should bear in mind that, many Developing
Partners provide also support to non-state actors, such as Non-governmental Organizations,
Community-based Organizations, or the private sector.
In the past years basket funding and direct project funding have been very popular compared to
the general budget support. During that period of implementation basket funding and project
funding have shown certain shortcomings.
Basket funding has experienced the following shortcomings:
They have created unnecessary parallel implementation systems and structures as
well as financing mechanisms, thus adding transaction costs to the Government;
They have limited the degree of Government ownership over resources allocation
across and within sectors and reforms;
Lack of complete and comparable information across sectors and reforms has created
difficulties in reducing duplication of activities and maximizing complementarities.
Direct project funding has experienced the following shortcomings:
Projects have often lacked transparency and Development Partners supporting the
projects have been better informed about their implementation than the Government
and other domestic stakeholders. Hence, accountability to Developing Partners has
been given priority over domestic accountability;
7. 6
The setting up of costly Project Implementation Units parallel to Government systems
and structures have undermined Government structures and systems and prevented
project sustainability;
The dominance of foreign project financing which continues to predominantly reflect
the priorities of Developing Partners has limited and undermined the discretion that is
available to the Government to allocate funds in accordance with national priorities.
This in turns has prevented the Government from taking full and effective ownership
and leadership in managing the development process.
In the 1990‟s crises occurred that partially interrupted the relationship of aid cooperation. For
instance in 1994 a crisis occurred when donor (particularly IMF) concerns over poor fiscal
discipline, corruption and tax evasion led to a freeze of programme aid and structural adjustment
programmes. It also coincided with the completion of a series of donor specific aid evaluation
reports; generally with negative assessment of aid effectiveness. Donors and the government of
Tanzania have worked very hard to repair relations that had become severely strained.
Appointment of independent advisers in mid-1994 under the leadership of Prof. Gerald K.
Helleiner has been one of the efforts into repairing the government-donor relationship. The
Consultant report (The Helleiner Report) examined the relationship between donors and the
government of Tanzania and set out a list of 22 recommendations for improvement on the basis
of transparency, predictability and trust, as well as steps to be taken by the Government with the
assistance from the donor community in order to strengthen its internal systems and processes.
Most of these initiatives constituted conditionalities for much needed balance of payment and
budget support, particularly as provided by the IMF and World Bank. Finally in the year 2000, as
an outcome of Helleiner Report a consensus was reached to improve aid coordination, promote
harmonization and strengthen government ownership of the development processes.
Tanzania Assistance Strategy (TAS) was launched in the 2002 as a unique initiative that resulted
from a joint understanding between the Government and Development Partners that there is an
urgent need to improve the efficiency and effectiveness of external resources in order for
Tanzania to achieve its development goals laid out in the National Vision 2025 and the National
Strategy for Growth and Reduction of Poverty (NSGRP) / MKUKUTA. TAS continued to be
8. 7
monitored by an Independent Monitoring Group (IMG), which advised on progress every two
years, formulating recommendations to Government and Development Partners on further
improvements.
TAS outlined 13 principles of „best practices‟ in development co-operation on how to strengthen
national ownership and improve aid delivery and these are listed below:-
i. Government leadership in developing policy priorities, strategic frameworks,
and institutionalised co-operation mechanisms in various areas/ sectors.
ii. Government involves civil society and the private sector in developing
national policies, strategies, and priorities.
iii. Government prioritises and rationalises development expenditures in line with
stated priorities and resources availability.
iv. Integration of external resources into the strategic expenditure framework
v. Integration of reporting and accountability systems.
vi. Adequacy in resource disbursements relative to prior commitments.
vii. Timing of resource disbursements is responsive to exogenous shocks to the
Tanzanian economy.
viii. Donor policies complement domestic capacity building.
ix. Firm ODA commitments are made for longer time periods.
x. Improvement in public financial management by Government.
xi. Government has created an appropriate national accountability system for
public expenditure.
xii. Ministries, regions and districts receive clean audit reports from the Controller
and Auditor General.
xiii. Transparency in reporting and accountability at the national and sectoral.
A TAS Action Plan specifies concrete actions in four priority areas to be undertaken by the
Government of Tanzania and Development Partners namely:
i. Increasing the predictability of aid flows,
ii. Integrating external resources into the Government budget and exchequer
system,
iii. Harmonising and rationalising processes and
9. 8
iv. Improving national capacities for aid coordination and external resources
management. (See box 1)
The idea to formulate a Joint Assistance Strategy for Tanzania (JAST) was born in the process of
rationalisation and harmonisation, as the Government and its DPs aimed to further reduce the
still high transaction costs that are incurred through the pursuit of different strategies with
multiple and often overlapping processes; despite the progress made under TAS. In addition, the
Government and the DPs intended to establish a Joint Assistance Strategy in order to extend
progress in enhancing national ownership and Government leadership of the development
process to all levels of society and the Government respectively and to increasingly shift
Government accountability from DPs to domestic stakeholders.
Thereafter, we have the Joint Assistance Strategy (JAST) of which in comparison to TAS, JAST
is more comprehensive, going beyond the 13 best practices and four priority areas of TAS and
covering all aspects of the developing partnership between the Government and DPs as well as
the role of Non state actors (NSAs) therein. It has meant to contribute to sustainable development
and poverty reduction in line with the National Vision 2025 and the Zanzibar Vision 2020 by
consolidating and coordinating Government efforts and DPs support under a single Government-
led framework to achieve results on the National Strategy for Growth and Reduction of Poverty
(NSGRP/MKUKUTA) and the Zanzibar Strategy for Growth and Reduction of Poverty
(ZSGRP/MKUZA) as well as other national development and poverty reduction programmes.
Basically GBS is a coordinated and harmonized way of aid financing, which is provided to
Tanzania by 14 Development Partners to directly support the implementation of the MKUKUTA
through the Government‟s budget.
1.2 Statement of the Problem
Developing countries including Tanzania rely heavily on external resources to finance their
development programmes due to inadequate local resources which to a large extent has narrow
tax base and shallow non-tax revenue yields. The experience shows that the finance provided to
these countries do not generate the economic growth as expected and most of the borrowing
decisions that are predicated for growth do not achieve the intended objectives which
consequently lead to debt-creating financial flows. The impetus for this has been the
10. 9
unsustainable debt crisis which has hampered development efforts and sucked resource away
from expenditure on health, education, water and sanitation, and economic infrastructures.
On the other hand, the experience of a number of fast–growing East Asian newly industrialized
economies (NIESs), and recently China, has strengthened the belief that attracting FDI is
significant to bridge the resource gap of developing countries and avoid further build–up of debt.
Therefore, opening up of the economy in order to attract massive inflows of FDI in a host
country is imperative. It is believed that FDI brings not only more stable capital inflows but also
greater technological know–how, employment opportunities and managerial skills hence
accelerating pace of economic growth and development.
The Government of Tanzania has adopted GBS aid modality, as it is facilitate effective aid
management, which is the key in attaining poverty reduction goals in the country. Consecutively
the GoT has adopted the MKUKUTA strategy as its homegrown strategy to tackle poverty and
boost economic growth. In order for GoT to meet the objectives set out in the MKUKUTA and
to implement its reform agenda, international donors (Developing Partners) are providing funds
directly to the Government. This enables the Government to allocate foreign resources according
to national priorities for the development of the country and benefit of the citizens of Tanzania.
Developing Partners are thereby supporting the Government in fulfilling its leading role in the
development of Tanzania. GBS also builds on the understanding that giving resources directly to
the government reduces the amount of time and resources spent by government to meet the entire
different requirement for different projects and different Developing Partners.
The principle behind general budget support in Tanzania is that the government to reach the
goals of the MKUKUTA uses the resources. These goals are set around achieving broad based
and equitable growth, improving the quality of life and social well-being, with particular focus
on the poorest and the most vulnerable groups, and improving good governance and
accountability. This means that the government is investing into improving various aspects of the
lives of the poorest Tanzanians, such as ensuring better education and healthcare, higher incomes
and more accountability of leaders towards their constituents. Budget Support contributes to
these efforts.
11. 10
1.3 Objectives of the Study
1.3.1 Broad Objective of the Study
Broadly the objective is to investigate the Effectiveness of foreign aid in budget support in
Tanzania that has to be reflected in the FDI. The main objective of this study therefore is
intrinsically to assess impact of FDI inflows on economic growth and poverty reduction in Sub–
Saharan Africa and to find the impact of foreign aid on economic growth in Tanzania
1.3.2 Specific Objective of the Study
The specific objectives are:
(i) Identify institutional and macroeconomic conditions of SSA economies,
(ii) Evaluate the trends and patterns of FDI inflows and the state of poverty,
(iii) Assess the link between FDI inflows and economic growth on the one hand
and growth–poverty relationship on the other hand,
(iv) Provide policy implications for sustainable economic and social
development in SSA.
