Helping Countries Develop

15 More Aid—Making It Work for the Poor

Benedict Clements, Sanjeev Gupta, and Gabriela Inchauste
Published Date:
September 2004
  • ShareShare
Show Summary Details
Peter S. Heller and Sanjeev Gupta 

There has been a renewed call within the international community for industrial countries to meet the goal of devoting 0.7 percent of their GNP for official development assistance (ODA). Originally proposed by the Pearson Commission in 1968, only a few countries are currently meeting this target and the average ODA level is only a third of the target. Raising ODA to 0.7 percent of industrial country GNP is an important element in the strategy for reducing global poverty and meeting the Millennium Development Goals (MDGs) by 2015. It could also lead to an expanded supply of needed global public goods.

If industrial countries were to meet the ODA target, financial aid would increase to about $175 billion, slightly more than three times current levels. This could pose challenges—both macroeconomic and microeconomic—for developing countries, particularly if the funds were distributed primarily to the world’s poorest countries. Transfers of extremely large amounts of money to a developing country relative to the size of its economy can be problematic. To ensure that enhanced ODA is used efficiently in the fight against global poverty, it is crucial that the international community examine closely alternative approaches to allocating the aid, both among countries and for complementary global poverty reduction programs.

Concerns and Challenges

The Scope of the Challenge

If one were to distribute the full 0.7 percent of GNP in aid only to the world’s least developed countries as defined by the OECD’s Development Assistance Committee (DAC) (and conditional on these countries’ satisfying certain governance criteria or establishing a track record of successful policy implementation)—the scale of transfers would be massive relative to these economies’ size. Moreover, applying such a distributional criterion would result in enormous differences in per capita transfers to the “absolute poor” of the world (individuals with incomes of less than $1 a day). It would mean that no transfers would go to poor people living in countries with per capita incomes above the DAC-defined threshold. Thus, some of the largest countries in the world would be excluded. The excluded countries would include those with higher annual per capita incomes, which are classified as “other low-income countries” (such as India, Nigeria, Pakistan, and Vietnam), as well as “lower-middle-income countries” (including China, Indonesia, and the Philippines). The allocation of a 0.5 percent target for ODA—equivalent to $125 billion and representing the level of increase estimated to respond to the MDGs—would yield broadly similar results.

If the increased ODA resources were distributed according to a different criterion—for example, proportional to the share of the world’s absolute poor in a country—the macroeconomic issues associated with resource transfers would be significantly diminished. However, the bulk of aid would then go, not to the poorest countries in the world, but to the larger countries listed above. Different scenarios illustrate these points:1

Scenario 1

In this scenario, aid is assumed to go to those least developed countries (as defined by DAC) that have good economic policies (based on Collier and Dollar’s (1999) criteria),2 but with the amounts scaled up to reflect the ODA target of 0.7 percent of GNP. As shown in Figure 1, the average ratio of ODA to GDP in recipient countries would be 32 percent, almost two and a half times what it is now, and the revenues available for government programs would almost triple.

Figure 1.Two Scenarios

(Unweighted averages)

Source: Poverty-efficient aid allocation based on Collier and Dollar (1999).

Note: Scenario 1 is based on Collier and Dollar’s (1999) poverty-efficient allocation of aid. The implied share of total aid for each country in the dataset was calculated, and then $175 billion and $125 billion were allocated accordingly, corresponding to 0.7 and 0.5 percent of industrial country GNP.

For many countries, however, the ratio of ODA to GDP would be much higher—90 percent in Ethiopia, 52 percent in Uganda, 60 percent in Burundi, 48 percent in Vietnam, 43 percent in Nicaragua, 57 percent in Guyana, and 74 percent in the Kyrgyz Republic. One problem with Scenario 1 is that aid to China and India—countries that have large numbers of absolute poor and that have pursued good policies—would account for no more than 11 percent of total ODA.

Scenario 2

Here, the Collier-Dollar criteria are used but with the allocation to China and India allowed to increase. ODA would then average about 12 percent of GDP, diminishing the problems related to absorption, but still with some important exceptions among the least developed countries. (For example, ODA transfers would be 33 percent of Ethiopia’s GDP.) China and India together would receive about $116 billion of the projected total of $175 billion, while Nigeria, Pakistan, the Philippines, and Vietnam would receive about $25 billion. Only about $30 billion of the increased ODA would be allocated to the least developed countries and about one-third of this would go to Bangladesh. Sub-Saharan African countries would receive no more than $20 billion, with $4 billion going to Nigeria.

