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A Policymakers' Guide to Dutch Disease

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  • Owen Barder

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    Abstract

    It is sometimes claimed that an increase in aid might cause Dutch Disease—that is, an appreciation of the real exchange rate which can slow the growth of a country’s exports— and that aid increases might thereby harm a country’s long-term growth prospects. This essay argues that it is unlikely that a long-term, sustained and predictable increase in aid would, through the impact on the real exchange rate, do more harm than good, for three reasons. First, there is not necessarily an adverse impact on exports from Dutch Disease, and any impact on economic growth may be small. Second, aid spent in part on improving the supply side—investments in infrastructure, education, government institutions and health—result in productivity benefits for the whole economy, which can offset any loss of competitiveness from the Dutch Disease effect. Third, the welfare of a nation’s citizens depends on their consumption and investment, not just output. Even on pessimistic assumptions, the additional consumption and investment which the aid finances is larger than any likely adverse impact on output. However, the macroeconomic effects of aid can cause substantial harm if the aid is not sustained until its benefits are realized. The costs of a temporary loss of competitiveness might well exceed the benefits of the short-term increase in aid. To avoid doing harm, aid should be sustained and predictable, and used in part to promote economic growth. This maximizes the chances that the long-term productivity and growth benefits will offset the adverse effects—which may be small if they exist at all—that big aid surges may pose as a result of Dutch Disease.

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    File URL: http://www.cgdev.org/content/publications/detail/8709
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    Bibliographic Info

    Paper provided by Center for Global Development in its series Working Papers with number 91.

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    Length: 18 pages
    Date of creation: Jul 2006
    Date of revision:
    Handle: RePEc:cgd:wpaper:91

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    Web page: http://www.cgdev.org

    Related research

    Keywords: Foreign aid; dutch disease; exchange rate; economic growth; consumption;

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    Cited by:
    1. Bernard Walters, 2007. "The Fiscal Implications of Scaling up ODA to Deal with the HIV/AIDS Pandemic," Conference Paper 3, International Policy Centre for Inclusive Growth.
    2. Volker Clausen & Hannah Schürenberg-Frosch, 2009. "Aid, Spending Strategies and Productivity Effects – A Multi-sectoral CGE Analysis for Zambia," Ruhr Economic Papers 0127, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
    3. Feeny, Simon & de Silva, Ashton, 2012. "Measuring absorptive capacity constraints to foreign aid," Economic Modelling, Elsevier, vol. 29(3), pages 725-733.
    4. Ranis, Gustav, 2013. "Another look at foreign aid," Working Paper Series UNU-WIDER Research Paper , World Institute for Development Economic Research (UNU-WIDER).
    5. Christos Nikas & Student Anastasia Blouchoutzi, 2014. "Emigrants’ Remittances and the “Dutch Disease” in Small Transition Economies: the Case Of Albania and Moldova," Romanian Statistical Review, Romanian Statistical Review, vol. 62(1), pages 45-65, March.

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