(v) To find out whether there is a positive relationship between foreign aid and
economic growth.
(vi) Investigating other variables which affect economic performance such as
export, investments (private sector capital formation) and weather.
(vii) To asses other influencing factors.
The Specific objectives go in tandem with the:
a) Determination of the objectives and positive effects of GBS;
b) Assessment of the challenges in implementation of NSGRP/ MKUKUTA by
using GBS as an aid modality;
c) Assessment of the level of Donor dependency in national budget; and
d) Assessment of the sustainability of NSGRP when donor support is wound up.
The World Bank analysis on poverty situation in Africa shows that Africa as a whole and Sub–
Saharan Africa (SSA) in particular, has been on periphery of the FDI inflows compared with
other regions. On average, 45 to 50 percent of population in SSA lives below the poverty line.
Currently, the availability and state of social services in most of these countries is the poorest in
the world. Sluggish economic growth has translated into an increase in both poverty rate and the
12. 11
numbers of poor people with the largest proportion are living below $1 a day (World Bank,
2001).
1.4 Research Questions
Given that growth is the most important factor affecting poverty reduction in developing
countries implies that growth is good for the poor people. In this vein, this study seeks to
examine the impact of FDI inflows on sustainable economic growth and poverty reduction in
Sub–Saharan Africa by seeking answers to the following questions:
(i) What relationship exists between FDI inflows and economic growth?
(ii) Is FDI Growth-enhancing in Sub-Saharan Africa?
(iii) Is there any positive effect of growth on poverty reduction? Alternatively is a
Growth–enhancing induced by FDI pro–poor?
(iv) Do institutional factors and macroeconomic policies act as desirable inputs in
enhancing growth and poverty reduction? and
(v) What precautions should policy makers observe when endeavoring to attract FDI
inflows in Sub-Saharan Africa?
(vi) What are the objectives, positive effects of GBS?
(vii) What is the level of donor dependency in the national budget?
(viii) What are the challenges in implementation of NSGRP by using GBS as an aid
modality?
(ix) What is the level of sustainability of NSGRP when donor support is wound up?
(x) Is there any positive relationship between foreign aid and overall economic
growth in Tanzania?
(xi) Are private sector capital formation and GDP growth positively related?
(xii) Are exports and GDP growth positively related?
(xiii) Does favorable weather condition contribute positively to GDP growth?
1.5 Research Hypothesis
The following hypothesis is tested from 2000 to 2007
a) Foreign aid (Loans, Grants) to Tanzania influenced positively GDP growth.
b) Private sector capital formation and GDP were positively related.
c) Exports and GDP growth were positively related.
d) Favourable weather condition contributed positively to GDP growth.
13. 12
1.6 Scope and Limitation of the Study
Tanzania under the current setting has two governments, the Government of the United Republic
of Tanzania and the Revolutionary Government of Zanzibar, each with its own budget. In order
to pursue any national procedures and systems for external aid, both governments need to be
involved. This study however covers only the Ministry of Finance and Economic Affairs of the
Government United Republic of Tanzania, Dar es Salaam. The study is also confined to foreign
aid as defined by Development Assistance Committee (DAC). It uses data disaggregated into
loans, and grants. It includes other variables such as weather condition, export and private sector
capital formation.
It also covers a period of five years from 2000 to 2007 because it is during this period that the
Government of Tanzania has instituted several economic reform programs for development and
worked on improving the aid relations with the development partners.
1.7 Significance of the Study
One of the requirements for the award of Master of Business Administration at ESAMI and the
researcher is accomplishment of the thesis of which this thesis has been in a position to assess
and understand the role played by donor agencies in poverty reduction through general budget
support and to assess the sustainability of NSGRP under the general budget support without
donor funds.
The study is useful source of information to other researchers interested in the research of similar
nature or discipline and make the researcher more exposed to policy analysis environment. It is
broaden the understanding of impact of foreign aid on economic growth in Tanzania and the
findings is be of interest to anyone involved in the budget process or seeking to influence it.
14. 13
CHAPTER 2
LITERATURE REVIEW
2.1 Theoretical and Empirical Literature review
Tanzania's history of development cooperation dates back to the early 1960s when external
financing policy was broadly derived from socio-economic policies spelt out in the ARUSHA
Declaration of 1967 and from Tanzania's policy of Socialism and self-reliance. The main
external finance guidelines were based on the fact that Tanzania recognized the role of external
finance in bringing about the intended Socialist Development. Because of Tanzania's limited
capacity to generate adequate domestic resources, external aid should be encouraged, in order to
complement the country's own resources.
However, for reasons beyond the scope of this paper, the intentions of the Arusha Declaration to
make Tanzania self-reliant were not realized. As a result, the country continued to be sustained
by foreign aid in order to meet development expenditure. Thus, foreign aid has played, and is
continue to play; a big role in the Tanzanian economy. It is estimated that, since 1990, the annual
aid flow to Tanzania has averaged around US$1 billion, at today's prices.1
The theoretical basis of growth model in development economics has relied greatly on two
frameworks, the Harrod-Domar model and Solow model. These models have been highly
renowned and recognized as a breakthrough in economic thought. The Harrod-Domar model
posits that the expansion of output linearly relates to the increase in the stock of physical capital.
In contrast, the Solow model output depends on three basic factors: the expansion of the
physical, the growth of effective labour force and the rate of technical progress.
In addition to facilitating advances in the conceptual frameworks, these models have played a
substantial role in empirical analysis. The Harrod-Domar model has often been used to compute
the amount of investment required to generate envisaged amount of output growth. Unlike the
prescriptive nature of the Harrod-Domar framework, the Solow model has been oriented toward
generating rates of economic growth into amounts that can be accounted for by investment in
physical capital, human capital, and technological change (Isard, 2005).
15. 14
In endeavouring to account for growth and rate of convergence based on steady-state analysis,
the technological change is the only possible source of per capital output growth in the long run.
It is further argued that countries do not have the same saving rate, depreciation rate and
population growth rate; therefore different convergence levels are expected. These ideas have
brought in the hypothesis of conditional convergence according to which countries converge to
their own growth paths and their overall economic growth rate depending on the growth rate of
the technology of the country.
In the same way, Barro (1991) finds evidence that helps to explain why it is possible for
countries to diverge in per capital income due to the differences in human capital. However,
despite the importance of widely established traditional growth accounting literature which focus
on the main proximate causes of growth, including physical capital, human capital and total
factor productivity, together with macroeconomic policies, a great deal of economic research in
recent years suggests that institutions are vital for economic growth and development. It has been
found that differences in per capita GDP around the globe ranging from about $100 a year in
Sub-Saharan Africa to over $40,000 in advanced economies are closed related to institutional
quality (IMF, 2003). North (1994:360) defines institutions clearly: Institutions are the humanly
devised constraints that structure human interaction. They are made up of formal constraints
(e.g., rules, laws, constitutions), informal constraints (e.g., norms of behaviour, conventions, self-
imposed codes of conduct), and their enforcement characteristics. Together they define the
incentive structure of societies and specifically economies. This definition distinguishes
institutions from organizations, although in most countries various organizations warrant
inclusion among the important institutions that define the incentive structures of economic
agents.
More importantly, institutions are the devices individuals create to maintain order, social lives or
rules, enforcement characteristics of rules and norms of behaviour that structure repeated human
interaction. It is commonly accepted that the key role of the institutions is to reduce transaction
costs incurred in conducting an economic exchange. It also seems clear that success in sustaining
economic growth depends critically on how well institutions adapt to permit low-cost
16. 15
transactions in the impersonal markets that characterize productive economies. In this context, it
is adaptive rather allocative efficiency which is the key to long-run growth (Isiamson, 1995).
In addition, economists have for a long time emphasized the allocative efficiency associated with
market systems. Decision making based on prices that equilibrate supply and demand in
competitive markets can provide an efficient way of allocating resources in economies. Market
mechanisms allow workers with different skills and firms managed by different individuals to
pursue their comparative advantages in production. However, experience has also demonstrated
that market systems in which many economic agents have opportunities and incentives to
innovate provide a relatively high degree of adaptive efficiency. In the same way, there is
widely-spread agreement that in order to adapt efficiently and function well in generating
economic growth, market economies require various types of institutions and a significant
amount of public sector involvement.
