• Aid flows

Aid flows

Aimed at policy-makers, this paper tackles the issue of Dutch Disease - that is, the theory that aid flows will lead to an appreciation of the real exchange rate which can slow the growth of a country’s exports— and that aid increases might thereby harm a country’s long-term growth prospects. The author argues that it is unlikely that a long-term, sustained and predictable increase in aid would, through the impact on the real exchange rate, do more harm than good, for three reasons:

• there is not necessarily an adverse impact on exports from Dutch Disease, and any impact on economic growth may be small
• aid spent in part on improving the supply side—investments in infrastructure, education, government institutions and health—result in productivity benefits for the whole economy, which can offset any loss of competitiveness from the Dutch Disease effect
• the welfare of a nation’s citizens depends on their consumption and investment, not just outputThe author argues that the additional consumption and investment which the aid finances is larger than any likely adverse impact on output, but that the macroeconomic effects of aid can cause substantial harm if the aid is not sustained until its benefits are realised. He stresses that, to avoid doing harm, aid should be sustained and predictable, and used in part to promote economic growth. This would maximise the chances that the long-term productivity and growth benefits will offset the adverse effects—which may be small if they exist at all—that big aid surges may pose as a result of Dutch Disease.

  Some of the questions addressed in the paper are:

  • why is it called Dutch Disease?
  • is the real exchange rate the same as the market exchange rate?
  • how does the aid increase affect exports in the long run?
  • how can countries cope with a temporary increase in aid?

  The policy recommendations include:

  • aid should be more stable: significant variations can lead to more economic costs than benefits
  • aid should be more predictable, enabling the recipient government to manage the macroeconomic effects of total aid flows, through monetary and fiscal policy
  • recipient governments should be given discretion to use aid flexibly
  • some aid should be directed towards activities that will enhance long-term economic productivity
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