the challenges of capital inflows including aid
DESCRIPTION
The Challenges of Capital Inflows Including Aid. Thorvaldur Gylfason Joint Vienna Institute/ Institute for Capacity Development Distance Learning Course on Financial Programming and Policies Vienna, Austria November 26–December 7, 2012. Outline. Capital flows History, theory, evidence - PowerPoint PPT PresentationTRANSCRIPT
![Page 1: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/1.jpg)
THE CHALLENGES OF CAPITAL INFLOWS
INCLUDING AIDThorvaldur Gylfason
Joint Vienna Institute/Institute for Capacity Development
Distance Learning Course on Financial Programming and Policies
Vienna, AustriaNOVEMBER 26–DECEMBER 7, 2012
![Page 2: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/2.jpg)
OUTLINE Capital flows
History, theory, evidence Foreign aid
Effectiveness: Does aid work?Macroeconomic challenges
Dutch diseaseAid volatility
![Page 3: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/3.jpg)
3
Definitiono International capital movements refer to the flow
of financial claims between lenders and borrowerso The lenders give money to the borrowers to be
used now in exchange for IOUs or ownership shares entitling them to interest and dividends later
Benefits of international trade in capitalo Allows for specialization, like trade in commoditieso Allows for intertemporal trade in goods and
services between countrieso Allows for international diversification of risk
CAPITAL FLOWS 1
![Page 4: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/4.jpg)
The case for free trade in goods and services applies also to capital
Trade in capital helps countries to specialize according to comparative advantage, exploit economies of scale, and promote competitionExporting equity in domestic firms not only earns foreign exchange, but also secures access to capital, ideas, know-how, technologyBut financial capital is volatile
GOODS AND CAPITAL
![Page 5: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/5.jpg)
The balance of payments R = X – Z + Fwhere
R = change in foreign reservesX = exports of goods and servicesZ = imports of goods and servicesF = FX – FZ = net exports of capital
Foreign direct investment (net)Portfolio investment (net)Foreign borrowing, net of amortization
SYMMETRY BETWEEN GOODS AND CAPITAL
X includes aid
![Page 6: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/6.jpg)
Trade in goods and services depends on
Relative prices at home and abroad
Exchange rates (elasticity models) National incomes at home and
abroad Geographical distance from trading
partners (gravity models) Trade policy regime
Tariffs and other barriers to trade
DETERMINANTS OF TRADE IN GOODS AND SERVICES
![Page 7: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/7.jpg)
Again, capital flows consist of foreign borrowing, portfolio investment, and foreign direct investment (FDI)
Trade in capital depends onInterest rates at home and abroadExchange rate expectationsGeographical distance from trading
partnersCapital account policy regime
Capital controls and other barriers to free flows
DETERMINANTS OF TRADE IN CAPITAL
![Page 8: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/8.jpg)
CAPITAL FLOWS: CONCEPTUAL FRAMEWORKEmerging
countries save a little
Saving
Investment
Rea
l int
eres
t rat
e
Loanable funds
![Page 9: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/9.jpg)
CAPITAL FLOWS: CONCEPTUAL FRAMEWORK
Industrial countries save a lot
Saving
Investment
Rea
l int
eres
t rat
e
Loanable funds
![Page 10: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/10.jpg)
CAPITAL FLOWS: CONCEPTUAL FRAMEWORKEmerging
countriesIndustrial countries
Saving
Saving
Investment Investment
Rea
l int
eres
t rat
e
Rea
l int
eres
t rat
e
Borrowing
Lending
Loanable funds Loanable funds
Financial globalization encourages investment in emerging countries and saving in industrial countries
![Page 11: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/11.jpg)
RELEVANCE AND CONTEXT Since 1945, trade in goods and
services has been gradually liberalized (GATT, WTO) Big exception: Agricultural commodities
Since 1980s, trade in capital has also been freed up Capital inflows (i.e., foreign funds
obtained by the domestic private and public sectors) have become a large source of financing for many emerging market economies
![Page 12: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/12.jpg)
EVOLUTION OF CAPITAL FLOWS
Source: Obstfeld & Taylor (2002), “Globalization and Capital Markets,” NBER WP 8846.