It is worthy however, emphasizing that most of the recent work on institutions and economic
growth has focused on the importance of a particular set of institutions. In this regard,
institutions can be divided into four types namely market creating, market regulating, market
stabilizing, and market legitimizing. In particular, growth requires institutions that create markets
by defining property rights and enforcing contracts; institutions that regulate markets and correct
market failures; institutions for stabilizing markets through the exercise of monetary and fiscal
policies and through prudential regulation and supervision; and institutions for legitimizing
markets through the provision of political voice and social safety nets.
It has been further suggested that each type of institution is important for sustaining economic
growth momentum, build resilience to shocks, and facilitate socially acceptable burden sharing
in response to such shocks (IMF, 2005 and Rodrik, 2003). In general, the most relevant
institution-building priorities and forms of institutions are country specific. Whereas most
countries can benefit from many types of institutional reforms, governments face difficult
choices on how to establish well functioning institutional structures for sustaining economic
growth as emphasized by North (1994) because countries have different informal norms and
enforcement mechanisms, thus, precautions need to be taken given that the formal institutional
structures that work well for one country may not adapt well to other.
17. 16
Furthermore, according to traditional neo-classical growth model, the extent to which FDI affects
output growth is limited with diminishing returns to physical capital. In this case, FDI can only
affect the level of income, leaving the long-run growth rate unchanged. Many scholars have
extensively devoted their time to analyse positive effects of FDI on economic growth in
developing countries given that FDI brings with it capital stocks, technology, managerial skills
and organization arrangements, hence affecting output growth in the long run through increasing
returns in the production process via spillover effects. If technology diffusion effects to the host
country impact strong and positive spill over to the local firms, FDI inflows is transform the
recipient country output from low steady state to a new steady state with higher induce-growth
rates and sustain their long-run growth permanently (De Mello, 1997).
It is worthy also noting that according to Multinational Corporations (MNCs) perspectives, FDI
is considered to be the outcome of corporate strategies and investment decisions. In this case,
institutional features of the recipient country are important determinants of FDI, including the
degree of political stability and the extent to which the government intervenes in the economy,
the level of implementation of property rights, limitation on foreign ownership and domestic
profit tax system and also efficiency of bureaucratic procedures.
Research over the past decade has provided strong convincing evidence of the importance of FDI
inflows in promoting economic growth. The existing empirical studies on the causal relationship
between FDI and economic growth using time series or panel data have found that this relation is
homogeneous because FDI is assumed to have strong positive effect on growth in developing
countries. However, given that the relationship between FDI and growth may be complex and
heterogeneous across countries, in this case, (Nair-Reichert and Weinhold, 2001) found
heterogeneity in the causal relationship between FDI and growth by using mixed fixed and
random model (MRF) in the panel data set of 24 developing countries over 25 years. Their result
was contradictory from the long-established panel estimators which assumed homogeneity effect
of FDI across countries. Furthermore, the study found that the relationship between investment
both foreign and domestic and economic growth in developing countries was extremely
heterogeneous.
18. 17
In the same vein, (Li and Liu, 2004) found significant results supporting the assumption that
there is strong complementarities of FDI and growth arising from the fact that positive effects of
FDI may enlarge market size which in turn attracts further FDI. Using a panel of data set from 84
developed and developing countries over the period of 29 years, they detected endogeneity of
FDI and economic growth which occurred in the second half of the sample in particular mid of
1980s and not from the whole sample period. Further, Li and Liu conducted a test to see whether
FDI affects growth alone or through interactions. The result showed strong positive interaction
effects of FDI with human capital, infrastructure and technology gap.
In addition, a strong empirical association between FDI and economic growth in export-
promoting than import-substituting countries was emphasized by (Balasubramanyam et al.,
1996). This finding implies that impact of FDI varies across countries and that trade policy can
affect the role played by FDI in economic growth. UNCTAD (1999a) found that FDI had either
positive or negative impacts depending on the variables that are entered alongside it in the model
equation. These variables includes the initial per capita GDP, education level, domestic
investment ratio, political instability, terms of trade, black market premium, and the financial
development.
In the same way, (Borensztein et al., 1998) found that FDI contributes more to economic growth
only when the host country has a minimum threshold stock of human capital. In their view,
differences in technological absorptive capability may contribute to the variation in growth
effects of FDI across countries. In their analytical framework, it was found that the quality of
human capital determines the rate and ability to absorb foreign technology. Thus, abundance and
state of human capital are assumed to induce higher growth rates given the amount of FDI
inflows. Borensztein and his colleagues‟ argument is strongly supported by their empirical
findings.
Moreover, the study suggests that a minimum threshold of human capital must be attained in
order for a country to experience positive effects of FDI inflows. Similarly, Carkovic and Levine
(2002) found that after controlling the factors that jointly determined growth, FDI inflows,
country-specific factors, and other growth determinants, the data set did not suggest a strong
19. 18
independent influence of FDI on growth. However, this finding does not dispute the fact that the
types of policies and institutions that are conducive to growth are also conducive to FDI.
Durham, (2004) did not identify a positive relationship between FDI and economic growth using
data on 80 countries for the period 1979-1998, but as an alternative suggested that absorptive
capacity of host country could determine effect of FDI on economic growth.
In addition, recent empirical works have provided strong association between institutions and
economic growth by considering three measures of institutions namely the aggregate governance
index, property rights and constraints on the executive (Kaufmann et al., 1999). In particular,
quality of governance index includes the voice and accountability, political stability and absence
of violence, public sector efficiency, regulatory burden, rule of law, and freedom from graft.
These measures are important in promoting good governance by encouraging institutional
arrangements that guard against corruption, promoting rule of law, and also creating a
meritocratic public service. Moreover, economic principles suggest that productive efficiency
which defines property rights and enforceable contracts and also institutions that place limits on
the president and other political leaders are immensely crucial to spearhead and sustain economic
growth and development.
In the same vein, Keefer and Knack (1997) researched on the effects of the poor institutional
quality on unconditional convergence among countries with special focus on inadequate legal,
political and regulatory frameworks. They assumed that poor and malfunctioning institutions
may interfere with growth, by enabling entrepreneurs to succeed because of political rather than
economical criteria. In their analysis they found that the extent to which developing countries
were relatively backward when compared with developed countries depended on the degree of
property rights protection and also the degree to which laws and regulations were fairly applied.
Furthermore, empirical research work over the past decade has provided convincing evidence on
the linkages between economic growth, institutional quality and economic policies.
Experience has demonstrated that quality of institutions affect economic growth via its choice of
macroeconomic and trade policies, such as outward orientation, financial liberalization,
20. 19
exchange rate flexibility, macroeconomic stability, and labour market flexibility (Asian
Development Bank, 2002).
Unarguably, it has been found that economic growth is for the most part important factor
affecting poverty reduction in developing countries. Moreover, it has been widely known that
there are two types of poverty defined as absolute or relative poverty. Absolute poverty involves
comparison of incomes or expenditures of households with some established pre-determined
standards. Absolute poverty is measured using indicators such as the headcount index and related
measures. Relative poverty involves a comparison of incomes or expenditures of poor
households with those of the rich. It is measured by indicators such as Gini coefficient among
others (Warr, 2005). However, under a common definition of what constitutes poverty still there
are major disagreements among scholars on to what extent of poverty has been changed over
time and how to measure the magnitude of that change.
Furthermore, it has been widely established theoretically and empirically that economic growth
is a means under which abject poverty can be reduced in order to meet the Millennium
Development Goals by 2015 for two reasons. First, economic growth directly reduces income
poverty for many households, increasing their savings and freeing resources for investment and
also expands human capabilities of poor people. Second, economic growth tends to increase
government revenue as most investments in human development such as health, nutrition,
education and infrastructure come from public spending. But, while economic growth is
necessary for increased public spending on building human capabilities, it is hardly sufficient.
Some governments neglect investment in economic and social services provision among
population groups thus weakening the potential benefits that the overall growth can provide in
reducing poverty. In this regard, there is intense debate on the extent to which the poor benefit
from this growth.
