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What Undermines Aid's Impacton Growth?

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  • Arvind Subramanian
  • Raghuram Rajan

Abstract

We examine one of the most important and intriguing puzzles in economics: why it is so hard to find a robust effect of aid on the long-term growth of poor countries, even those with good policies. We look for a possible offset to the beneficial effects of aid, using a methodology that exploits both cross-country and within-country variation. We find that aid inflows have systematic adverse effects on a country''s competitiveness, as reflected in a decline in the share of labor intensive and tradable industries in the manufacturing sector. We find evidence suggesting that these effects stem from the real exchange rate overvaluation caused by aid inflows. By contrast, private-to-private flows like remittances do not seem to create these adverse effects. We offer an explanation why and conclude with a discussion of the policy implications of these findings.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/126.

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Length: 54
Date of creation: 01 Jun 2005
Date of revision:
Handle: RePEc:imf:imfwpa:05/126

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Keywords: Economic growth; Export competitiveness; exchange rate; standard deviation; real exchange rate; exchange rate overvaluation; standard errors; equations; exchange rates; real exchange rate overvaluation; correlation; statistics; samples; outliers; overvalued exchange rates; standard error; exchange rate regime; nominal exchange rate; foreign exchange; financial statistics; overvalued exchange rate; regression analysis; real exchange rate appreciation; exchange rate appreciation; instrumental variables; exchange earnings; equation; foreign exchange earnings; exchange controls; history of exchange rate; standard deviations; counting; fixed exchange rate regime; causation; statistic; flexible exchange rates; survey; predictions; measurement error; real exchange rates; cross-country variation; instrumental variable; dual exchange rates; prediction; foreign exchange market; exchange rate policies; exchange rate arrangements; exchange restrictions; correlations; fixed exchange rate; sample bias; statistical significance;

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References

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  1. Michael Clemens & Steven Radelet & Rikhil Bhavnani, 2004. "Counting Chickens When They Hatch: The Short-term Effect of Aid on Growth," Working Papers 44, Center for Global Development.
  2. Easterly, William & Levine, Ross, 2003. "Tropics, germs, and crops: how endowments influence economic development," Journal of Monetary Economics, Elsevier, vol. 50(1), pages 3-39, January.
  3. Carl-Johan Dalgaard & Henrik Hansen & Finn Tarp, 2001. "On the Empirics of Foreign Aid and Growth," EPRU Working Paper Series 03-13, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics, revised Sep 2003.
  4. Svensson, Jakob, 2003. "Why conditional aid does not work and what can be done about it?," Journal of Development Economics, Elsevier, vol. 70(2), pages 381-402, April.
  5. Barro, Robert J. & Lee, Jong-Wha, 2005. "IMF programs: Who is chosen and what are the effects?," Journal of Monetary Economics, Elsevier, vol. 52(7), pages 1245-1269, October.
  6. Esther Duflo & Abhijit Banerjee & Shawn Cole & Leigh Linden, 2006. "Remedying Education: Evidence from Two Randomised Experiments in India," Working Papers id:360, eSocialSciences.
  7. Reinhart, Carmen & Rogoff, Kenneth, 2004. "The modern history of exchange rate arrangements: A reinterpretation," MPRA Paper 14070, University Library of Munich, Germany.
  8. Raghuram G. Rajan & Arvind Subramanian, 2008. "Aid and Growth: What Does the Cross-Country Evidence Really Show?," The Review of Economics and Statistics, MIT Press, vol. 90(4), pages 643-665, November.
  9. Raghuram Rajan & Arvind Subramanian, 2005. "Aid and Growth," IMF Working Papers 05/127, International Monetary Fund.
  10. Burnside, Craig & Dollar, David, 2004. "Aid, policies, and growth : revisiting the evidence," Policy Research Working Paper Series 3251, The World Bank.
  11. Collier, Paul & Dollar, David, 1999. "Aid allocation and poverty reduction," Policy Research Working Paper Series 2041, The World Bank.
  12. William Easterly & Ross Levine & David Roodman, 2003. "New Data, New doubts: A Comment on Burnside and Dollar's "Aid, Policies, and Growth" (2000)," NBER Working Papers 9846, National Bureau of Economic Research, Inc.
  13. David H. Romer & Jeffrey A. Frankel, 1999. "Does Trade Cause Growth?," American Economic Review, American Economic Association, vol. 89(3), pages 379-399, June.
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