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Aid Effects on Developing Economies Arvind Subramanian

Papers/Articles. Presentation draws upon:

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Aid Effects on Developing Economies Arvind Subramanian

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    1. Aid Effects on Developing Economies Arvind Subramanian Conference on Developing Countries Madrid, February 2-3, 2006 The views expressed here are personal and not those of the IMF, its Management or Executive Board.

    2. Papers/Articles Presentation draws upon: “Aid and Growth: What Does the Cross-Country Evidence Really Show,” (Rajan and Subramanian, 2005a, NBER Working Paper 11513) “What Undermines Aid’s Impact On Growth,” (Rajan and Subramanian, 2005b, NBER Working Paper 11657) “Aid and Growth: The Policy Challenge,” (Rajan, 2005, Finance and Development) “How to help Poor Countries,” (Birdsall, Rodrik, and Subramanian, 2005, Foreign Affairs)

    3. Background MDGs, UN Millennium Report, and Blair Commission Report (Big Push Strategy) The likely numbers are big

    4. Aid to Government Expenditure Under “Big Push”

    5. Structure of Presentation New evidence on aid and growth New evidence on Dutch disease Policy conclusions on aid and on aid versus other levers for helping poor countries

    6. Aid and Growth Typically, cross-country aid-growth literature focuses on one aspect of aid-growth relationship Conditional on institutions (Burnside-Dollar, 2000) Conditional on geography (Dalgaard et. al., 2004) Type of aid (Clemens et. al., 2004) Panel (Hansen and Tarp, 2000) Questions about how endogeneity of aid is addressed

    7. Two Features We use a framework to assess the general validity of aid-growth That is, we test robustness across: time horizons (5, 10, 20, 30, 40 years) time periods (1960-2000; 70-00; 80-00; 90-00) sources of aid (multilateral versus bilateral) types of aid (economic, social;) timing of impact (early versus late) types of recipients (good vs. bad institutions and locations) cross-section and panel

    8. Main results Despite correcting for the bias arising from endogeneity of aid, we find no robust relationship between aid and growth across any of the dimensions

    9. What Should we Infer? No robust impact from aid to growth across a wide variety of dimensions? Possible that such an impact exists but we just have not been able to figure it out Or, perhaps there has been no impact? Why?

    10. What Undermines Aid’s Impact: Motivation Aid can have little impact in the long run if positive effects are offset by the fact that: Development needs more than resources E.g. school building is useless unless teacher incentives improved Aid undermines institutions Analogy with natural resources Aid hurts competitiveness “Dutch Disease”

    11. Aid and tradable sector competitiveness Aid causes real exchange rate to appreciate (if flexible), undermining competitiveness of tradable sectors either by: driving up nominal rate or aid is spent in part on non-traded goods, driving up their price and hence the price of their inputs. If these inputs are also used by the traded sector, it becomes uncompetitive. Consequence: potential impact on aggregate growth

    12. Aggregate Growth and Concentration of Value-Added in Labor-Intensive Manufacturing

    13. Main results Labor intensive/exportable industries grow slower in countries that receive more aid. Effect of aid seems to work through exchange rate overvaluation. Not just relative differential between industries but also overall effect – the manufacturing sector in countries that receive more aid grows slower.

    14. Heuristic Depiction of Core Result

    15. Channel: Overvaluation?

    16. Aid,Overvaluation and Manufacturing Magnitude: 1 percentage point increase in the ratio of aid to GDP has the same impact on labor-intensive sectors as a 3.8 percent overvaluation. A 1 percentage point increase in aid-to-GDP reduces the growth of the average manufacturing sector by 0.5 percent per year.

    17. Conclusions on Aid Aid for humanitarian reasons, to alleviate suffering, and improve health and social outcomes is terribly important in its own right (But Good Samaritan’s Dilemma). Aid absorption and aid delivery are not second order issues, nor is aid dependence. These can be vitally important in determining aid’s long-term impact on growth and poverty reduction We need to be more open-minded to experimentation about what works. We need to be a little more cautious about old-style approaches involving a rapid ramp-up of aid without addressing the other impediments.

    18. The Broader Agenda: How to Help the Poorest Countries? Aid and Trade important for the poorest but how important? There is another agenda Do no harm (acts of commission) Intellectual property Global warming Help (acts of omission) Address supply side of corruption Finance R&D of interest to the poorest Facilitate labor mobility

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