In the same context, there has been increasing interest on the question of whether the poor
relative to other segments of society share the benefits of growth proportionally. One strand of
empirical research analyzes the cross-country relationship between economic growth and per
capita income of individuals in the first quintile of the distribution. Using the same data set and
similar econometric techniques, Adams (2003) estimated growth elasticity of poverty to be –2.0
21. 20
and –3.0. This means a 10% increase in economic growth is result into 20–30% decrease in
poverty. But, Adams (2004) argues that growth elasticity of poverty is depend on how growth is
measured. If economic growth is measured as mean income, there is a strong negative link
between growth and poverty. Similarly, if economic growth is measured as changes in GDP per
capita the growth–poverty relationship is weaker. In the same way, Roemer and Gugerty (1997)
and Dollar and Kraay (2002) estimate the growth elasticity of per capita incomes of the poor to
be one, implying that growth in average income leads to a one-for-one increase in the incomes of
the poor.
The second strand of literature examines the effect of economic growth on absolute poverty.
Ravallion (2000) and Ravallion and Chen (1997) found that the elasticity of the poverty
headcount ratio was greater than two when average income increased by 10 percent, the
proportion of poor declined by more than 20 percent.
Other studies define a situation in which incomes of the poor grow at a higher rate when
compared with non-poor. According to this definition, the absolute living standards of the poor
may rise even when there is no relative change in income distribution. In addition, Ravallion and
Chen (2003) propose this definition and apply it to a particular poverty measure known as the
Watts index. However, Kraay (2004) applied the standard poverty decomposition techniques to
identify three potential sources of pro–poor growth namely a high rate of growth of average
incomes, a high sensitivity of poverty to growth in average incomes and a poverty-reducing
pattern of growth in relative incomes in household survey data for a large sample of countries in
the 1980s and the 1990s. The results showed that a high rate of growth of average income and a
poverty-reducing pattern of growth in households of relative incomes were empirically relevant.
Further, in the medium and long run, cross-country differences in growth in average incomes are
the dominant factor explaining changes in poverty. Thus, these decomposition results indicate
that the search for pro–poor growth should begin by focusing on determinants of growth in
average incomes.
It is worthy, however emphasizing that many scholars have tried to define growth which benefits
the poor; that is, pro-poor growth as labour intensive when accompanied by policies and
22. 21
programmes that reduce income inequality and generate income and employment opportunities
for the poor people in particular women and other excluded groups in the society (Asian
Development Bank, 1996). In the same way, Goudie and Ladd (1999) suggest that analysis of the
link between economic growth and poverty reduction needs to integrate the distributional effects,
which may make the overall growth process to be more or less pro-poor over time. Similarly,
World Bank (2001) observes that the extent of poverty for a given rate of growth depends on
how the distribution of incomes changes with changes in growth and on initial inequality, level
of productive asset and access to opportunities which allow the poor to share the benefits of
growth.
Retrospectively, the policy concern related to poverty reduction among multilateral organizations
can be traced as far back as 1970 when the United Nation‟s Committee for Development
Planning declared that the efforts needed are best characterized by what is sometimes called the
necessary war on poverty (United Nations, 1970). The Committee declared poverty reduction
through accelerated development, improved income distribution, and other social changes as a
paramount objective of an appropriate international development strategy. The World Bank‟s
(1990) concerns on poverty stresses that a successful attack on poverty needs to be mounted
simultaneously on three fronts: economic growth that generates employment and incomes for the
poor; development of human resources of poor, which allows them to better exploit the
opportunities created by economic growth; and establishment of a social safety net among the
poor who are unable to benefit from growth and human development opportunities.
Most recently, the World Bank (2001) has come up with a new analytical framework to attack
poverty that is built on three pillars namely empowerment, security, and opportunities.
Empowerment is the process of enhancing the capacity of poor people to influence the state
institutions that affect their lives, by strengthening their participation in political processes and
local decision making. Security is the protection of the poor against adverse shocks, both via
better management of macroeconomic shocks as well as more comprehensive safety nets.
Opportunity is the process of increasing the access of the poor to physical and human capital and
increasing the rates of return of these assets.
23. 22
In general poverty reduction policies could be grouped into three categories. Firstly, policies that
help and empower the poor to escape poverty on their own. These policies help to enhance
productivity assets that poor people own such as labour, farms, enterprises and credit facilitation.
They may also enable the poor to accumulate assets particularly their human capital as well as
improve the quality of such assets. Secondly, economic wide-policies which improve economic
growth and productivity such as macroeconomic policies, trade and sectoral policies that affects
overall economic growth and its impact on the poor. Thirdly, policies that seek to redistribute
income and wealth.
In this context, it seems that for any poor country, policies and strategies directed at promoting
economic growth is have a significant impact in raising the incomes of the poor people on a
sustained basis contributing to reduction of absolute poverty. In addition, the framework for
analysis developed by the Asian Development Bank shows that there are strong linkages
between economic growth, policies, institutions, and poverty reduction. These factors are related
to each other with poverty reduction as an outcome. Further, it has been observed that quality of
institutions affects economic growth and income distribution via policymaking structures and
regulatory frameworks. Figure 1.3 below illustrates how these factors are related to each other
with respect to poverty reduction.
2.2 The Conceptual Framework
2.2.1 Theories of Foreign Aid
The Concept of Foreign Aid
According to the dictionary of contemporary English (Longman), foreign aid is defined as
money or goods given to a poor country. This may be in the form of capital goods, food, military
hardware or technical assistance. The Development Assistance Committee defines foreign aid as
Official Development Assistance which involves transfer of resources from one country to
another on concessional terms. The transfer may be in the form of technical assistance, soft
loans, grants or food aid. The transfer of resources is classified as ODA if it is undertaken by
official agencies; it has the promotion of economic development and welfare as its main
25. 24
According to this model foreign aid has two effects: First it supplements domestic savings and
leads to higher rate of accumulation of capital, and second, it raises income per capita and hence
the proportional of income saved. Chenery (1990) argues that after a certain period of foreign aid
inflows, the rate of growth is become self sustaining.
2.2.3 Foreign Exchange Gap Model
Foreign Exchange Gap is the other propounded model. Some economists believe that the
difficulties experienced by LDCs arise not from their inability to save but from their inability to
acquire foreign exchange by exporting goods and services.
Accordingly, these economists view the role of foreign aid not as supplementing savings but
supplementing foreign exchange earnings. In this model the volume and value of exports(X) is
autonomous, while imports (M) are determined by the level of income(Y) and the propensity to
import (m). The import relationship can be expressed as:
............mYM …………………………………………………………………………………(5)
Given the desired level of growth of national income, the demand for foreign exchange to
finance imports may exceed the supply of foreign exchange obtained from export. If a foreign
exchange gap rises, which could reduce the rate of growth, foreign aid would be an important
agent to stimulate economic development. The absolute size of the gap would equal:
)6..(..............................................................................................................a
Y
XmXmY
The implication of models which stress the foreign exchange gap is that potential domestic
savings are being frustrated because some of the capital goods necessary to undertake a desired
level of investment are not produced domestically and cannot be obtained from abroad. If
additional foreign exchange were available the level of investment and the rate of growth would
increase.
Basically, these models are Keynesian in nature and rely on fixed technical relationship
(example, the incremental output-capital ratio) and the stable savings and imports propensities.
26. 25
These models assume that, first, the rate of development is increase if the ratio of investment to
national income rises, and second, the investment ratio is rise if capital imports increase.
2.2.4 Foreign Aid in Tanzania
The current debate on aid flows to Tanzania has centered mainly on the specific projects and
individual donors with regard to effectiveness, intensity of aid, aid dependency, and the impact
of aid dependence on governance and institutions as well as the aid relationship. All of these
issues have been addressed by a number of studies such as Lancaster (1999), Ali, Malwanda and
Suleiman (1999) Bagachwa et.al. (1997), Helleiner (1999), Rugumamu (1997), World Bank
Report(1996). The studies concluded that those projects had high administrative cost. Further,
the projects were operating on the basis of tied aid and more uncoordinated among donors.
Furthermore, the existence and desire of the donor to see that resources did go to priority sectors
were identified by the donor rather than Tanzania government.
In a number of studies conducted such as Mbegani Fishery Development Centre, Bureau of
Statistics, the Veterinary Medicine Projects at the Sokoine University, Rugumamu, (1997) the
results show that aid supported project tended to be run and managed like private donor
companies. In the process, the recipient and beneficiary organizations were not only
marginalized but also increasingly showed little interest in what appeared to be foreign concerns.