Absolute poverty is not limited to the poorest countries. Indeed, in Scenario 3 (not shown), if ODA were distributed to countries in relation to the proportion of population living below US$1 a day, China and India together would receive about $112 billion—almost the same total as in Scenario 2. However, India would receive more ($73 billion) than China ($39 billion) because it has a greater concentration of individuals in absolute poverty, whereas, in Scenario 2, China would receive $76 billion and India $40 billion. Similarly, using the criterion of the number of individuals living in absolute poverty, countries in sub-Saharan Africa would receive no more than $33 billion in ODA. Recipients among the least developed countries would receive ODA transfers averaging about 32 percent of GDP, compared with 8 percent for low-income countries.

Macroeconomic and Microeconomic Policy Challenges

Why are large aid flows relative to the size of an economy problematic? Here we underscore some of the factors and bottlenecks that would have to be addressed if a significant expansion of ODA were to occur for many countries.

Macroeconomic Issues of Absorption

The likelihood of significant macroeconomic problems will depend both on the size of the external resource transfers relative to the scale of the recipient economy and the extent to which such transfers take the form of financial transfers for spending on domestic goods and services rather than imports. If ODA were spent entirely on imports, the balance of payments would be unchanged; the increase in imports would be completely financed by foreign inflows. In this case, there would be no direct impact on the money supply or aggregate demand in the domestic economy.3 For example, a significant expansion of externally financed imports of antiretrovirals for the treatment of AIDS could be readily absorbed with only negligible macroeconomic effects.

In contrast, if a significant share of foreign inflows were to be spent on nontraded goods, the price of domestic goods and services would increase. To make local purchases, foreign exchange would need to be converted into local currency that in turn would expand the monetary base. This would fuel an increase in domestic demand, some of which would be met by expanded imports, contributing to a weakening of the trade balance. However, there would also be a significant increase in demand for nontraded goods. Because the worsening of the trade balance would be more than offset by foreign inflows, the pressure of demand for nontraded goods, coupled with supply constraints on their production, would contribute to an increase in their prices, leading to an increase in the overall domestic price level. In the case of a fixed exchange rate regime, the pressure of expanded liquidity on domestic demand and prices of nontraded goods would lead to a real exchange rate appreciation, as the domestic price level would rise while the nominal exchange rate would remain unchanged.

In the case of a flexible exchange regime, the increased supply of foreign currency, not wholly absorbed by imports of goods and services, would drive up the price of the domestic currency, in effect leading to an appreciation in the nominal exchange rate.4 Neither situation would be conducive to growth or poverty reduction. When domestic inflation is high, the poor and middle-income groups are likely to suffer. But the poor would also suffer if the competitiveness of the goods they produce were adversely affected by an exchange rate appreciation. Likewise, a poor country’s capacity to compete in world markets, and ultimately to be weaned from ODA, would suffer if the competitiveness of its export industries were to be undermined by a real exchange rate appreciation.

This phenomenon, where large inflows of foreign currency into an economy have harmful consequences, is termed the “Dutch disease” problem. It is not a new problem. The debate on the relationship between international payments and the real exchange rate (the so-called transfer problem) dates back to the 1920s when the issue of German war reparations arose. Effecting a large capital transfer requires a flow of real goods and services or the appreciation of real exchange rates (Mundell, 1991). The sharp increase in oil prices in the 1970s, and subsequently, the macroeconomic policy management challenges confronting some of the poorer countries that have benefited from substantial aid flows, have all led to a resurgence of interest in this topic.5

Resolving the macroeconomic policy challenges posed by significant external resource transfers can be difficult, given that there are limits as to how much direct commodity imports can be readily absorbed without incurring adverse domestic disincentive effects. For most poor countries, with limited infrastructure and human capital, absorptive capacity bottlenecks cannot be quickly removed.

