The textbook neoclassical growth model predicts that countries with faster productivity growth should invest more and attract more foreign capital. We show that the allocation of capital flows across developing countries is the opposite of this prediction: capital does not flow more to countries that invest and grow more. We call this puzzle the “allocation puzzle. ” Using a wedge analysis, we find that the pattern of capital flows is driven by national saving: the allocation puzzle is a saving puzzle. Further disaggregation of capital flows reveals that the allocation puzzle is also related to the pattern of accumulation of international reserves. The solution to the “allocation puzzle”, thus, lies at the nexus between growth, saving and international reserve accumulation. We conclude with a discussion of some possible avenues for research. 1.

In most destination countries, immigration policies are tilted more and more in favor of skilled individuals. Whether this shift hurts economic prospects in sending countries, as argued by the traditional brain drain literature, is somewhat controver-sial. The most recent literature focuses on the link between skilled outmigration and educational achievements in the home country. This article emphasizes a different channel. It considers the argument that skilled migrants raise economic welfare at home by sending a relatively larger flow of remittances. While skilled migrants typi-cally earn more, and so might be expected to remit more, they are also likely to spend more time abroad and to reunite with their close family in the host country. These second two factors should be associated with a smaller propensity to remit. Thus, the sign of the impact of the brain drain on total remittances is an empirical question. A simple model has been developed showing that skilled migrants may indeed have a lower propensity to remit from a given flow of earnings. An empirical equation of remittances is estimated as a measure of the brain drain in developing countries using the Docquier and Marfouk (2004) data set. Evidence is found that the brain drain is associated with a smaller propensity to remit. JEL codes: F02, F22 Immigration policies in receiving countries are increasingly tilted in favor of skilled migrants (Beine, Docquier, and Rapoport 2003; OECD 2003). This trend is raising considerable concern among policymakers in developing countries, wary of having to bear the cost of educating and then losing their most entrepreneurial and talented workers. Anecdotal evidence is startling. According to Stalker (1994), Jamaica had to train five doctors to retain

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 in the data, and corrects for possible reverse causality. We find that aid inflows have systematic adverse effects on a country’s competitiveness, as reflected in the lower relative growth rate of labor intensive and exporting industries, as well as a lower growth rate of the manufacturing sector as a whole. We provide evidence suggesting that the channel for these effects is the real exchange rate overvaluation caused by aid inflows. We are grateful for helpful comments from Chris Adam, Andy Berg, Jagdish Bhagwati,

We analyze the growth impact of official development assistance to developing countries. Our approach to this heatedly debated subject is different from that of previous studies in two major ways. First, we disentangle the effects of two components of aid: a developmental, growth-enhancing component, and a geopolitical, possibly growthdepressing component. Second, our specifications allow for the effect of aid on economic growth to occur over long time-lags involving periods of up to several decades. This approach allows us to take account of aid-financed investments in economic infrastructure and human capabilities that can by their nature create returns only over time. Our results indicate that aid of the right kind promotes long-run growth. The effect of developmental aid is significant, large, and withstands a battery of robustness checks including alternative proxies for developmental aid, specifications and treatments of outliers. The paper has important policy implications: it indicates that increasing the level of developmental aid (whether by changing the composition or level of total aid) can have a sizable impact on long-run growth. Furthermore, we find no evidence that there are diminishing returns to aid nor that aid is only effective in “good ” policy environments.

Recent research yields widely divergent estimates of the cross-country relationship between foreign aid receipts and economic growth. We re-analyse data from the three most influential published aid-growth studies, strictly conserving their regression specifications, with sensible assumptions about the timing of aid effects and without questionable instruments. All three research designs show that increases in aid have been followed on average by increases in investment and growth. The most plausible explanation is that aid causes some degree of growth in recipient countries, although the magnitude of this relationship is modest, varies greatly across recipients and diminishes at high levels of aid. Economists have spent decades debating, without resolution, the cross-country relationship between foreign aid receipts and economic growth. Some find that aid robustly causes positive economic growth on average. Others cannot distinguish the average effect from zero. Still others find an effect only in certain countries, such as those with good policies or governance. Wearied readers of this literature would be right to wonder what produces diverse findings from apparently the same aid and growth data. Here, we show that two traits of previous research help to explain why different studies reach different conclusions. Both traits relate to how these studies treat the timing of causal relationships between aid and growth. First, the most cited research has focused on measuring the effect of aggregate aid on contemporaneous growth, while many aid-funded projects can take a long time to influence growth. Funding for a new road might affect economic activity in short order, funding for a vaccination campaign might only affect growth decades later and humanitarian assistance may never affect growth. Second, because current growth is likely to affect current aid, these studies require a strategy to disentangle correlation from causation. They have tended to rely on instrumental variables but the instruments that have been used are of questionable validity and strength. When these issues are addressed, the divergence in empirical findings is greatly reduced. We show this by stepwise altering the research design of the three most influential papers in the aid and growth literature. We hold all else constant: we begin by

The classic narrative of economic development-- poor countries are caught in poverty traps, out of which they need a Big Push involving increased aid and investment, leading to a takeoff in per capita income-- has been very influential in development economics since the 1950s. This was the original justification for foreign aid. The narrative lost credibility for a while but has made a big comeback in the new millennium. Once again it is invoked as a rationale for large foreign aid programs. This paper applies very simple tests to the various elements of the narrative. Evidence to support the narrative is scarce. Poverty traps in the sense of zero growth for low income countries are rejected by the data in most time periods. There is evidence of divergence between rich and poor nations in the long run, but this does not imply zero growth for the poor countries. Moreover, this divergence is more associated with institutions rather than the disadvantages of initial income. The idea of the takeoff does not garner much support in the data. Takeoffs are rare in the data, most plausibly limited to the Asian success stories. Even then, the takeoffs are not associated with aid and investment as the standard narrative would imply.

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. 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

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In this paper, we propose a tractable variant of the open economy neoclassical growth model that emphasizes political economy and contracting frictions. The political economy frictions involve disagreement and political turnover, while the contracting friction is a lack of commitment regarding foreign debt and expropriation. We show that the political economy frictions induce growth dynamics in a limitedcommitment environment that would otherwise move immediately to the steady state. In particular, greater political disagreement corresponds to a high tax rate on investment, which declines slowly over time, generating slow convergence to the steady state. While in the standard neoclassical growth model capital’s share in production plays an important role in determining the speed of convergence, this parameter is replaced by political disagreement in our open economy reformulation. Moreover, while political frictions shorten the horizon of the government, the government may still pursue a path of tax rates in which the first best investment is achieved in the long run, although the transition may be slow. The model rationalizes why openness has different implications for growth depending on the political environment, why institutions such as respect for property rights evolve over time, why governments in open countries that grow rapidly tend to accumulate net foreign assets rather than liabilities, and why foreign aid may not affect growth.