Instead of promoting prudent resource management, donor agencies encouraged the recipient to
embark on costly and often low priority investments. Instead of strengthening weak and
ineffective institutions, donor agencies created parallel aid organization to manage their aid
projects. Instead of utilizing and developing the recipient‟s natural and human resources, donor
resorted to deploying foreign technical assistance
2.2.5 Empirical Evidence
Mwinyimvua (1988) examined the role of exports and foreign aid in enhancing the economic
growth of Tanzania for the period 1966-1985. A single equation model was specified using the
OLS technical of estimation. First, foreign aid was regressed against GDP growth rate. The result
indicated the coefficient of foreign aid to be positive and statistically significant at 1 percent
27. 26
level. Second exports and foreign aid were regressed jointly against GDP growth rate, foreign aid
still showed a positive effect on growth rate.
Kwabena (1992) examined the relationship between aid and economic growth for Sub Saharan
Africa for the period 1968 to 1987. The study used a disaggregated cross-national time series aid
data and a least squares dummy variables model to investigate the effect of aid on economic
growth. The result showed the foreign aid has a small but positive and significant effect on
economic growth in Sub Saharan Africa. While the coefficient of loans was positive and
significant, the coefficient of grants was negative and statistically significant. This negative
coefficient was consistent with the findings of the critics of foreign aid who find a negative
relationship between foreign aid and economic growth. It is also consistent with Cashel-Cord and
Crag‟s (1990) argument that government may treat unconditional grants as pure resources
transfers. These result seem to be reasonable but the cross section data analysis does not fare
well in terms of drawing policy lessons for a specific country due to heterogeneity of sample
countries.
2.2.6 Current status on Partnership, Aid Coordination and Harmonization
The Government of Tanzania, its development partners and civil society have come a long way
in building successful partnerships and in improving aid management, donor/aid coordination
and harmonization. This was possible because, following the adoption of the Helleiner, (1999)
recommendations, both sides of the partnership played their role. The international community
accepted the need for harmonization and enhanced aid efficiency. For its part, the Government
adopted a clearly articulated development policy framework (including the Vision 2025, NPES
and the PRS), strengthened accountability, and improved financial management systems. Most
importantly, both sides agreed to work together in mutual trust and renewed their focus on the
common goal of poverty reduction.
Today, Tanzania is widely recognized as being at the forefront on issues of aid coordination,
harmonization and partnership. This has resulted in a store of knowledge of best practices that
can be shared with other countries and institutions. The TAS document articulates the national
development agenda and policy framework, as well as the best practices in development
28. 27
cooperation and a framework for monitoring progress towards achieving best practices in
development partnership. While the TAS provides a broad outline of best practices for Tanzania
and her development partners in development cooperation, the TAS Action Plan, which was
developed in FY 2002/03, sets out the practical steps that the government and development
partners is follow in order to implement the TAS in the short and medium term.
The TAS Action Plan highlights four areas requiring urgent attention and representing the
greatest challenges in terms of reducing the burden of transaction costs and inefficiency, and
promoting harmonization over the three years of TAS' implementation. These are: first,
improving the predictability of external resources; second, increasing aid flows captured in the
government budget system; third, promoting government leadership of the policy process and
rationalizing processes; and fourth, improving national capacities in aid coordination and
external resource management.
2.2.7 Integrating Donor Funds into the Government Budget System
Improvements have been made to integrate donor funding into the government budget system.
This integration hinges on the on-going and significant reforms of the government's public
financial management system. They include: the Integrated Financial Management System
(IFMS), the Public Expenditure Review (PER), the Medium Term Expenditure Framework
(MTEF), the Public Finance Act 2001, the Procurement Act, 2001 and the Public Financial
Management Reform Programme (PFMRP). The Integrated Financial Management System
(IFMS), which has been adopted and implemented in all government ministries and agencies, has
strengthened the capacity of the government to record, monitor and control expenditures. It has
also allowed government to introduce standardized coding to facilitate monitoring and tracking
of expenditure through the budget system.
The consultative forums with development partners and other stakeholders, including the Public
Expenditure Review (PER), the Medium Term Expenditure Framework (MTEF) and the
Consultative Group Meeting, have been very successful in establishing an open dialogue on
budgetary issues, giving comfort to all partners and stakeholders. This in turn has led to greater
transparency and trust in the government financial management system. The Secretariat, which
29. 28
was previously housed by the World Bank, has now been shifted to the Ministry of Finance,
thereby enhancing local ownership.
In addition, the ongoing implementation of the Public Financial Management Reform
Programme (PFMRP), together with the Public Finance Act and Public Procurement Act of
2001, has enhanced confidence in the government's financial management capacity and control
processes.
All these undertakings have resulted in increased donor trust in the government. This has
encouraged them to provide direct support to the government budget, through the PRBS and
PRSC facilities and to support sector-wide basket approaches in the Education and Health
Sectors, as well as joint funding of the Poverty Monitoring System, the Legal Sector Reform
Programme, and Local Government Reform Programme. While budget support and basket funds
are already integrated within the Government's exchequer system, the greatest challenge remains
in capturing resources that flow directly to projects being implemented by sector ministries and
local government.
2.2.8 Foreign Aid in the Long Run
According to Waweru (1995) aid is given with the hope and expectation that in the long run it is
enable recipient counties to build up their productive capacity so that they can finance their
investment and import requirement through normal commercial channels.
In this respect, it can be argued that in the long run aid help to promote self-reliance. This issue
can be illustrated by looking at experiences of two countries. South Korea received large amount
of aid in the 1950s, which then declined sharply. Overtime, its economy has grown rapidly and
its domestic savings rose from 6.9 percent of GDP in 1953-5 to 18.7 percent in 1974-76. Its
external trade deficit remained roughly constant, at a round 9 percent of GDP, while aid‟s share
in financing fell from 80 percent to 17 percent. South Korea still requires foreign capital, but
obtains it through private market (Waweru, 1995). India has also done well in terms of
promoting self-reliance through receipt of aid. Indians net inflow of foreign aid peaked during
the early 1960s. Gross domestic savings rose from around 13 per cent of GDP in early 1960s to
around 22 per cent in the late 1970s. The net inflow of saving from abroad declined from
30. 29
between 2.5 and 3.0 per cent of GDP to less than 1 per cent. Therefore, despite the direct and
indirect costs associated with aid, its contribution in the long run is very vital (Waweru, op.cit).
2.2.9 Sustainability
There are two aspects of sustainability that are important to consider in light of the increasing use
of foreign aid. The first is economic growth since it is recognized that growth is a sine qua non
for poverty reduction (URT, 2000). The second, which depends to some extent on progress on
the first, is the tax effort. It is clear that Tanzania‟s economic performance in recent years has
been impressive, particularly relative to most of sub-Saharan Africa. In the last five years,
growth has averaged more than five percent, and in 2002, it registered 6.2 percent in real terms.
Inflation has also remained low.
The PAF contains a number of actions that seek to ensure the maintenance of macro-economic
stability, and the government‟s progress in these areas was deemed to be satisfactory following
the November 2003 PRSC annual review (Helleiner, 1999).
The main concern about Tanzania‟s growth performance is that it has not resulted in much
poverty reduction. Growth has been strongest in the capital city, where poverty is least prevalent,
and those sectors that have limited employment-generating effects, such as mining and tourism.
But it has not touched rural areas and the agriculture sector, from which a large majority of
Tanzanians derive their livelihoods, to the same extent (URT 2001). Ensuring that the benefits of
growth reach more Tanzanians require that certain structural barriers to private sector
development be addressed (Griffins et al, 1996).
Although the Europe Aid and ODI (2003) analytical framework posits than an improved
investment climate is be an intermediate outcome of greater use of foreign aid, experience
suggests this is unlikely (Lancaster, 1999). The reason is that donors involved in a general
budget support arrangement are usually primarily concerned with tracking the use of public
resources and for obvious reasons. However, an unintentional consequence can be that issues
that should be addressed in the policy dialogue surrounding the provision of general budget
support, but are only indirectly related to the use of public resources, are given lower priority.
While several donors believe this is the case in Tanzania, the PAF includes numerous measures
31. 30
that are intended to improve the enabling environment for business, suggesting that private sector
development is a key topic in the policy dialogue.
A second aspect of sustainability is the ability to finance public expenditure from locally
generated revenue rather than through large infusions of external assistance. Tanzania is very
much dependent on foreign aid. External assistance accounted for 5.9 percent of GDP in FY02
and was projected to reach 7.9 percent of GDP in FY03 (Maxwell, 1996). In FY03, aid
accounted for 45 percent of the Government‟s total budget 87 percent of the development budget
and 24 percent of the recurrent budget (Motoki, 2002). At the same time, Tanzania‟s tax effort,
measured by revenue as a share of GDP, is one of the lowest in sub-Saharan Africa (Mushi,
1980).
