Aid
Does aid mitigate external shocks?
Aid and shock mitigation - a study of commodity dependent countries
Authors:
C. Collier; B. Goderis
Publisher:
World Institute for Development Economics Research (WIDER), 2008
This paper investigates the role of aid in mitigating the adverse effects of commodity export price shocks on growth in commodity-dependent countries. It also looks at whether aid has historically been targeted at shock-prone countries.
Some key findings include:
- large adverse commodity export price shocks reduce constant price GDP - the costs arise from realised shocks rather than the ex ante risk of shocks; a problem that continues to be faced by a relatively small group of low-income countries that have failed to diversify their exports
- negative shocks matter for short-term growth, while the ex ante risk of shocks does not seem to be as significant
- both the level of aid and the flexibility of the exchange rate substantially lower the adverse growth effect of shocks
- while the mitigating effect of aid is significant in both countries with pegs and countries with floats, the effect seems to be smaller for the latter, suggesting that aid and exchange rate flexibility are partly substitutes
- there is no evidence that aid has historically been targeted at shock-prone countries, but find no evidence that this is the case. This suggests that donors could increase aid effectiveness by redirecting aid towards countries with a high incidence of commodity export price shocks.
The authors conclude that the decline in constant price GDP compounds the decline in income that is an inevitable consequence of terms of trade deterioration, and so subjects already fragile societies to episodes of economic crisis. It is now known that even temporary periods of intensified poverty can have long-lasting effects. Shock-contingent aid does not appear to be effective but a sustained higher level of aid does significantly mitigate shocks. De facto exchange rate flexibility also mitigates shocks and is, to an extent, a substitute for aid. However, even with a flexible exchange rate, aid significantly reduces the cost of adverse shocks.
