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The Allocation of volatile aid and economic growth: Evidence and a suggestive theory

We present evidence on the effects of aid transfers and their degree of volatility on economic growth and show that these effects can be categorised in relation to the allocation of foreign aid between productive and non-productive purposes. Using a stochastic endogenous growth model, we provide a theoretical rationalisation for our empirical evidence. Both the empirical and the theoretical analyses generate a pertinent conclusion: situations in which aid actually inhibits the recipient’s growth rate may appear if and only if aid is volatile. As a result, we conclude that it is only in conjunction with the presence of aid variability that aid allocation decisions determine whether aid hurts or promotes trend growth.

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Paper provided by Department of Economics, Loughborough University in its series Discussion Paper Series with number 2007_07.

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Date of creation: Mar 2007
Date of revision: Mar 2007
Handle: RePEc:lbo:lbowps:2007_07
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  1. Dalgaard, Carl-Johan & Hansen, Henrik & Tarp, Finn, 2002. "On the Empirics of Foreign Aid and Growth," MPRA Paper 63696, University Library of Munich, Germany.
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  13. Maurice Obstfeld., 1998. "Foreign Resource Inflows, Saving, and Growth," Center for International and Development Economics Research (CIDER) Working Papers C98-099, University of California at Berkeley.
  14. Minoiu, Camelia & Reddy, Sanjay G., 2010. "Development aid and economic growth: A positive long-run relation," The Quarterly Review of Economics and Finance, Elsevier, vol. 50(1), pages 27-39, February.
  15. Santanu Chatterjee & Stephen Turnovsky, 2005. "Foreign Aid and Economic Growth: The Role of Flexible Labor Supply," Working Papers UWEC-2004-07-P, University of Washington, Department of Economics, revised Nov 2005.
  16. Gomanee, Karuna & Girma, Sourafel & Morrissey, Oliver, 2005. "Aid and Growth in Sub-Saharan Africa: Accounting for Transmission Mechanisms," Working Paper Series RP2005/60, World Institute for Development Economic Research (UNU-WIDER).
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  18. Alessandro Prati & Thierry Tressel, 2006. "What is the Most Effective Monetary Policy for Aid-Receiving Countries?," Working Papers 12, United Nations, Department of Economics and Social Affairs.
  19. Pantelis Kalaitzidakis & Sarantis Kalyvitis, 2008. "On the Growth Implications of Foreign Aid for Public Investment Co-Financing," Review of Development Economics, Wiley Blackwell, vol. 12(2), pages 354-371, 05.
  20. A. Javier Hamann & Ales Bulir, 2006. "Volatility of Development Aid: From the Frying Pan into the Fire?," IMF Working Papers 06/65, International Monetary Fund.
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  22. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
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  24. George Mavrotas & David Fielding, 2010. "The Volatility of Aid," Working Papers id:3166, eSocialSciences.
  25. 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.
  26. Blundell, R. & Bond, S., 1995. "Initial Conditions and Moment Restrictions in Dynamic Panel Data Models," Economics Papers 104, Economics Group, Nuffield College, University of Oxford.
  27. Radelet Steven & Sachs Jeffrey & Lee Jong-Wha, 2001. "The Determinants and Prospects of Economic Growth in Asia," International Economic Journal, Taylor & Francis Journals, vol. 15(3), pages 1-29.
  28. Collier, Paul & Hoeffler, Anke, 2002. "Aid, policy, and growth in post-conflict societies," Policy Research Working Paper Series 2902, The World Bank.
  29. J. Svensson, 1999. "Aid, Growth and Democracy," Economics and Politics, Wiley Blackwell, vol. 11(3), pages 275-297, November.
  30. William Easterly, 2003. "Can Foreign Aid Buy Growth?," Journal of Economic Perspectives, American Economic Association, vol. 17(3), pages 23-48, Summer.
  31. Futagami, Koichi & Morita, Yuichi & Shibata, Akihisa, 1993. " Dynamic Analysis of an Endogenous Growth Model with Public Capital," Scandinavian Journal of Economics, Wiley Blackwell, vol. 95(4), pages 607-25, December.
  32. David Roodman, 2004. "The Anarchy of Numbers: Aid, Development, and Cross-country Empirics," Development and Comp Systems 0412003, EconWPA.
  33. Kent P. Kimbrough, 1986. "Foreign Aid and Optimal Fiscal Policy," Canadian Journal of Economics, Canadian Economics Association, vol. 19(1), pages 35-61, February.
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