Despite meeting IMF revenue targets in recent years, tax revenue only stands at approximately
12 percent of GDP (Mutahaba, 1989). Consistent with the arguments of Sadawa (1996) and
Lancaster (1999), several donors in Tanzania argue that the high levels of aid are dampening the
incentives for the Government to further develop its own revenue sources. Tax policy touches on
a number of complicated issues, and, as Bagachwa et al (1997) note, focusing too heavily on
raising the revenue-to-GDP ratio can have corrosive consequences on state-society relations
without attacking the main reasons for poor tax compliance poor quality of services, corruption,
mismanagement, and waste in the case of Tanzania (Helleiner, 1999). It is also not obvious what
the appropriate balance is between generating revenue and providing strong incentives for
private investment. In the context of a growing economy, a constant revenue-to-GDP ratio can
still finance increasingly ambitious targets for service delivery.
Nevertheless, the PAF includes a few rather sensible actions related to broadening the tax base
and simplifying the tax system. These focus on limiting tax exemptions, eliminating a number of
“nuisance taxes” at the local level, and harmonizing the local tax system with the national
system.
2.2.10 Capacity Building for Aid Coordination and External Resource Management
The TAS and the multiplicity of reforms that have been launched since the mid 1990s, all place
government firmly in the lead of the development programme. It is widely accepted that
32. 31
government leadership and ownership is one of the key factors that is determine the success of
these reform programmes. In the past, donor support to capacity building tended to focus on
strengthening capacity in relation to the requirements of specific projects or particular donor
systems, rather than general on capacity building to support the system. This, coupled with the
fact that government did not articulate an overall vision of capacity building, has led to a
somewhat weak capacity for aid coordination and resource management.
In order to improve performance and strengthen the voice of Tanzanians in managing external
resources, capacity is needed within the civil service and at all levels of government as well as
within civil society to act as a monitor on government performance on external resources across
a whole spectrum of activities, including financial management, project management, and
negotiation skills.
Now the focus of both government and the development partners is on building capacity in
sector ministries, in particular, the Policy and Planning Departments. These departments are
supposed to play a leadership role in coordinating all processes and in promoting the effective
ownership of budgeting processes, such as the PER/MTEF, as well as in aid coordination and
resource management of their ministries.
2.2.11 National Development Policy Framework
During the late 1990s, the Government of Tanzania, in consultation with other stakeholders,
formulated the National Vision 2025, which provides the overall development framework. It sets
out the national objectives for social and economic development and the vision of attaining a
middle-income society by 2025.
The long-term poverty reduction targets are articulated in the National Poverty Eradication
Strategy (NPES). In the short and medium term, the Poverty Reduction Strategy Paper (PRSP)
provides strategies for poverty reduction in those areas that are identified as priorities, as well as
indicating financing needs and monitoring mechanisms.
The framework for strengthening aid/donor coordination, harmonization of processes,
partnership, national ownership of the development process and managing the external resources
33. 32
for development is provided in the Tanzania Assistance Strategy (TAS), launched in June 2002.
The aims encapsulated in the TAS are also a reflection of the international consensus that has
emerged since the early 1990s on aid management.
It is now widely agreed that, in order to improve the effectiveness of aid in support of poverty
reduction goals, there is an urgent need to improve aid coordination, promote harmonization of
systems and strengthen government ownership of the development processes. Recently, the High
Level Forum on Harmonization (2003), the OECD DAC Task Force on Donor Practices (2003)
and the New Partnership for Africa's Development (NEPAD), have all outlined the practical
steps needed to bring about substantial improvements in aid/donor coordination and
harmonization. The TAS is Tanzania's guide to ensuring that these objectives are achieved on the
ground and transformed into real benefits for people living in poverty, in terms of increased aid
effectiveness.
The TAS and the multiplicity of reforms that have been launched since the mid 1990s, all place
government firmly in the lead of the development programme. It is widely accepted that
government leadership and ownership is one of the key factors that is determine the success of
these reform programmes.
In the past, donor support to capacity building tended to focus on strengthening capacity in
relation to the requirements of specific projects or particular donor systems, rather than general
on capacity building to support the system. This, coupled with the fact that government did not
articulate an overall vision of capacity building, has led to a somewhat weak capacity for aid
coordination and resource management.
In order to improve performance and strengthen the voice of Tanzanians in managing external
resources, capacity is needed within the civil service and at all levels of government as well as
within civil society to act as a monitor on government performance on external resources across
a whole spectrum of activities, including financial management, project management, and
negotiation skills. Now the focus of both government and the development partners is on
building capacity in sector ministries, in particular, the Policy and Planning Departments. These
departments are supposed to play a leadership role in coordinating all processes and in promoting
34. 33
the effective ownership of budgeting processes, such as the PER/MTEF, as well as in aid
coordination and resource management of their ministries.
2.2.12 Sources and Recipients of Aid
Most of the government in developed country give their aid both directly-bilateral aid-and
directly via multilateral and other channels. One of the main channels of multilateral aid is the
International Development Association (IDA), the World Banks soft loan window. IDA funds
are contributed by donor government in triennial replenishment; its loans are highly confessional
and go mostly to low-income countries.
The other main multilateral channel is the regional banks and the UN agencies such as UNDP,
FAO, WHO and regional banks such as the Africa, Asian and Inter- America Development
Banks. Finally there is the EU‟s aid program and its main instrument, is the European
Development Fund (EDP).
Recipients of aid include low-income and middle-income countries. In Africa, and Sub-Saharan
Africa in particular, nearly all aid goes to low-income. Most of the aid for middle-income
countries goes to Israel, Jordan and Syria. Egypt, which is low-income in the OECD‟s tables but
lower middle in the World Bank‟s tables, is the main recipient in North Africa. Aid to America
mainly goes to Central American and the Caribbean countries. American countries that receive
aid include Cyprus, Malta and Turkey. The main recipient of aid in Europe is Turkey which is an
Upper Middle Income Country.
2.2.13 Institutional Set-up for Promoting Donor/Aid Coordination and Harmonization
In order to guide the government and development partners in moving forward on improving aid
coordination and harmonization, and in implementing the TAS, a TAS/Harmonization
Implementation Group, under the chair of the Ministry of Finance, has been established with
joint membership of the government and the local Development Assistance Committee (DAC).
The role of the group is to advise and oversee the implementation of TAS and harmonization
initiatives. In addition, a TAS Technical Secretariat, consisting of Government and DAC
representatives, has been established to support the work of the TAS/Harmonization
35. 34
Implementation Group by providing technical inputs. The secretariat is stationed at the Ministry
of Finance.
Consensus has been reached between the government and development partners to
institutionalize the process of independent monitoring of the development partnership in
Tanzania. The IMG undertakes a medium term assessment of progress made towards the goals of
the development partnership as jointly adopted by both the government and development
partners, and as set out in the TAS. The group is involved in setting targets and recommending
solutions to overcome any difficulties in attaining these targets. The first IMG report was
submitted at the CG meeting held in December 2002. The report provided some important
suggestions for improving aid coordination and harmonization.
2.2.14 Constraints, Challenges and the Way Forward
There are institutional constraints, with the donors' institutional set-up not being supportive. In
most cases, decisions have to come from head offices rather than local offices. Commitment is
required, both by the local DAC and by development partners' head offices, to make practical
improvements in this area. The government's capacity to manage the various processes,
implement the TAS and harmonization initiatives is also constrained. Although capacity building
is being addressed across a wide range of programmes, including the Public Sector Reform
Programme and the PFRMP, efforts are needed to develop a comprehensive capacity building
Programme.
Parallel systems and structures for implementing development projects and programmes are a
major challenge both to the government and the development partners. Development assistance
is badly needed in Tanzania to tackle the greatest enemy, namely, poverty. However, for this
assistance to be effective, and in order for the government to be held accountable for these funds,
they should be delivered in a manner that supports national public financial management systems
and structures. While it looks easier to integrate new development projects and programmes
within the government systems and structures, the real challenge is to integrate those projects
and programmes currently operating parallel to the government systems and structures.
36. 35
As recognized by the OECD Task Force on Donor Practices and the Declaration on
Harmonization, made by development partners at the February 2003 High Level Forum on
Harmonization, development partners should provide opportunities to rationalize the various
processes, systems and structures. Some joint initiatives have started to take place, such as the
joint portfolio review of the UN System and World Bank held in May 2003. In the medium term,
efforts should be made to consolidate donor interventions within a common Country Assistance
Strategy with a single cycle of reviews. Such a strategy would indicate comparative advantages
between donors in sector work and modality.
