International Development Aid Xavier Sala-i-Martin Columbia University March 2007

Empirical Evidence There was little consensus by the early literature on whether economic growth was correlated with international aid. One prominent view was that during the cold war, most international aid had little to do with real development. It had to do with politics, military and strategic geography. But the empirical evidence was mixed.

Empirical Evidence Then a very Influential paper was written by Burnside and Dollar (2000): They find α 2 close to zero and α 3 >0. That is, AID has a positive effect on growth ONLY if the country at the receiving end conduct good policies. After this paper was published, IFIs and the whole world demanded more international aid and conditionality on good policies.

Empirical Evidence Problems with the paper: it is NOT robust to the definition of “aid”, “growth”, or “good policy” (Easterly, Levine and Rodman (2003).

Empirical Evidence Definition of Aid: –Burnside and Dollar use “Grant Aid” (excluding subsidized loans and debt rescheduling). –Normal definition (called ODA) includes subsidized loans and debt rescheduling. –The two measures are highly correlated (0.933) –But when Easterly et all use this second measure, α 3 becomes insignificantly different from zero.

Empirical Evidence Definition of Good Policy: –Burnside and Dollar construct a measure which is an average of inflation, fiscal deficit and a measure of openness (originally proposed by Sachs and Warner 1995) –Easterly et al use TRADE/GDP instead of Sachs- Warner qualitative measure, they add “Black market premium” and “financial depth” (ratio of M2/GDP which is a measure of financial development) and… –… the coefficient α 3 becomes insignificantly different from zero.

Empirical Evidence Definition of growth –Burnside and Dollar use 4 year averages –Easterly et al criticize this because it contains business cycle noise. –If use 10-year averages… α 3 becomes insignificantly different from zero.

Source: Easterly (2003), JEP

Source: Rajan and Subramanian (2005)

Notes on Causality Aid could systematically go to countries that are in trouble (like a natural disaster): if natural disasters tend to generate low (or negative) growth, this will tend to generate a negative association between growth and aid. Aid could systematically go to “reward” countries that did things well in the past. If growth persists, then there will be a positive association even though aid does not really cause positive growth. In order to solve this problem, econometricians use “instrumental variables”. IV estimates are supposed to see the correlation between exogenous aid and growth

Source: Rajan and Subramanian (2005)