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Why Do Some Countries Manage to Extract Growth From Foreign Aid?

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  • Jean-François Ruhashyankiko
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    Abstract

    Aid is primarily given to governments whereas the engine of sustained growth is the private sector. It is therefore illusory to investigate the impact of aid on growth without considering the impact of government interventions on the private sector. The model shows how these interventions improve capacity utilization and growth. However, distortionary interventions can also cause capacity underutilization and an increase in the informal economy, that is, the very market failures the interventions initially sought to address. Countries that fall into this trap are characterized by insufficient credibility in promoting the private sector, which translates into aid dependence and slower growth over time. The empirical evidence is supportive. This paper finds that aggregate aid has a positive impact on growth (even without diminishing returns) but the impact is substantially smaller for low-income countries.

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    Bibliographic Info

    Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/53.

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    Length: 34
    Date of creation: 01 Mar 2005
    Date of revision:
    Handle: RePEc:imf:imfwpa:05/53

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    Keywords: Economic growth; Foreign investment; Economic models; capacity utilization; foreign aid; ethnic fractionalization; diminishing returns; income per capita; credibility problem; international finance; rate of investment; direct investment; foreign direct investment; private investment; conflicts of interests; foreign assistance; foreign capital; internal rate of return; expropriation; institutional framework; public investment; domestic saving; rate of return;

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    1. Henrik Hansen & Finn Tarp, 2000. "Aid effectiveness disputed," Journal of International Development, John Wiley & Sons, Ltd., vol. 12(3), pages 375-398.
    2. Alesina, Alberto & Devleeschauwer, Arnaud & Wacziarg, Romain & Kurlat, Sergio & Easterly, William, 2003. "Fractionalization," Scholarly Articles 4553003, Harvard University Department of Economics.
    3. 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.
    4. Svensson, Jakob, 1997. "When is foreign aid policy credible : aid dependence and conditionality," Policy Research Working Paper Series 1740, The World Bank.
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    13. Michael A. Clemens & Steven Radelet & Rikhil Bhavnani, 2004. "Counting chickens when they hatch: The short-term effect of aid on growth," International Finance 0407010, EconWPA.
    14. James Kirkley & Catherine Morrison Paul & Dale Squires, 2002. "Capacity and Capacity Utilization in Common-pool Resource Industries," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 22(1), pages 71-97, June.
    15. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June.
    16. Burnside, Craig & Dollar, David, 1997. "Aid, policies, and growth," Policy Research Working Paper Series 1777, The World Bank.
    17. Johnson, Simon & Kaufmann, Daniel & Zoido-Lobaton, Pablo, 1998. "Regulatory Discretion and the Unofficial Economy," American Economic Review, American Economic Association, vol. 88(2), pages 387-92, May.
    18. C-J. Dalgaard & H. Hansen, 2001. "On Aid, Growth and Good Policies," Journal of Development Studies, Taylor & Francis Journals, vol. 37(6), pages 17-41.
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    20. Matthew D. Shapiro, 1989. "Assessing the Federal Reserve's Measures of Capacity and Utilization," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 181-242.
    21. Azam, Jean-Paul & Laffont, Jean-Jacques, 2003. "Contracting for aid," Journal of Development Economics, Elsevier, vol. 70(1), pages 25-58, February.
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    Cited by:
    1. Strand, Jon, 2009. ""Revenue management"effects related to financial flows generated by climate policy," Policy Research Working Paper Series 5053, The World Bank.

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