A stylized view of capital mobility 1860-2000
Cap
ital
mob
ility
First era of internationa
l financial integration
Capital controls
Return toward
financial integration
![Page 13: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/13.jpg)
TOTAL CAPITAL INFLOWS (USD, BILLIONS)
![Page 14: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/14.jpg)
Capital flows result from interaction between supply and demandCapital is “pushed” away from investor countries Investors supply capital to recipients
Capital is “pulled” into recipient countriesRecipients demand capital from
investors
CAUSES OF CAPITAL INFLOWS:PUSH VS. PULL FACTORS
![Page 15: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/15.jpg)
Internal factors “pulled” capital into LDCs from industrial countries
Macroeconomic fundamentals in LDCsMore productivity, more growth, less inflation
Structural reforms in LDCsLiberalization of tradeLiberalization of financial markets Lower barriers to capital flows
Higher ratings from international agencies
CAUSES OF CAPITAL INFLOWS:PUSH VS. PULL FACTORS
![Page 16: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/16.jpg)
CAUSES OF CAPITAL INFLOWS:PUSH VS. PULL FACTORSExternal factors “pushed” capital from
industrial countries to LDCs Cyclical conditions in industrial
countriesRecessions in early 1990s reduced investment
opportunities at homeDeclining world interest rates made IC
investors seek higher yields in LDCs Structural changes in industrial
countriesFinancial structure developments, lower costs
of communicationDemographic changes: Aging populations
save more
![Page 17: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/17.jpg)
Improved allocation of global savings allows capital to seek highest returnsGreater efficiency of investment More rapid economic growthReduced macroeconomic volatility through risk diversification dampens business cyclesIncome smoothingConsumption smoothing
EFFECTS OF CAPITAL INFLOWS:POTENTIAL BENEFITS
![Page 18: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/18.jpg)
Open capital accounts may make receiving countries vulnerable to foreign shocks Magnify domestic shocks and lead to contagionLimit effectiveness of domestic macroeconomic
policy instrumentsCountries with open capital accounts are vulnerable to Shifts in market sentiment Reversals of capital inflowsMay lead to macroeconomic crisisSudden reserve loss, exchange rate pressureExcessive BOP and macroeconomic adjustmentFinancial crisis
EFFECTS OF CAPITAL INFLOWS:POTENTIAL RISKS I
![Page 19: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/19.jpg)
Overheating of the economy Excessive expansion of aggregate demand
with inflation, real currency appreciation, widening current account deficit
Increase in consumption and investment relative to GDP
Quality of investment suffers Construction booms – count the cranes!
Monetary consequences of capital inflows and accumulation of foreign exchange reserves depend on exchange regime
Fixed exchange rate: Inflation takes off Flexible rate: Appreciation fuels spending
boom
EFFECTS OF CAPITAL INFLOWS:POTENTIAL RISKS II
![Page 20: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/20.jpg)
EPISODES OF LARGE NET PRIVATE CAPITAL INFLOWS: NUMBER, SIZE, AND ENDING
Source: IMF WEO, Oct. 2007, Chapter 3, Table 3.1.
![Page 21: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/21.jpg)
-3 -2 -1 0 1 2 3 4 5 6 70
100
200
300
400
500
600
-200
0
200
400
600
800
1,000
1,200
1,400
1,600
Year with respect to start of inflow periodNote: The index for Finland, Mexico, and Sweden is shown on the
left; the index for Chile during the 1980s and 1990s and for Venezuela is shown on the right.
Source: World Bank (1997).