A large inflow of donor funds may leave a country facing a trade-off between selling foreign exchange or treasury bills in order to mop up the excess liquidity generated from these inflows. Such an operation could lead to a real exchange rate appreciation and an increase in interest rates. Both outcomes would have adverse effects on growth, as the real appreciation of the exchange rate would hurt competitiveness while the selling of government securities would crowd out private sector credit. In addition, increased foreign inflows could potentially have an adverse impact on domestic revenue mobilization efforts, creating a disincentive for policy makers to incur the political cost of a strengthening in tax administration.

Another policy challenge that can arise with heavy reliance on external assistance for financing basic public services is an increase in fiscal uncertainty, making long-term planning more difficult. The disbursement of donor aid is often conditional not only on satisfactory progress in the efficient use of resources but also on other factors. These include political concerns, the various requirements of donors, and the often cumbersome procedures for disbursing aid flows. Time-series data show that donor commitments systematically exceed disbursements and that aid flows cannot be predicted reliably on the basis of donor commitments alone (Bulíř and Javier Hamann, 2001).6 Aid in such circumstances can become a source both of instability and of year-to-year fiscal volatility. Consumption volatility has significant social costs and its welfare consequences are much higher in poorer countries (Pallage and Robe, 2003). Over the longer term, the permanent increase in expenditure commitments may also have a negative impact on long-run fiscal sustainability, as countries are expected to eventually “graduate” from their dependence on aid.

Microeconomic Absorption Issues

There are a number of microeconomic challenges that would need to be addressed if external inflows were to be substantially increased, reflecting the limited domestic absorption capacity of many potential recipient countries. First, studies show that large inflows of aid can overwhelm the management capacity of governments.7 Over the 1990s, ODA commitments of the European Union exceeded gross disbursements by more than US$1.6 billion each year, peaking at US$2.2 billion in 1994 (OECD, 1998). This has been attributed, in part, to the limited absorptive and administrative capacities of the recipient countries. It is also possible that the existing administrative infrastructure is such that recipient countries may be unable to use additional resources efficiently, thus leading to wastage and a congestion externality.

This is particularly true for countries where fiscal decentralization has gone hand in hand with donor support and where increasingly the resources are being channeled through subnational governments for strengthening local service delivery. In Uganda, for example, the large expansion of resources for education, health, and water supply has exposed administrative difficulties, such as deficiencies in payroll systems. This could reduce the productivity of increased expenditures unless these deficiencies are directly addressed.

Second, it would be critical to ensure that increased aid does not reduce the incentive of countries to adopt good policies and discourage efforts to reform inefficient institutions. This is analogous to the observed “welfare dependency” among poor households, where welfare payments create high implicit marginal tax rates and discourage work. For recipient countries, the implicit marginal tax rates would correspond to a situation where donors would reduce aid flows in response to rising per capita income levels. As such, aid may create perverse incentives for recipient governments, creating, in effect, a “moral hazard” problem. In addition, foreign aid may undermine progress in institutional development, such as in the recipient government’s efforts to strengthen revenue collection (Azam and others, 1999).

Third, in the past, aid dependence has been said to weaken accountability and encourage rent seeking and corruption. Aid can impede the development of a healthy “civil society,” with recipient governments becoming accountable to donors rather than to domestic taxpayers. Unless donors’ commitment and disbursement practices change, with higher levels of external assistance, recipient governments will need to increase further the time spent fulfilling the requirements of donors.8 In addition, because aid may be used for patronage purposes, such as the provision of subsidies to state-owned enterprises and increased public employment, it can represent a potential source of rents, thus leading to unproductive, rent-seeking activities. Using cross-country data for about 80 countries, Knack (2000) finds that indeed higher aid levels may erode the quality of governance.9

A Multi-Pronged Approach to Allocating an Expanded ODA Effort for Poverty Reduction

In seeking to meet the MDGs and obtain a dramatic reduction in the incidence of world poverty, the world community has set out ambitious but realistically achievable objectives. Many believe that the longstanding goal of raising ODA to 0.7 percent of industrial country GNP should be an important element of this overall strategy. There is some urgency in moving quickly to realize this target. Within 10 to 15 years, the industrial countries of the world will begin to confront the budgetary pressures of aging populations. Industrial countries are likely to have more budgetary room in the next decade for an expanded ODA effort than they will thereafter.

