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The dynamic implications of foreign aid and its variability

  • Arellano, Cristina
  • Bulír, Ales
  • Lane, Timothy
  • Lipschitz, Leslie

The paper examines the effects of aid and its volatility on consumption, investment, and the structure of production in the context of an intertemporal two-sector general equilibrium model, calibrated using data for aid-dependent countries in Africa. A permanent flow of aid mainly finances consumption rather than investment--consistent with the historical failure of aid inflows to translate into sustained growth. Large aid flows are associated with higher real exchange rates and smaller tradable sectors because aid is a substitute for tradable consumption. Aid volatility results in substantial welfare losses, providing a motivation for recent discussions of aid architecture stressing the need for greater predictability of aid. These results are also consistent with evidence from cross-country regressions of manufactured exports, presented later in the paper.

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Article provided by Elsevier in its journal Journal of Development Economics.

Volume (Year): 88 (2009)
Issue (Month): 1 (January)
Pages: 87-102

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Handle: RePEc:eee:deveco:v:88:y:2009:i:1:p:87-102
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