Sweden
Venezuela
Chile 1978-81 Mexico
Chile 1989-94
Finland
REAL STOCK PRICES DURING INFLOW PERIODS, SELECTED COUNTRIES
![Page 22: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/22.jpg)
Large deficitsCurrent account deficitsGovernment budget deficits
Poor bank regulationGovernment guarantees (implicit or explicit),
moral hazardStock and composition of foreign debt
Ratio of short-term liabilities to foreign reservesMismatches
Maturity mismatches (borrowing short, lending long)
Currency mismatches (borrowing in foreign currency, lending in domestic currency)
EARLY WARNING SIGNS
![Page 23: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/23.jpg)
RATIO OF SHORT-TERM LIABILITIES TO FOREIGN RESERVES IN ASIA 1997
Guidotti-Greenspan rule
![Page 24: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/24.jpg)
FINANCIAL CRISES IN 1990S CALLED CAPITAL LIBERALIZATION IN DOUBT Financial globalization is often blamed for
crises in emerging marketsIt was suggested that emerging markets had
dismantled capital controls too hastily, leaving themselves vulnerable
More radically, some economists view unfettered capital flows as disruptive to global financial stabilityThese economists call for capital controls
and other curbs on capital flows (e.g., taxes)Others argue that increased openness to
capital flows has proved essential for countries seeking to rise from lower-income to middle-income status
![Page 25: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/25.jpg)
Capital controls aim to reduce risks associated with excessive inflows or outflows
Specific objectives may includeProtecting a fragile banking systemAvoiding quick reversals of short-term
capital inflows following an adverse macroeconomic shock
Reducing currency appreciation when faced with large inflows
Stemming currency depreciation when faced with large outflows
Inducing a shift from shorter- to longer-term inflows
ROLE OF CAPITAL CONTROLS
![Page 26: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/26.jpg)
TYPES OF CAPITAL CONTROLS Administrative controls
Outright bans, quantitative limits, approval procedures
Market-based controlsDual or multiple exchange rate systemsExplicit taxation of external financial
transactions Indirect taxation
E.g., unremunerated reserve requirement Distinction between
Controls on inflows and controls on outflowsControls on different categories of capital
inflows
![Page 27: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/27.jpg)
IMF (which has jurisdiction over current account, not capital account, restrictions) maintains detailed compilation of member countries’ capital account restrictions
The information in the AREAER has been used to construct measures of financial openness based on a 1 (controlled) to 0 (liberalized) classification
They show a trend toward greater financial openness during the 1990s
But these measures provide only rough indications because they do not measure the intensity or effectiveness of capital controls (de jure versus de facto measures)
IMF ANNUAL REPORT ON EXCHANGE ARRANGEMENTS AND EXCHANGE RESTRICTIONS
![Page 28: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/28.jpg)
![Page 29: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/29.jpg)
![Page 30: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/30.jpg)
CONCLUSION ON CAPITAL FLOWS Capital flows can play an
important role in economic growth and developmentBut they can also create
macroeconomic vulnerabilities Recipient countries need to
manage capital flows so as to avoid hazardsNeed sound policies as well as effective
institutions, including financial supervision, and good timing
![Page 31: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/31.jpg)
Development aid Unrequited transfers from donor to country designed to promote the economic and social development of the recipient (excluding commercial deals and military aid)
Concessional loans and grants included, by tradition Grant element ≥ 25%
FROM CAPITAL INFLOWS TO AID: DEFINITION 2
![Page 32: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/32.jpg)
Development aid can bePublic or privateBilateral (from one country to another) or multilateral (from international organizations)
Program, project, technical assistance
Linked to purchase of goods and services from donor country, or in kind
Conditional in nature IMF conditionality, good governance
DEFINITION
![Page 33: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/33.jpg)
MOTIVATION: WHY AID? Moral duty Neocolonialism Humanitarian intervention Public good
National (e.g., education and health care)International
Social justice to promote world unity UN aid commitment of 0.7% of GDP
World-wide redistributionIncreased inequality word-wideMarshall Plan after World War II
1.5% of US GDP for four years vs. 0.2% today Think tank in Nairobi disagrees, see
www.irenkenya.com
![Page 34: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/34.jpg)
ObjectivesIndividuals in donor countries vs. governments in recipient countriesWho should receive the aid?
Today’s poor vs. tomorrow’s poorAid for consumption vs. investment
ConflictsBeneficiaries’ needsDonors’ interests
MOTIVATION: WHY AID?