We now describe a number of strategies that can be pursued to address the challenges raised above with respect to the effective allocation and utilization of expanded ODA. In essence, we believe the world community should adopt a multi-pronged strategy that has five essential elements. First, by reconsidering the criteria according to which ODA is distributed, much of ODA should be channeled to countries for which the macroeconomic absorptive challenges would not be significant, and yet where there are large parts of the population in absolute poverty. Second, policy programs must intensely focus on ways to relax the key microeconomic and institutional bottlenecks that limit a country’s capacity to absorb significant external financial resources. This is critical to enable higher real resource transfers, consistent with macroeconomic stability and adequate incentives for sustainable and rapid real growth.

Third, there is considerable scope for investments in research and development (R&D) that could lead to technological innovations readily absorbable by the poorest countries in their agricultural and manufacturing sectors. By expanding the range of technologies relevant to the situation of poor countries, there is greater scope to expand production capacity and foster productivity growth. Recognizing absorptive capacity limitations in the poorer countries, such investments might need to be made in some of the more advanced developing countries in a region.

Fourth, ODA can be mobilized now, with the intention of deferring its distribution, pending a strengthening of the absorptive capacity of some of the poorer countries. The increased emphasis on the accumulation of trust funds in multilateral institutions illustrates this approach. Fifth, some resources could be channeled to finance the removal of the barriers that now prevent access, by the poorest countries, to the markets of the industrial economies.

Reconsidering the Distributional Criteria for Expanded ODA

Earlier, we underscored the need to channel some of the increased ODA funds to countries that are not normally seen as the poorest.10 Simply to respond to the problems of absolute poverty, this would appear appropriate. But it would also be consistent with the present distribution of ODA. Donor countries have multiple objectives in the granting of external assistance in addition to a country’s per capita income level or its incidence of poverty. Political considerations obviously enter, e.g., as relates to aid to post-conflict and transition countries, or on the basis of geopolitical considerations. An expanded ODA effort is not likely to mean a reduction of such assistance. But equally, if the objective of the expanded ODA effort is to achieve the MDGs and to reduce poverty, then additional resources should be directed to where the poor are. This would imply far greater ODA to countries in South and East Asia. But low- and middle-income countries with high concentrations of poverty must do their part as well, utilizing ODA to narrow the significant prevailing inequalities in income distribution and to address the sources of endemic poverty.

Facilitating an Expanded Direct Flow of ODA to the Poorest Countries

For the least developed countries, the scale of the resource transfer associated with the realization of the 0.7 percent target would still be large relative to the size of their domestic economies. This would be true even if much of the resources were provided in the form of imports and services. Over the short to medium term, this puts a premium on limiting the expansion of domestically produced services involving nontradable goods and services, particularly within the public administration.

Much of the ODA in the short term would thus need to be concentrated on imported goods and services. But there are many imported goods that could still make an enormous difference in addressing critical needs in many poor countries. One need only mention pharmaceutical products, including antiretrovirals (ARVs) to address the HIV/AIDS crisis. Of course, since it may take some time before overall aid flows actually attain the 0.7 percent target, a gradual enhancement in absorption capacity may occur naturally. An enhanced role of external technical assistance—the supply of skilled manpower to address initial shortages—may facilitate this process.11

Careful monitoring of the macroeconomic situation in the poorest countries will be critical. Some macroeconomic pressures in the form of inflation and real exchange rate depreciation are probably inevitable, but there are limits beyond which such effects will undermine the very sustainability of the desired development effort. But a testing of the limits will be necessary, and particularly with a significant risk of some inflationary pressure, social safety net schemes need to be in place in order to minimize the burden on the poorest groups within a country. Gradual augmentation of ODA levels may be needed for some countries, particularly if simply increasing the scale of imports is inappropriate for the country’s development needs.

The recent emphasis on the production of poverty reduction strategy papers (PRSPs) in low-income countries remains critical. It ensures both local ownership in terms of decisions on how the enhanced resources are used and provides some check on the governance process. Efforts to strengthen public expenditure and budget management (PEM) systems will be even more important if adequate accountability is to be provided to donor nations for this enhanced aid effort. Given the scale of the expansion of the public sector that would be implied by greater ODA, resource flows must be sustained and dependable, in order to avoid disruptions in the provision of public services.