Table 1.3 and Figure 1 and 2 summarizes the conceptualized framework whereby Development
Partners contributing to GBS, Major clusters of poverty reduction outcomes, and External
Resources Projections Data were use to review the literature review in order to achieve study
objectives.
Basic Assumptions
FDI and economic growth relationship is homogeneous;
The technological change is the only possible source of per capital output growth in the long
run;
Productive efficiency which defines property rights and enforceable contracts and also
institutions that place limits on the president and other political leaders are immensely crucial
to spearhead and sustain economic growth and development.
GBS directly flow in the budget frame through budgetary cash flow; and
There is a strong relationship between the three clusters of MKUKUTA; and indeed between
productive and service sectors
General budget support (GBS) has been an increasingly important mode of development
assistance, receiving growing attention from bilateral donors and international financial
institutions in the context of a partnership-based approach to aid. General budget support is a
coordinated and harmonised way of aid financing, which is provided to Tanzania by 14
Development Partners to directly support the implementation of the NSGRP through the
Government‟s budget. These 14 Development Partners are 11 bilateral and 3 multilateral donors.
Their share of total amount of GBS flowing into the budget is made up in the following way in
financial year 2006/07 as seen in Table 1 below.
37. 36
This form of aid promises benefits for both donors and recipient countries: increased scope for
scaling up development assistance, reducing transaction costs, strengthening country ownership,
and achieving greater development effectiveness than traditional modes of aid delivery. Yet the
concept of budget support itself is still emerging and subject to different interpretations, and
skeptical observers question its impact and fiduciary soundness and the incentives it provides.
According to GBS Annual Review 2006; General budget support makes up 16% of the
Government of Tanzania‟s budget in financial year 2006/07 and it is the preferred aid modality
for the following reasons:
i. The funds go straight into the national budget and the GoT decides how to spend
the money, thereby increasing national ownership of development issues.
ii. GBS strengthens the parliamentary role for decision-making and shifts
government accountability from donors to citizens.
iii. It makes aid contributions more predictable and so makes it easier for the GoT to
implement its poverty reduction programme.
iv. GBS saves time and is eventually save money as there is one, rather than many,
process for reviews, assessment and dialogue with Development Partners.
National Strategy for Growth and Reduction of Poverty (NSGRP) is the country‟s strategy to
reduce poverty and boost economic growth over the next years. NSGRP was launched in 2005
and is a second national organizing framework for putting the focus on poverty reduction high on
the country‟s development agenda. The NSGRP is informed by the aspiration of Tanzania‟s
Development Vision (Vision 2025) for quality education and international competitiveness. It is
committed to the Millennium Development Goals (MDGs), as internationally agreed targets for
reducing poverty, hunger, diseases, illiteracy, environmental degradation and discrimination
against women by 2015. It strives to widen the space for country ownership and effective
participation of civil society, private sector development and fruitful local and external
partnerships in development and commitment to regional and other international initiatives for
social and economic development.
The NSGRP builds on the Poverty Reduction Strategy Paper (PRS(P)) (2000/01-02/03), the PRS
Review, the Medium Term Plan for Growth and Poverty Reduction and the Tanzania Mini-Tiger
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Plan 2020 (TMTP2020) that emphasize the growth momentum to fast-track the targets of Vision
2025. The NSGRP is expected to last 5 years, i.e. form 2005/06 to 2009/10. The end point of the
strategy coincides with the targets of the National Poverty Eradication Strategy (NPES-2010); it
is two thirds of the way towards the MDGs (2015) and 15 years towards the targets of Vision
2025. The longer-term perspective (5 years) is considered to be a better time frame than that of
three years. It allows for a more sustained effort of resource mobilisation, implementation and
evaluation of poverty.
Analyses of poverty profile strongly support the views from the consultation about the factors
that precipitate poverty in Tanzania. Poverty has many dimensions, often caused and reinforced
by underlying unequal distribution of resources, incomes and opportunities. The Strategy
identifies three major clusters of poverty reduction outcomes: (i) growth and reduction of income
poverty; (ii) improvement of quality of life and social wellbeing and (iii) good governance
(Figure 2)
One of the major conditions for poverty reduction is high economic growth. In general, growth
depends on the quantity and the quality of inputs including land and natural resources, capital,
labour and technology. Quality of inputs implies embodied knowledge, which is a basis for
innovation, technological development, increases in productivity and ultimately,
competitiveness.
There is a strong relationship between the three clusters; and indeed between productive and
service sectors. Growth leads to higher incomes, thus reducing income poverty, assuming
equitable distribution. Higher incomes enable households to improve human capabilities through
better education, health, nutrition, and shelter, i.e. social well being. Human capability is, in turn,
one of the critical sources of long-term growth. Also, growth enables the government to collect
more revenue for provision of public services such as health, education, administration and
infrastructure.
Governance, on the other hand, provides conditions within which growth, well-being and
poverty reduction take place. A social-political environment is required that ensures equal access
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to productive resources, social services and human rights. Therefore, equity applies to all the
three major clusters.
According to Graham Teskey, Head of Africa Division, DFID; General budget support does not
simply involve a transfer of funds, however. This point is often misunderstood. In reality, GBS
consist of three core components. These are : ( Based on GBS Evaluation Study Common
Definitions) a) Dispersal of funds b) Policy dialogue and c) Technical assistance and capacity
building activities primarily in the area of public expenditure management and public financial
management.
2.2.15 Key Characteristics of Budget Support
The OECD definition outlined in recent DAC guidelines defines budget support “as a method of
financing a partner country‟s budget through a transfer of resources from an external financing
agency to the partner government‟s national treasury. The funds thus transferred are managed in
accordance with the recipient‟s budgetary procedures” (OECD-DAC 2005a).
According to TAS Implementation Report FY 2002/03- 2004/05 Budget Support is an aid
delivery modality that provides financial assistance to the overall national budget (Government
Consolidated Fund). It is allocated by the Government according to its legal and budgetary
process and hence subjected to the same degree of contestability as domestic resources.
General Budget Support Annual Review 2006 document, says; General Budget Support is an aid
financing modality which provides financial assistance to the overall national budget; provides
resources to support the financing of Tanzania‟s national poverty reduction strategy as set out in
the MKUKUTA/ NSGRP. The funds are provided to the GoT to spend for the implementation of
MKUKUTA, using its own financial management and accountability systems.
The definitions of Direct Budget Support (DBS), of General Budget Support (GBS) and of
Sector Budget Support (SBS) are presented in Table 2 below
Therefore the Key characteristics of Budget Support are;
i. Channelling of donor funds to a partner country using its own allocation, procurement,
and accounting systems;
ii. Support for recipient country‟s own development programs, typically focusing on
growth, poverty reduction, fiscal adjustment, and the strengthening of institutions,
particularly the budgetary processes;
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iii. Policy content, performance assessment, and an accountability framework that focus on
policy measures benchmarks related to overall budget and policy priorities, set out in the
country‟s own poverty reduction strategy and medium-term expenditure framework;
iv. Provision of donor funds at regular intervals, ideally in alignment with the country‟s
annual budget cycle; and
v. Agreements on general budget support priorities and expenditures, so that in principle
there is no need to earmark funds for specific items.
Budget support is provided in foreign currency, which is deposited with the central bank to be
converted into local currency and credited to the central government account at the central bank.
2.2.16 Expectations from the Budget Support
Underlying the shift to increased budget support is the hope that this mode of financing is make
aid more effective by:
i. Strengthening country ownership and ensuring the sustainability of reforms.
(Stefan and Zoran, World Bank 2001) indicated that sustainable reform requires deep and
broad country ownership, because successful policy implementation, of NSGRP for
instance, ultimately depends on strong political commitment. In countries where such
commitment does not exist, budget support could not effectively support a program of
policy actions and reforms. Compared to other aid modalities, budget support creates a
framework more conducive to strengthening country ownership, for a number of reasons:
Integration of external assistance into national budget; Better management of public
expenditures, as a centrepiece of budget support programs and by providing more
discipline in the budget process.
ii. Reducing transaction costs for the government by avoiding parallel project and reporting
arrangements.
