Working Paper: NBER ID: w11657
Authors: Raghuram G. Rajan; Arvind Subramanian
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.
Keywords: aid; economic growth; real exchange rate; competitiveness; Dutch disease
JEL Codes: O19; F35
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| aid inflows (F35) | real exchange rate (F31) |
| real exchange rate (F31) | share of labor-intensive and tradable industries in manufacturing (F16) |
| aid inflows (F35) | share of labor-intensive and tradable industries in manufacturing (F16) |
| aid inflows (F35) | overvaluation of the real exchange rate (F31) |
| overvaluation of the real exchange rate (F31) | decline in share of manufacturing in total GDP (O14) |
| aid inflows (F35) | decline in competitiveness of manufacturing sector (O14) |
| aid inflows (F35) | slow down of manufacturing sector's growth (O14) |