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This paper draws on research undertaken to provide an analytical scheme for examining the macroeconomic impact of foreign aid in Uganda. The author thanks Menachem Katz, Godfrey Kalinga, Pierre van den Boogaerde, Calvin McDonald, W. Scott Rogers, Ulrich Bartch, and the participants at an African Department seminar for useful comments and suggestions. Stephanie Denis’ assistance with the diagrams, and Tom Walter’s and Louise Mushikiwabo’s editorial suggestions are greatly appreciated.
The decline should not necessarily be perceived as bad by aid proponents as it could be the result of selectivity that curtails strategic nondevelopmental aid.
The RER is the ratio of the price of nontradables to tradables, such that an increase in the ratio is an appreciation.
Donor countries and agencies may have difficulties gathering support for aid levels perceived as causing a “disease.”
The policy measure used in Burnside and Dollar (2000) was confined to three macroeconomic indicators while the CPIA covers indicators of broad macroeconomic policies and structural and institutional issues.
One problem with the statement is the difficulty of determining what constitutes “reasonable institutions.”
This is important because of the tendency to characterize RER appreciations associated with booms as the Dutch disease.
Although the authors mention the appreciation of the French franc against the dollar during the period under examination as a problem, they indicate that they choose not to include the nominal exchange rate in the RER regressions because the countries included in the study belong to a fixed exchange rate zone. Actually, prior to the 1994 devaluation of the CFA franc, the fixed exchange rate between the CFA franc and the French franc played an important role in the appreciation of the RER of countries in the CFA franc zone.
In the core Dutch disease model, there are three sectors: the booming, the lagging, and the nontradables, with the booming and the lagging sectors producing traded goods. The Salter-Swan framework adopted here has only two sectors, producing either tradables or nontradables.
The increase in the price of nontradables from PNT to PNT′ is associated with an internal imbalance represented by M′, resulting from the spending effect alone. Equilibrium is reestablished at a subsequent stage when price and cost effects—including the effect of a higher cost of labor—draw labor from the tradables sector, encourage an increased demand for tradables as they become relatively less expensive, and mitigate the increase in the price of nontradables. In the (NT, PNT) plane, the shift of the supply schedule to the right reflects part of these changes.
The income line Y′ is shown only to illustrate the increased relative price of nontradables.
As far as policies are concerned, demand management—including through fiscal and monetary policy—can be used to limit the increase in the disposable real income, the upward shift in the demand for nontradable goods, and the ensuing resource transfer and worsening of the trade balance that appear unavoidable without such policies.
In the context of the three-sector core Dutch disease model, these developments would mitigate the risk of deindustrialization. However, as Corden (1984) points out, “deagriculturalization” rather than deindustrialization could be the appropriate term if the shrinking tradables sector produce agricultural products.
Increased production can also result from a shift in the PPF induced by improved efficiency. Such a shift—which can result from improved efficiency even if the economy was initially operating at full employment— is not necessary for the conclusion drawn in this paper to hold although it cannot be excluded from the experience of some countries. The paper concentrates primarily on the increased use of available production factors, allowing the economy to move its production from point A to any point in the area EAF in the lower-right quadrant of Figure 2.
Bandara’s statement is at odds with his analysis, from which he concludes that the traditional Dutch disease model does not adequately address the impact of windfall gains on the economic structure of LICs.
Torvik (2001) develops a model in which he keeps the full employment premise; however, by assuming that there are learning spillovers between the tradables and nontradables sectors, he finds that both sectors may grow in the long run, despite the appreciation of the RER in the short run.
The REER is computed as the nominal effective exchange rate (NEER) index adjusted for relative movements in national prices or cost indicators. The NEER index itself is the ratio of an index of period average exchange rates of a country’s currency to a weighted geometric average of exchange rates for its trading partners.
Facts on Botswana referred to in this paragraph are drawn from Harvey (1992). More recent developments indicate that Botswana’s rate of economic growth continued to be strong in the 1990s, sustained in part by an expansion of the nonmining economy (Auty, 2001).
Whether one concurs with the appropriateness of the goals of foreign aid is a different issue. Easterly (2003) calls for a realistic vision for foreign aid. He suggests that the goal of foreign aid is simply to benefit some poor people some of the time rather than fostering societywide transformation from poverty to wealth.
If there is a genuine perception that such a transformation would not materialize in countries whose poverty reduction strategies point toward considerable cuts in poverty, these strategies, as well as the underpinning expenditure programs, could be called into question.
In the successful case of Botswana referred to above, increased government spending from the mining boom has transformed the economy remarkably, helping it move from one of the world’s poorest countries in 1965 to a middle-income country by the mid-1980s. There has been remarkable progress in the provision of physical infrastructure, education, health, and other government services. This progress has contributed to high rates of economic growth, accompanied by a spread of jobs to rural households and an improvement in living conditions. Transparency and efficiency in the use of public resources played an important role in the successful outcome, easily referred to as an “economic miracle.” Auty (2001) mentions that Botswana’s consensual democracy exhibited a high level of transparency in public revenue and achieved a corruption perception index on a par with Belgium, Portugal and Japan, and significantly better than the vast majority of developing countries.