Some enhanced aid could be allocated to strengthen public institutions and improve the quality of governance (Knack, 2000). Many low-income countries have identified governance and/or institutional strengthening as critical in their poverty reduction strategies (e.g., Madagascar and Cameroon). The New Partnership for Africa’s Development (NEPAD) is promoting peer reviews of economic and corporate governance practices to make recommendations on appropriate standards and codes of good practice. One could even consider targeting aid to countries that have taken steps to reduce corruption or increase accountability and transparency (Bräutigam, 2000). For countries that are undertaking reforms to strengthen their PEM systems, aid should be provided in the form of direct budgetary support. Budgetary resources are fungible. General budgetary support provides recipient governments with the greater flexibility to build administrative capacity, particularly when donors are not designing and implementing projects, or providing tied aid and technical assistance (Knack, 2000).

Finally, aid flows should not create perverse incentives for the recipients. Good performance would have to be an explicit criterion for allocating aid.

Expanding the Potential for Increased Technological Innovations Benefiting the Poorest Countries

Some expanded ODA could be directed to the production and provision of global public goods. The recent report of the WHO-sponsored Commission on Macroeconomics and Health (2001) argues for expanded outlays on a significant R&D effort directed at the principal disease problems underlying excess mortality among the poor. It also urges the provision of commercial distribution incentives for any drugs and vaccines developed under such a program.

In a similar vein, R&D on alternative technologies to replace fossil fuels will be particularly important in the coming decades to provide low-cost alternatives for developing countries seeking to substitute for inefficient and carbon-emitting energy facilities or technologies. The consequences of climate change in coming decades are likely to be the most adverse for developing countries. While much R&D effort is under way in the industrial world, it is important that affordable and efficient energy technologies relevant for developing countries are also developed and commercially brought on stream. This may require the financing of directed research that would not necessarily emerge from industrial countries.

Additional financial support will also be needed for R&D on agricultural technologies that will facilitate adaptation by tropical countries in response to climate change (Heller and Mani, 2002). Such R&D may also be critical if countries that are heavily dependent on traditional agriculture are not to suffer adverse consequences from prospective technological developments in the agricultural sector. A critical focus of efforts of major commercial investors in agricultural R&D in the industrial countries is the development of “genetic use restriction technologies” (GURTs).12 Recent research suggests that, over time, such GURTs could inhibit significant diffusion of technological gains and weaken the prospects for agricultural productivity growth in the poorest countries most susceptible to food shortages and high population growth. To facilitate their capacity to absorb and profit from new agricultural technology developments, many developing countries will need to develop a capacity for R&D in the agricultural biotech sector (Swanson, 2002) and enhanced ODA could finance such efforts.13

Finally, there is a need to focus on areas of key vulnerability in the future. If the industrial countries galvanize the necessary ODA resources, it will be desirable to proactively consider investments in the developing world that would frontally address some of the most important looming potential shortages that will affect both development and global stability in coming decades. For example, pressures on available water supplies—as a consequence of population growth, economic development, and climate change—may prove a particularly dangerous source of political and economic vulnerability in coming decades. Such shortages are particularly worrisome in the Middle East and South Asia.

A multinational effort to consider alternative approaches to addressing potential emerging pressures can have a high payoff in terms of the problems of poverty in the future.

Trust Funds for the Accumulation of ODA Resources

Given that there may be limits on how much ODA can be sustainably transferred to some of the poorest countries, one possible option is to accumulate resources in a trust fund. Most industrial countries are likely to have more budgetary room for an expanded ODA effort now than in the future. Given current absorptive capacity constraints in many poor countries, it may be desirable to sever the temporal link between disbursement of aid and its expenditure. Some increased ODA could thus be paid into internationally controlled “trust fund” arrangements and released on a pre-determined schedule or according to observable milestones related to improvements in absorptive capacity. Such a trust fund already exists to finance debt relief initiative for highly indebted poor countries (HIPCs). The total cost of HIPC assistance—estimated at about US$33 billion in 2000—is financed by both bilateral creditors and multilateral lenders. The multilateral component of the initiative has been provided through the HIPC Trust Fund, administered by the World Bank, the total pledges for which have reached US$2.6 billion, with paid-in contributions amounting to almost US$1 billion. Should ODA increase gradually over time, the need for inter-temporal planning will be less critical.