![Page 35: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/35.jpg)
PAST TRENDS Aid is a recent phenomenon Four major periods since 1950
1950s: Fast growth (US, France, UK)1960s: Stabilization and new donors
Japan, Germany, Canada, Australia1970s: Rapid growth in aid again due to oil shocks, recession, cold war
1980s: Stagnation, aid fatigue, new methods
![Page 36: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/36.jpg)
PAST TRENDS: 1950S Rapid growth of development aid US provided 50% of total ODA
To countries ranging from Greece to South Korea along the frontier of the “Sino-Soviet bloc”
France provided 30%To former colonies, mainly in West Africa
UK provided 10%To Commonwealth countries
![Page 37: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/37.jpg)
PAST TRENDS: 1960S Stabilization of aid from traditional
donors and emergence of new donors US contribution decreased considerably
after the Kennedy presidency (1961-63) The French contribution decreased
starting from the early 1960s New donors included Japan, Germany,
Canada, and Australia
![Page 38: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/38.jpg)
PAST TRENDS: 1970S Rapid growth in aid from industrial
countries in response to the needs of developing countries due to Oil shocksSevere drought in the Sahel
The donor governments promised to deliver 0.7% of GNI in ODA at the UN General Assembly in 1970The deadline for reaching that target
was the mid-1970s
![Page 39: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/39.jpg)
PAST TRENDS: 1980S AND 1990S Stagnation of development assistanceDonor fatigue?Private investor fatigue?
![Page 40: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/40.jpg)
41
DONOR FATIGUE?
![Page 41: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/41.jpg)
WHO ARE THE DONORS? United States: largest donor in
volume, but low in relation to GDPUS aid amounts to 0.2% of GDP
Japan: second-largest donor in volume
Nordic countries, Netherlands Major donors to multilateral programsOnly countries whose assistance
accounts for 0.7% of GDP EU: leading multilateral donor
![Page 42: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/42.jpg)
WHO ARE THE DONORS? Even though targets and
agendas have been set, year after year, almost all rich nations have constantly failed to reach their agreed obligations of the 0.7% target
Instead of 0.7% of GNI, the amount of aid has been around 0.4% (on average), some $100 billion short
![Page 43: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/43.jpg)
OFFICIAL DEVELOPMENT ASSISTANCE BY DONOR 2004 (% OF GNP)
![Page 44: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/44.jpg)
OFFICIAL DEVELOPMENT ASSISTANCE BY DONOR 2005 (USD BILLION)
![Page 45: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/45.jpg)
MACROECONOMICS OF AID Aid fills gap between investment
needs and saving and increases growthPoor countries often have low savings
and low export receipts and limited investment capacity and slow growth
Aid is intended to free developing nations from poverty trapsExample: Capital stock declines if saving does not keep up with depreciation
![Page 46: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/46.jpg)
AID AND INVESTMENT To understand the link between aid and investment, consider resource constraint identity by rearranging the National Income Identity:
Y = C + I + G + X – ZI = (Y – T – C) + (T – G) + (Z – X)
In words, investment is financed by the sum of private saving, public saving, and foreign saving
Aid is treated as part of government saving which increases domestic resources to finance investment.
![Page 47: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/47.jpg)
AID AND GROWTH Poor countries are trapped by poverty
Driving forces of growth (saving, technological innovation, accumulation of human capital) are weakened by poverty
Countries become stuck in poverty traps Aid enables poor countries to free
themselves of poverty by enabling them to cross the necessary thresholds to launch growthSavingTechnologyHuman capital
![Page 48: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/48.jpg)
AID AND POVERTY Is it feasible to lift all above a dollar a day?
