The issue of aid effectiveness in developing countries has increasingly become a central problem since the 1970s. Many development policies have been discredited because of their poor capacity to make radical changes in the countries. As many organizations and researchers have been trying to understand to which extent it is possible to consider economic aid as a clear and effective way for developing countries to alleviate their poverty, it is important to understand what obstacles can arise at a microeconomic level.
There are two ways through which international organizations can help developing countries: physical capital accumulation and human capital accumulation. These two approaches have, however, seemed to be successful only occasionally. Accumulation of physical capital refers to all the investments that aim at financial help, for example, in the fields of: new infrastructures, lower capital costs and easing the technological catch-up. All these policies can improve the capacity of developing countries by widening their market, and in turn increase imports and exports with the rest of the world.
Let’s for instance take the case of technology transfer to developing countries. Developing countries, through the acquisition and diffusion of technology can foster productivity growth. Imported capital goods and technological inputs can directly be used in the production process and can thus enhance productivity.
Nevertheless, most developing countries are forced to rely on imported technology in order to increase their productive knowledge. This often leads to inefficiencies that prevent the transfer of technology to be efficient. Such inefficiencies come from asymmetric information and market power.
There is asymmetry in the information of the providers, who knows the technology well, and the buyers (local population), who are not aware of the value of the good and therefore cannot estimate its importance beforehand. This inevitably leads to high transactions costs that do not reflect the value that local people attribute to these technologies. The companies that own the technologies, relying on their market power, will set a price that does not correspond to the marginal benefit of the consumer, which is the price he is willing to pay for that good. This way, the companies providing the technologies will maximize their utility but the social welfare of the developing country will decline.
Clearly, the inefficiencies mentioned above are only few of the possible distortions that occur when trying to invest in physical capital. It is well known that growth is subject to many other factors, such as: political stability, institutions transparency, level of inequality in income distributions and many others. Additionally, local governments and donors have shown problems in directing aid funds to the right purposes. On one hand, donors have often pursued political, economic and strategic interests in inter-country aid allocation reducing the effect of financial aid. On the other hand, governments of developing countries are often corrupted and financial investments hardly ever reach the needing sectors.
All in all, it is hard to find optimal policies able to minimize distortions and maximize the investments in technology transfer. A must for developing countries, in order to benefit from technology transfer, is investing in human capital. The problems in physical capital accumulation suggest that the benefits of technology transfer should be reached by other means, i.e. by the previously mentioned human capital, for example, through education.