Specialized global trust funds are also starting to emerge to finance the provision of selected global public goods. These act as endowments for future earmarked pro-poor programs, sometimes focused on specific sectors, and managed at the center, provincial, or community levels, in a developing country. For example, a global fund was recently set up to pool, manage, and allocate new resources to fight AIDS, tuberculosis, and malaria, diseases that collectively cause 25 percent of deaths worldwide. This global fund, which is supported by a small secretariat based in Geneva, already has committed US$1.6 billion to 40 programs in 31 severely affected countries.

Addressing Barriers to Industrial Country Market Access by the Poorest Countries

A strengthening of social policy instruments in industrial countries may be a necessary investment to soften some opposition to the removal of trade barriers in these countries. Most observers recognize that the opening up of industrial country markets to the products of the developing world is as essential as additional ODA for engendering self-sustaining development.

Concluding Remarks

In conclusion, any significant expansion of ODA must be accompanied by a concerted effort by all partners in the development community to anticipate the macro and microeconomic challenges associated with utilizing external resources effectively. This is an issue that extends beyond simply the multilateral and bilateral donors. It will also entail a collaborative partnership with aid recipients, external NGOs, civil society, and the private sector. The central objectives are to achieve the MDGs in the years ahead and to foster self-sustaining development by the poorest countries of the world. The potential channels and instruments through which additional ODA funds can play a productive role are many. This paper outlines only a few.

In addition to ensuring good usage of ODA resources and pursuing effective policies, the paper emphasizes the importance of targeting ODA as much on the basis of the size of a country’s population in absolute poverty as on whether it is among the least developed countries. It also suggests that modalities other than direct bilateral ODA transfers may contribute to the goal of world poverty reduction.

But it will not be easy to secure consensus on both the allocation and institutional modalities for creative and effective use of these resources. At the same time, the importance of moving quickly to achieve such a consensus is great. Much goodwill would be lost if additional resources are inefficiently used or diverted from their principal objectives.


    AdenauerIsabell and LaurenceVagassky1998“Aid and the Real Exchange Rate: Dutch Disease Effects in African Countries,”Inter economics: Review of International Trade and DevelopmentVol. 33 (July/August) pp. 17785.

    AzamJean-PaulShantayananDevarajan and Stephen A.O’Connell1999“Aid Dependence Reconsidered,”World Bank Policy Paper No. 2144 (Washington: World Bank).

    BräutigamDeborah2000Aid Dependence and Governance (Stockholm: Almqvist & Wiksell International).

    BulířAles and A. JavierHamann2001“How Volatile and Predictable Are Aid Flows and What Are the Policy Implications?”IMF Working Paper 01/167 (Washington: International Monetary Fund).

    BulířAles and TimothyLane2002“Aid and Fiscal Management,”IMF Working Paper 02/112 (Washington: International Monetary Fund).

    CollierPaul1999“Aid Dependency: A Critique,”Journal of African EconomiesVol. 8No. 4pp. 52845.

    CollierPaul and DavidDollar1999“Aid Allocation and Poverty Reduction,”World Bank Policy Research Working Paper No. 2041 (Washington: World Bank).

    Commission on Macroeconomics and Health2001Macroeconomics and Health: Investing in Health for Economic Development (Geneva: World Health Organization).

    EasterlyWilliam2001The Elusive Quest for Growth: Economists’ Adventures and Misadventures in the Tropics (Cambridge: MIT Press).

    Financing for Developmentprepared by the staff of the World Bank and the IMF for the Development Committee.

    HellerPeterS. and MuthukumaraMani2002“Adapting to Climate Change,”Finance & DevelopmentVol. 39 (March) pp. 2931.

    HellerPeterS. and SanjeevGupta2002“Challenges in Expanding Development Assistance,”IMF Policy Discussion Paper No. 02/5 (Washington: International Monetary Fund).

    HjertholmPeterJytteLaursen and HowardWhite2000“Macroeconomic Issues in Foreign Aid,”University of Copenhagen Institute of Economics Discussion Paper No. 00-05.

    KanburS. M.RaviToddSandler and Kevin M.Morrison1999The Future of Development Assistance: Common Pools and International Public GoodsPolicy Essay No. 25 (Washington: Overseas Development Council).

    KnackStephen2000“Aid Dependence and the Quality of Governance: A Cross-Country Empirical Analysis,”World Bank Policy Paper No. 2396 (Washington: World Bank).