How much would it cost to eradicate extreme poverty? Let’s do the arithmetic (Sachs)
Number of people with less than a dollar a day is 1.1 billionTheir average income is 77 cents a day, they need 1.08 dollars
Difference amounts to 31 cents a day, or 113 dollars per year
Total cost is 124 billion dollars per year, or 0.6% of GNP in industrial countries
Less than they promised! – and didn’t deliver
![Page 49: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/49.jpg)
Several empirical studies have assessed the impact of aid on growth, saving, and investment
The results are somewhat inconclusiveMost studies have shown that aid has
no significant statistical impact on growth, saving, or investment
However, aid has positive impact on growth when countries pursue “sound policies”Burnside and Dollar (2000)
EMPIRICAL STUDIES OF AID
![Page 50: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/50.jpg)
AID AND GROWTH Foreign aid has
sometimes been compared to natural resource discoveries
Aid and growth are inversely related across countries
Cause and effect 156 countries,
1960-2000
-8
-6
-4
-2
0
2
4
6
-20 0 20 40 60 80
Foreign aid (% of GDP)Per
cap
ita g
row
th a
djus
ted
for i
nitia
l inc
ome
(%) r = -
0.36
r = rank correlation
![Page 51: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/51.jpg)
DOES AID WORK?THE CURRENT DEBATE No robust relationship between aid
and growth Aid works in “countries with good
policies” Aid works if measured correctly Distinction between fast impact aid
(infrastructure projects) and slow impact aid (education)Infrastructure: High financial returnsEducation and health: High social
returns
![Page 52: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/52.jpg)
REASONS FOR THE POSSIBLE INEFFECTIVENESS OF AID I Aid may lead to corruption Aid may be misused, by donors as
well as recipients Donors: Excessive administrative
costsRecipients: Mismanagement,
expropriation Aid is badly distributed,
sometimes for strategic reasonsSupporting government against
political opposition
![Page 53: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/53.jpg)
REASONS FOR THE POSSIBLE INEFFECTIVENESS OF AID II Aid increases public consumption, not
public investment Aid is procyclical
When it rains, it pours Aid leads to “Dutch disease”
Labor-intensive and export industries contract relative to other industries in countries receiving high aid inflows
Dutch disease may undermine external sustainability
![Page 54: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/54.jpg)
REASONS FOR THE POSSIBLE INEFFECTIVENESS OF AID III Aid volatility and unpredictability
may undermine economic stability in recipient countriesEconomic vs. social impact
Growth is perhaps not the best yardstick for the usefulness of aidLong run vs. short run
E.g., increased saving reduces level of GDP in short run, but increases growth of GDP in long run
![Page 55: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/55.jpg)
DUTCH DISEASE Appreciation of currency in real terms,
either through inflation or nominal appreciation, leads to a loss of export competitiveness
In 1960s, Netherlands discovered natural resources (gas deposits)Currency appreciated Exports of manufactures and services
suffered, but not for long Not unlike natural resource discoveries,
aid inflows could trigger the Dutch Disease in receiving countries
See “Dutch Disease” in the New Palgrave Dictionary of
Economics Online
![Page 56: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/56.jpg)
Foreign exchange
Real
exc
hang
e ra
te
Imports
Exports
AID REDUCES EXPORTS
Exports plus aid
Aid leads to appreciation, and thus reduces exports
A
C B
![Page 57: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/57.jpg)
Foreign exchange
Real
exc
hang
e ra
te
Imports
Exports
OIL: SAME STORY
Exports plus oil
Oil discovery leads to appreciation, and reduces nonoil exports
A
C B
![Page 58: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/58.jpg)
Aid can play a key role in the development of recipient countries, but it can also generate macroeconomic vulnerabilities
Recipients need to implement appropriate policies to manage aid flows to avoid macroeconomic hazardsThe appropriate policy response needs to take
into account Potential impact of aid on competitiveness Existence of constraints to aid absorption Risks linked to aid volatility and to external debt
sustainability
MANAGEMENT OF AID FLOWS: MAIN LESSONS
![Page 59: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/59.jpg)
AID VOLATILITY AND UNPREDICTABILITY Aid is increasingly volatile and unpredictable
Aid flows are 6-40 times more volatile than fiscal revenue
Volatility is largest for aid dependent countries (Bulir and Hamann 2003, 2007)
Volatility increased in the 1990sAid delivery falls short of pledges by over
40% Reasons for aid volatility
Donors: Changes in priorities; administrative and budgetary delays
Recipients: Failure to satisfy conditions IMF conditionality often guides donors, helping
them decide if the country’s policies are on track
![Page 60: The Challenges of Capital Inflows Including Aid](https://reader035.vdocuments.net/reader035/viewer/2022062411/568167e2550346895ddd48e3/html5/thumbnails/60.jpg)
CONCLUSION ON AID Aid can play an important role in
the growth and development of recipient countries …… but it can also create
macroeconomic vulnerabilities Recipient countries need to
manage aid flows so as to avoid hazardsNeed to consider potential impact of aid
on Competitiveness Constraints to aid absorption Risks linked to aid volatility and to
external debt sustainability
THE END
These slides will be posted on my website: www.hi.is/~gylfason