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The present paper re-examines the effectiveness of foreign aid theoretically and empirically. Using a standard OLG model we show that aid inflows will in general affect long-run pro-ductivity. The size and direction of the impact may depend on policies, ‘deep ’ structural characteristics and the size of the inflow. The empirical analysis investigates these possibi-lities. Overall we find that aid has been effective in spurring growth, but the magnitude of the effect depends on climate-related circumstances. Finally, we argue that the Collier-Dollar allocation rule should be seriously reconsidered by donor agencies if aid effectiveness is related to climate. The usefulness of foreign aid in promoting growth in developing countries has been an area of controversy ever since Rosenstein-Rodan in 1943 advocated for aid to Eastern and South-Eastern Europe. Browsing through successive editions of a leading textbook in development economics provides a telling illustration of how the confidence in aid effectiveness dwindled over the years. In the first edition of ‘Leading Issues in Economic Development’, Meier (1964) dedicated a full 18-page section to the issue of foreign aid. He started out asking: ‘How much aid?’. By the

in all aspects of economic development and international trade on both a long term and a short term basis. To this end, CREDIT organises seminar series on Development Economics, acts as a point for collaborative research with other UK and overseas institutions and publishes research papers on topics central to its interests. A list of CREDIT Research Papers is given on the final page of this publication. Authors who wish to submit a paper for publication should send their manuscript to

Growing concern that the Millennium Development Goals (MDGs) will not be achieved by 2015 should not obscure the bigger picture that development progress has been occurring at unprecedented levels over the past thirty or more years. At the same time, the MDGs may perhaps create an unnecessary pessimism toward aid by labeling many development successes as failures. The first MDG of halving the number of people living in poverty will probably be met globally, but for most developing countries to achieve this at the national level, the growth rates required are at the bounds of historical precedent. Additionally, there appears to be only a weak relationship between aid and rapid economic growth. A similar problem holds for many of the other education and health goals. For many countries, the rates of progress required to meet the MDGs by 2015 are extremely high compared to historical experience and there is only a tenuous relationship between expenditure and outcomes. Nevertheless, estimates that an additional $50 billion in aid per year is necessary to meet the MDGs are frequently misinterpreted to suggest that it is also sufficient. Most of the goals are unlikely to be reached, but this will probably not be due primarily to shortfalls in aid. This is in part because development is a long-term and complex process dependent on relieving more than a supply-side constraint on resources. Aid remains vital and contributes to development progress, but even considerable increases in aid are unlikely to buy these particular goals. Goal setting is also useful, but continuing to suggest that the MDGs can be met may undermine future constituencies for aid (in donors) and reform (in recipients). The MDGs might be better viewed not as realistic targets but as reminders of the stark contrast between the world we want and the world we have, and a call to redouble our search for interventions to close the gap.

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

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It is clear from the implications of growth theory that the impact of aid depends on how it affects savings, investment and government behaviour. In respect of low-income countries, which are the principal aid recipients and the economies for which the issue of the impact of aid on growth is most important, it is government that is most important. This paper presents a review of studies that address the impact of aid on government fiscal behaviour. In particular, the focus is on fungibility and fiscal response studies. We argue that fungibility studies have been granted too much attention; these are narrowly focussed on the composition of government spending, and are not sufficiently informative about fiscal behaviour. Fiscal response studies are of greater relevance, as they attempt to address the effects of aid on behaviour regarding total spending, tax revenue and borrowing. Results show that the effects are complex and varied, but that aid tends to be associated with government spending increases in excess of the value of the aid, and can also have effects on tax effort and borrowing.

This paper was prepared within the HWWA Programme