The evidence to date suggests that there is still a long way to go to fully reap the promise
of reduced transaction costs through budget support arrangements in the Strategic Plan
with Africa (SPA) review (SPA 2005) point to insufficient progress in harmonization and
alignment across the board as a determining factor. Similar scepticism has been
expressed by Killick (2004), who suggests that the rhetoric on lower transaction costs is
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not sufficiently evidence based. Lawson and others (2005) find that in Tanzania the lack
of evidence of reduction in transaction costs arises substantially from the fact that budget
support arrangements have been additional to continuing large numbers of donor projects
in public sector and the parallel rise in the importance of common-basket funding.
iii. Increasing the predictability of funding. Achieving greater clarity and predictability of
funding presents significantly challenges to both Development Partners and the
Government of Tanzania. For donors, this effort usually requires: (a) announcing multi-
annual commitments in advance; (b) disbursing funds as early as possible in the partner
country‟s budget process and fiscal year; (c) better donor coordination and exchange of
information about the likely timing and conditions of disbursements; and (d) an attempt
to minimize in-year suspension of committed funds to avoid disrupting development
expenditures. As a result of these measures, evidence suggests that in recent years, budget
support to Tanzania has become more predictable and less variable than project aid.
(World Bank Report on Tanzania Public Expenditure Review, 2003).
iv. Addressing cross-cutting government-wide policy, expenditure, and institutional
priorities that cannot be tackled with stand-alone and sector projects.
v. Promoting government accountability, both internal (to parliament and taxpayers) and
external (to donors).
vi. Improving the efficiency and transparency of budget spending, reducing the
fragmentation of public expenditure management, and integrating recurrent and capital
expenditures.
vii. Buttressing the recipient country‟s own budget process and public financial management;
and
viii. Encouraging a greater orientation to medium-term results by focusing on national
development objectives rather than on donor-driven priorities, operational issues, or
activities with limited scope and effect.
2.2.17 The Rationale for General Budget Support
According to (Joint Assistance Strategy for Tanzania, 2006), GBS has been associated with
greater ownership, harmonisation, alignment, managing for results, and mutual and domestic
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accountability. Specifically, GBS has demonstrated the following advantages over other
instruments:
i. It is consistent with the Government legal framework:
The Constitution of the United Republic of Tanzania, Chapter 7, Article 135 and 136 on
the control of the legislature on public finances, which state that all revenues/finances
derived from various sources for the use of the Government shall be deposited in the
Consolidated Fund and be appropriated by the Parliament.
ii. It increases the proportion of external resources subjected to the national budget process,
thereby increasing national ownership of the development process. This allows for a
more equitable distribution of development funds within and across MDAs, Regions and
LGAs, as all funding allocations are planned in a single process-the national budget.
iii. It enhances domestic accountability as it places the Government more fully within the
scrutiny of the Parliament and civil society; more decisions are taken within the
framework of a transparent budgetary process.
iv. It is shifting Government accountability from DPs to citizens through the Parliament and
thus strengthens the Parliamentary role for decision-making.
v. It contributes to transaction cost reduction, DP harmonisation and the alignment process
through adopting common PAF and holding joint dialogue.
vi. It strengthens national public financial management and accountability system by
providing funds directly to the budget to be utilized through Government‟s own systems
and by using national accounting and audit procedures and systems.
vii. It increases the predictability of external resource availability and disbursements by
basing funding decisions on outcomes of a joint review of performance based on a
commonly agreed Performance Assessment Framework.
2.2.18 Foreign Aid in Tanzania
According to the Congress of the United States (1997) a common means of defining and
measuring foreign aid is official development assistance, which is used by the Development
Assistance Committee of the Organization for Economic Cooperation and Development
(OECD). Official development assistance consists of grants or loans that one government or
multilateral organizations gives to a developing country to promote economic development and
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welfare. That assistance must be granted on concessional terms, which in the case of a loan
means that at least 25 percent of it must be in the form of a grant. Development assistance also
include technical cooperation, such as teaching farmers new techniques or providing advice on
making economic reforms; they exclude military assistance, political development programs,
export credits, and debt relief for military loans.
The current debate on aid flows to Tanzania has centered mainly on the specific projects and
individual donors with regard to effectiveness, intensity of aid, aid dependency, and the impact
of aid dependence on governance and institutions as well as the aid relationship. All of these
issues have been addressed by a number of studies such as Lancaster (1999), Ali, Malwanda and
Suleiman (1999) Bagachwa et. Al (1997), Helleiner (1999), Rugumamu (1997), World Bank
Report (1996). The studies concluded that those projects had high administrative cost. Further,
the projects were operating on the basis of tied aid and more uncoordinated among donors.
Furthermore, the donor rather than Tanzania government identified the existence and desire of
the donor to see that resources did go to priority sectors.
In a number of studies conducted such as Mbegani Fishery Development Centre, Bureau of
Statistics, the Veterinary Medicine Projects at the Sokoine University, Rugumamu (1997) the
results shows that aid supported project tended to be run and managed like private donor
companies. In the process, the recipient and beneficiary organizations were not only
marginalized but also increasingly showed little interest in what appeared to be foreign concerns.
Instead of promoting prudent resource management, donor agencies encouraged the recipient to
embark on costly and often low priority investments. Instead of strengthening weak and
ineffective institutions, donor agencies created parallel aid organization to manage their aid
projects. Instead of utilizing and developing the recipient‟s natural and human resources, donor
resorted to deploying foreign technical assistance.
However, general budget support, particularly when provided by bilateral donors, may be more
prone to unpredictability than other aid instruments because it is easier to hold up disbursements
in the face of changing political circumstances. An explicit goal of the Partnership Framework
then is to improve the predictability of donor flows to the Government. To do so, PRBS/PRSC
donors have endeavored to, first, sanction the Government for poor performance in the current
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fiscal year with a reduction in budget support in the subsequent fiscal year and, second, disburse
budget support as early as possible in Tanzania‟s fiscal year. Though, while there have been a
few minor incidents that threatened to hold up disbursements of general budget support by
individual donors; For example, the UK withheld £10 million from its FY02 disbursement when
it was disclosed that the Government intended to purchase a $40 million air traffic control
system designed for military use; the arrangement has not yet been tested by a major event that
might cause a majority of donors to withhold general budget support.
2.2.19 Capacity Building
This is one of the advantages of budget support over other aid modalities, is that, it more
effectively draws on governments‟ existing budgeting and planning capacities and can have the
effect of strengthening those capacities as a result of learning-by-doing effects. But in Tanzania
it is widely recognized that most actors i.e. the Parliament, NGOs, the private sector, research
organizations, the media, etc. suffer from serious capacity constraints.
As has been argued, the effectiveness of service delivery is depend to a great extent on these
actors being able to play their appropriate roles in holding the Government accountable,
disseminating accurate information to citizens, engaging in informed policy debate, and
contributing to a growing economy that helps deliver sustainable benefits to Tanzanians. General
budget support offers little assistance to these entities for strengthening their capacities. In
addition, it is likely that there are limits to the capacity building effects of general budget support
within the Government. For example, general budget support requires that line ministries
develop greater technical capacity to more effectively make their cases to the Ministry of
Finance for budget allocations since they lose access to extra-budgetary finance. Technical
assistance can help in this regard. Even when it comes to improving public expenditure
management-perhaps the most automatic benefit arising from providing assistance as general
budget support i.e technical assistance is often needed. The point is not that general budget
support is an inappropriate instrument for aid delivery, but rather that it requires various forms of
complementary investments to deliver the kinds of benefits to which it aspire
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CHAPTER 3
RESEARCH METHODOLOGY AND WORKING DATA
It is pertinent at this juncture to describe how the study is designed and how it is conducted by
covering the research design, area of the study, sampling procedures, population and sample size,
validity and reliability of data, data collection techniques, data analysis plan and scope of the
study.
3.1 Research Methodology
3.1.1 Research Design
A case study design is hereby adopted; essentially this is an analytic research study because it
describes the state of affairs, as it exists at present. It also allows an in depth investigation of
issues as well as making use of available information which is analysed to make critical
evaluation. The case study design is easier to describe, analyse and discuss data originating from
the Ministry of Finance. The study is quantitative approach, to be supplemented by the
qualitative approach.
3.1.2 Reasons of choosing a Case Study design
The case study design is used due to the following reasons:
a) Study was conducted at a single unit that is the Ministry of Finance (MoF).
b) It is possible to use its findings to other units or organizations.
c) The accessibility to the area of study and relevant information could be possible.
d) The study focuses on contemporary events and does not need control over behavior events.
e) The time factor is be limited and the report must be prepared within the period of four
months.
f) It is be a complete study on itself in a sense that the research topic is be studied and
observed in detail.
g) It is enable the researcher to get fair answers of the research questions, which stress on a
particular aspect of the selected topic i.e. the effectiveness of foreign aid in budget support.
