The Knicks seriously suck. Luckily for Eric, he's a Celtics fan. Not that last season was any good, but this one is looking much better. Luckily for me, I have every plan to abandon the hapless Knickerbockers the second the Nets put "Brooklyn" on their new jerseys.
Over email, Eric pointed out an error in my reasoning in the last post. Here's our interchange:
Eric: ah almost forgot — i don't think your social rate of return methodology goes through — you would need a 100% rate of return on the 16% that got through to get a 16% rate of return on the initial aid, no?
Noel: You’re right! I think I made an error. It’s not quite that I assumed a return of 100%, inasmuch as I treated a flow of future benefits (from the investment) the same as a one-time benefit (the aid).
Aid has two benefits, in theory. The first is the consumption boost provided by the aid itself. (After all, no corresponding good or service is given up in return.) The second is whatever permanent flow of "good" comes from that initial aid dollar — longer lifespans, better education, roads, whatever it may be.
FDI, on the other hand, provides very little initial boost (save the increase in wages and locally-sourced input prices that might occur during the initial construction). It then, however, provides a flow of social benefits, defined as the benefits that aren't captured by the owners of the investment. Excess wages paid to employees (meaning their wages minus the wage available from the next best alternative) seem to be the most obvious social benefit. Profits and excess wages earned by local suppliers would be another. You’d also probably want include tax payments to the local government. Lastly, you’d include the benefits from any nonexcludable public goods made as part of the investment, such as roads or excess electric generation or what have you.
You'd need to calculate NPVs to do it right. Following my post, let’s assume a worst-case in which the aid has no long-term effect at all; it’s pure consumption. That means that 16¢ of aid has an NPV of 16¢.
The World Bank calculated an 11% social return to electricity generation. So let’s run with a discount rate of 11% — implicitly making electricity generation the benchmark marginal investment. A discount rate of 11% means that $1 of investment needs to produce a social rate of return of 1.8% to generate public benefits with an NPV (assuming a 30-year project lifespan) of 16¢.
I really have no idea if spillovers of 1.8% are high or low.
Of course, the comparison is with a worst-case scenario, in which the aid has no lasting benefit whatsoever. That doesn’t sound like it can be true for a lot of aid programs, such as vaccinations or emergency food aid — which provide benefits equal to the value of life in that country — or more tangible things like roads and sewers. It might or might not be true for institution-building aid programs, although I suspect mileage varies a lot on those. To compete with aid that does have long-term benefits, FDI would need to produce a social rate-of-return well above 1.8% over the life of the project.
Eric: You should work for the MCC! We had lots of conversations like this.
Noel: Is that a compliment?
Over to you, Doug.