Dutch disease and aid

There have been a lot of publications lately arguing about the effectiveness or otherwise of foreign aid. Owen Barder - expat Brit, jogger, blogger, and researcher at the Center for Global Development - adds to the debate with a useful paper: A Policymakers' Guide to Dutch Disease

It is sometimes claimed that an increase in aid might cause Dutch Disease - that is, 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. This essay 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.

First, there is not necessarily an adverse impact on exports from Dutch Disease, and any impact on economic growth may be small. Second, 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. Third, the welfare of a nation's citizens depends on their consumption and investment, not just output.

Even on pessimistic assumptions, the additional consumption and investment which the aid finances is larger than any likely adverse impact on output. However, the macroeconomic effects of aid can cause substantial harm if the aid is not sustained until its benefits are realized. The costs of a temporary loss of competitiveness might well exceed the benefits of the short-term increase in aid. To avoid doing harm, aid should be sustained and predictable, and used in part to promote economic growth. This maximizes 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.

Comments

[Øystein Sjølie]

The problems of aid are related to the Dutch Disease, a term named for the economic problems of Hollland following the explotation of natural gas. However, the clue is not in the real exchange rate. The clue is that aid and money made from natural resources are similar because they are not made from work. Therefore, the money is easy to "hide" from the general population, and are usually spent with far less attention than money made from normal economic activities, or from the governments point of view: taxes on these activities. If the aid or gas money make a substantial part of the nations income, there is a high risk that the most profitable business will be to get hands on a part of the free money, aka rent seeking. If rent seeking is the most profitable business in a country, it will never grow wealthy.

[A. PERLA]

"If rent seeking is the most profitable business in a country, it will never grow wealthy."

Then, how do you explain that Norway has pulled it off so successfully. Its treasure chest of accumulated oil wealth (in the billions) will see very nicely for its aging population, just as it is intended.

I am no expert on Norwegian industry, and it is not all that "thick" meaning diversified, but it does not seem to have the attributes of which you speak.

Isn't it therefore a matter of how the money is managed. Perhaps the Norwegians learned from Holland's mismanagement?

[David Wiczer]

It seems a bit cynical to say that Dutch Disease is the result of mismanagment, and kleptocrats "hiding" aid/resource boons from the people. The point of Dutch disease is the (mis)incentives that it creates by distorting the relative prices within the economy by its exchange rate impact. So the skewed economy is not just mismanagement from the top - everyone does their part just following the incentives given to them. Norway's fund impoves on Holland's experience by avoiding the incentive distortions.

[Owen Barder]

The 'Dutch Disease' effect discussed in the working paper which you were kind enough to link to is the narrow question of the impact on the real exchange rate as a result of the shift in the composition of demand.

The comments above refer to a wider set of issues known as "the resource curse" - that is, the effects on a country's political economy of sources of revenue such as oil, diamonds and (possibly) aid, which may reduce the accountability of government. I have discussed that wider set of issues in a companion working paper, 'Are The Planned Increases In Aid Too Much Of A Good Thing?', which you can read here:
http://www.cgdev.org/content/publications/detail/8633

Owen

[Owen Barder]

PS we runners hate being called a 'jogger'!

[J. M. Lawrence]

The problem is capital flight -

Unlike the U.S., the vast majority of defaulting emergineg market countries are net creditors to the rest of the world.

-"Is Africa a Net Creditor?…Capital Flight From Severely-Indebted Sub-Saharan African Countries, 1970-1996," University of Massachusetts, Amherst" "This paper presents estimates of capital flight from 25 low-income sub-Saharan African countries in the period 1970 to 1996. Capital flight totaled more than $193 billion (in 1996 dollars); with imputed interest earnings, the accumulated stock of flight capital amounts to $285 billion. The combined external debt of these countries stood at $178 billion in 1996."

-On the foreign bank accounts held by Nigerian elites, Mr. David Asonye Ihenacho writes for Nigeriaworld :
First, the sum of 170 billion dollars…is about 60% of the entire debt owed by the entire continent of Africa to the rest of the world…
Second, who are these Nigerians with this large sum of money stored overseas? The sum of 170 billion dollars is by far bigger than the entire wealth of the four richest people in the world combined. The wealth of Bill Gates III of Microsoft, Warren E. Buffett of Berkshire Hathaway, Karl and Theo Albrecht of Wal-mart retail and Paul G. Allen of Microsoft combined does not rise up to 170 billion dollars.

http://foreigndebtforgiveness.com, and please, also, note the links which include the first of the above.

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