DEVELOPMENT ECONOMICS
Sponsored by a Grant TÁMOP-4.1.2-08/2/A/KMR-2009-0041 Course Material Developed by Department of Economics,
Faculty of Social Sciences, Eötvös Loránd University Budapest (ELTE) Department of Economics, Eötvös Loránd University Budapest
Institute of Economics, Hungarian Academy of Sciences Balassi Kiadó, Budapest
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Author: Katalin Szilágyi Supervised by Katalin Szilágyi
January 2011
Week 8
Foreign aid and growth
Resource curse and foreign aid
• Windfall wealth can be harmful
• Especially in countries with bad institutions
• Foreign aid is a clear analogy
• Rent-seeking, corruption
• Underinvestment
• Effect of foreign aid on growth
• Other criteria (humanitarian)
Outline
• Aid effectiveness
• Arguments for and against
• Empirical results
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• Meta-analysis
• Famous results
1. Aid effectiveness Foreign aid
• Foreign aid (official development assistance, ODA): unilateral transfer
• Mostly fungible
• No big deal for donors
• Modern phenomenon
• After WWII
• Political ties play a role
• Less politically motivated after 1990
Aid effectiveness
• From the 1990s
• OECD: Monterrey-consensus
• UN: MDG
• Effective: good for growth
• Timing?
• Measurement?
• Results?
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Classic schools of thought
• Marxists: aid is a tool for exploitation
• Libertarians: aid goes to corrupt governments
• Peter Thomas Bauer: Dissent on development
Arguments for effective aid
• Micro-level evidence: individual projects
• Macroeconomics: increase in government expenditures (with no future tax increase) stimulates the economy
• Growth theory: investments → growth
• Donor motivation: rational actors behind
1. Micro evidence
• Mosley (1986): Aid-effectiveness: The Micro-Macro Paradox
• Analogy: exchange rate disconnect puzzle
• Micro-level evidence vs. macro-level correlations
• Explanation: aid is fungible
• Projects with lower return
• Consumption
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2. Effect of government expenditures
• Reaction from the private sector is the key
• Labor supply effect of a positive shock to income?
• Savings effect?
3. Government investment
• Investment rate → growth
• Private sector reaction is key
• Crowding out?
4. Donor motivations
• Revealed preference of rational actors
• But:
• No big deal (cca. 0,3% of donors’ GDP), aid fatigue
• Not necessarily economic motivations
• Kuziemko–Werker: How Much Is a Seat on the Security Council Worth? Foreign Aid and Bribery at the United Nations (http://www.hbs.edu/research/pdf/06-029.pdf)
2. Empirical evidence
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Aid effectiveness
• Does foreign aid spur growth?
• Model: g = g(h)
• Aid is effective if μ = ∂g/∂h > 0
• Conditional or unconditional
• Meta-analysis
• Quantitative summary of the empirical literature
• Doucouliagos–Paldam (2007): The Aid Effectiveness Literature: The Sad
Results of 40 Years of Research
(http://www.econ.cam.ac.uk/dae/repec/cam/pdf/cwpe0773.pdf)
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Aid effectiveness II
Aid and growth
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Estimated trend in AEL
Models
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Regressions
• A: ait = α + μ hit + γj xjit + uit
• B: git = α + μ hit + γj xjit + uit
• C: git = α + μ hit + δ zit + ω hit zit + γj xjit + uit
Trends in models
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„A” models
• Intuition: aid spurs investment
• Harrod-Domar
• I – Sp – Sg = net foreign financing (foreign aid)
• Sp can decrease – Griffin–Enos (1970)
• Sg can decrease – Boone (1996)
„A” results
„B” models
• Intuition: if we are interested in the direct effect, let’s estimate it directly!
• Barro-type regressions
• Endogenity bias
• Instruments:
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• Aid lagged
• Political determinants of aid
• Recipient’s size
• 2SLS
„B” results
„C” models
• Intuition: heterogenity is key
• Two types of models:
• Good policy
• Medicine
• Good policy: World Bank (Burnside–Dollar, Dollar–Collier)
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• Conditional effectiveness: only with good institutions
• Medicine: Danida-group (Hansen-Tarp)
• Effective only in small portion
Good policy model
• Burnside-Dollar:
• git = α + μ hit + δ zit + ω hit zit + γj xjit + uit,
• z: institutional quality
• Openness
• Budget deficit
• Inflation
• Burnside–Dollar (1997): Aid, policies, and Growth. AER (http://ideas.repec.org/a/aea/aecrev/v90y2000i4p847-868.html)
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• Burnside-Dollar (2004): Aid and Growth: Revisiting the Evidence. World Bank Policy Research Working Paper 3251
• Influential results
• Effect on WB
• Results are fragile, heavily criticised
• Easterly-Levine-Roodman: New Data, New Doubts
(http://www.nyu.edu/fas/institute/dri/Easterly/File/aid_nber.pdf)
• Institutional bias?
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Medicine model
• Hansen–Tarp:
git = α + μ hit + ω h2it + γj xjit + uit,
• z = h (condition is the size of aid)
• Usual (famous) result: optimal size
• Not very robust
Lessons
• Growth effect of foreign aid is limited
• Average elasticity of average aid implies 20% increase in per capita income after 40 years
• China/India: per capita income doubles in 10 years
