No. 24 — June 23, 2000


Weekly Review

--- by Marc Castellano

Although Japan again was the world's largest aid donor in 1999 (see JEI Report No. 23B, June 16, 2000), more of its official development assistance was extended on conditional terms. According to the Japan Bank for International Cooperation, the government-affiliated agency created from the October 1999 merger of the Export-Import Bank of Japan and the Overseas Economic Cooperation Fund, the proportion of tied loans reached 16.4 percent in FY 1999 — the highest level in 10 years (see Figure). Aid provided on this basis requires recipients to procure goods and services for development projects from Japanese sources.

Ministry of Foreign Affairs officials say that the recent increase in tied aid is due in part to a special yen loan program for environmental projects introduced in FY 1998. Eligibility requirements specify that all contractors must be Japanese or owned by the borrowing country. Aid administrators also point to a ¥600 billion ($5.5 billion at ¥110=$1.00) facility unveiled in December 1998 as part of Japan's broad effort to support East Asian nations affected by the region's 1997-99 financial and economic crisis (see JEI Report No. 1B, January 8, 1999). In principle, all contracts awarded under this scheme must go to Japanese companies.

Tokyo began a gradual effort to untie its yen loans in the late 1970s in response to international criticism that most of its ODA funds were being used to promote exports and to support domestic companies. By FY 1996, Japan's aid was free of procurement conditions — at least in the official telling. However, the business community, which faced an increasingly dismal situation at home and tougher competition abroad, soon pressured Tokyo to retie some of its lending. In the past five years, Japanese companies have won on average only 30 percent of the contracts for development projects funded by yen loans.

The Development Assistance Committee, the aid arm of the Organization for Economic Cooperation and Development, has been working to build support for global regulations that would prohibit attaching strings to ODA or at least to aid disbursed to the world's poorest countries. Opponents of tied aid claim that it encourages donor governments to collude with favored suppliers, excluding competitors that might be able to do the job more effectively. The practice also reduces the benefits of the assistance by forcing recipients to accept what donors want to provide rather than what is needed. Inappropriate development projects can result, leaving beneficiaries no better off than before and sometimes in even worse shape. In a few cases, excessive donations of clothing or food have ruined local industry. In short, according to critics, tied aid is inefficient, wasteful, selfish and anti-competitive. Limiting such economic distortions has been a mutual concern of both DAC and the Export Credit body of the OECD for some time.

In fact, two years of negotiations are close to culminating in a proposal to limit tied aid. Under it, donors would be prohibited from tying aid extended to the world's 48 least-developed economies (as defined by the United Nations Development Program) for the purchase of all goods and some services. Technical assistance, food aid and investment-related advisory services would not be included.

Despite the proposal's narrow scope, the OECD effort is expected to fail. Denmark, France and Japan are among the major donors opposing the restrictions. Strong support from the World Bank, other development organizations, charities and some OECD members has not swayed entrenched national interests. Tokyo, for instance, remains concerned that Japanese technical consultants would lose business if all ODA programs were open to international competition. Development assistance officials contend that in today's lackluster business environment, corporate Japan must receive some sort of payback if domestic backing for the nation's massive foreign aid program is to be maintained.

Tokyo insists that its long-term policy of promoting untied aid remains unchanged. At the same time, however, a senior MOFA official has been quoted as saying that "a certain percentage of yen loans needs to be tied in order to avoid a loss of public support for Japanese ODA itself in the current tight fiscal situation." Moreover, the Foreign Ministry concluded in its most recent five-year aid plan, released in 1999, that Japan's ODA program should be crafted to respond to the needs of the domestic business community as well as to promote the advancement of developing economies (see JEI Report No. 32B, August 20, 1999). With the prospects for economic recovery at home still uncertain and new policy directives aimed at serving national interests in place, eliminating tied aid may be difficult for Japan.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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