    MundellRobert1991“The Great Exchange Rate Controversy: Trade Balances and the International Monetary System,” in C. FredBergstened.International Adjustment and Financing: The Lessons of 1985-1991 (Washington: Institute for International Economics).

    OECD1998“European Community,”Development Cooperation Review Series No. 30 (Paris: Organization for Economic Co-operation and Development).

    PallageStéphane and MichelRobe2001“Foreign Aid and the Business Cycle,”Review of International EconomicsVol. 9No. 4 pp. 64172.

    PallageStéphane and MichelRobe2003“On the Welfare Cost of Economic Fluctuations in Developing Countries,”International Economic ReviewVol. 44 (May) pp. 67798.

    SwansonTimothyed.2002Biotechnology Agriculture and the Developing World: The Distributional Implications of Technological Change (Cheltenham: Edward Elgar).

    WhiteHoward and GaneshanWignaraja1992“Exchange Rates, Trade Liberalization and Aid: The Sri Lankan Experience,”World DevelopmentVol. 20 (October) pp. 147180.

    World Bank1998Assessing Aid: What Works What Doesn’t and Why (Washington: Oxford University Press).

Reprinted with permission from World Economics, Vol. 3, No. 4 (October-December), 2002. Peter S. Heller and Sanjeev Gupta are members of the Fiscal Affairs Department, International Monetary Fund. They wish to thank Eduardo Aninat, Gabriela Inchauste, Erwin Tiongson, Shamit Chakravarti, and Solita Wakefield for extensive help in preparing this paper. Michael Hadjimichael, Timothy Lane, Kevin Fletcher, and Edward Frydl also provided useful comments on an earlier draft.

Detailed discussions of these and other scenarios are provided in Heller and Gupta (2002).

Paul Collier and David Dollar (1999) of the World Bank recently carried out an analysis of how aid might be reallocated if countries with severe poverty and good policies were targeted and if countries with civil strife or poor policies were excluded.

If government spending substitutes for existing private consumption, private consumers may shift resources to other uses, thus possibly generating second-round effects.

Hjertholm, Laursen, and White (2000) suggest that foreign aid that eases local supply bottlenecks can have a deflationary impact, which may, in turn, exceed the upward pressure on the real exchange rate resulting from significant external resource transfers.

Bulíř and Lane (2002) review the theoretical and empirical literature on the Dutch disease. They find substantial evidence of aid-induced exchange rate appreciation. Evidence of Dutch disease has also been found for Burkina Faso, Côte d’Ivoire, Senegal, and Togo (Adenauer and Vagassky, 1998) as well as for Sri Lanka (White and Wignaraja, 1992).

The cross-country evidence on the volatility of aid, however, is mixed. Collier (1999) found that aid to Africa has been both less volatile than other revenue sources and is negatively correlated with them. In contrast, recent studies by Bulíř and Javier Hamann (2001) and Pallage and Robe (2001) suggest that aid is more volatile than revenues, that the relative volatility increases with the degree of aid dependency, and that aid flows are significantly procyclical, suggesting that aid flows may not smooth out fluctuations in consumption among recipient countries.

With increased aid, however, recipient governments also have more resources for fulfilling donor requirements.

Recent reviews of the impact of aid on growth and economic development have concluded that the record of aid has, at best, been mixed. The World Bank (1998) found that foreign aid has been “highly effective, totally ineffective, and everything in between.” In addition, the review suggested that aid has had a beneficial impact only in countries that have made substantial progress with reform of policies and institutions. Easterly (2001) has suggested that aid has tended to reward poor performance, going to countries with poor policies where aid is wasted, rather than countries with good policies where aid could have high payoffs.

This appears to be implicitly recognized by both the UN and the Zedillo Commission. They advocate that between US$37.5 billion (0.15 percent of GDP) and US$50 billion (0.2 percent of GDP) should be earmarked for the least developed countries.

Many would argue that the more intensive importation and delivery of ARVs to treat HIV/AIDS must be accompanied by an adequate buildup of clinical and research services to monitor treatment and prevent the possible emergence of resistant strains of the HIV virus.

These relate to plant varieties that cannot subsequently be reproduced by the purchaser in subsequent growing seasons.

Only a limited number of developing countries, principally low- and low-to-middle-income countries, have such a capacity for agricultural biotech research (Swanson, 2002).

    Other Resources Citing This Publication