Foreign Aid

Aid and conditionality

Temple, Jonathan R. W. (2010). Aid and conditionality. In Dani Rodrik and Mark Rosenzweig (eds.), Handbook of Development Economics, Volume 5, pp. 4415-4523.

This chapter examines the conditions under which foreign aid will be effective in raising growth, reducing poverty, and meeting basic needs in areas such as education and health. The primary aim is not to draw policy conclusions, but to highlight the main questions that arise, the contributions of the academic literature in addressing them, and the areas where much remains unknown. After describing some key concepts and trends in aid, the chapter examines the circumstances under which aid might transform productivity, and when it can achieve things that private capital flows cannot. The chapter reviews the relevant theory and evidence. Next, it turns to some of the other considerations that might form part of a structural model linking outcomes to aid. These include Dutch Disease effects, the fiscal response to aid, and the important connections between aid and governance, both positive and negative.

The second half of the chapter examines when donors should attach conditions to aid. It reviews the debates on traditional policy conditionality, and potential alternatives, including the ideas underpinning the new “partnership” model. This model gives greater emphasis to a combination of autonomy and accountability, for countries where governance is strong. In other cases, donors may seek to attach conditions based on governance reform, and introduce new versions of traditional policy conditionality. The chapter also discusses controversies over the appropriate role of country ownership of aid programs. It goes on to discuss some donor failings, the future roles of randomized trials and evaluation, and the scope for aid to meet basic needs. The chapter ends with a discussion of some of the most innovative ideas for the reform of aid, and a summary of the main conclusions.

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Dynamic aid allocation

Carter, Patrick, Postel-Vinay, Fabien and Temple, Jonathan R. W. (2015). Dynamic aid allocation. Journal of International Economics, 95(2), March, 291-304.

This paper introduces a framework for studying the optimal dynamic allocation of foreign aid among multiple recipients. We pose the problem as one of weighted global welfare maximization. A donor in the North chooses an optimal path for international transfers, anticipating that consumption and investment decisions will be made by optimizing households in the South, and accounting for limits in the extent to which recipients can effectively absorb aid. We present quantitative results on optimal aid policy by applying our approach to a neoclassical growth model, where the scope for aid-funded growth is determined by the recipients’ distance from steady-state.

Download the final version (ungated/open access). This is a revised version of CEPR discussion paper no. 9596.

Foreign aid and domestic absorption

Temple, Jonathan R. W. and Van de Sijpe, Nicolas (2015). Foreign aid and domestic absorption. Revised, 22 May 2015. Under review.

This paper introduces a new ‘supply-push’ instrument for foreign aid, to be used together with an instrumental variable estimator that filters out unobserved common factors. We use this instrument to study the effects of aid on macroeconomic ratios, and especially the ratios of consumption, investment, imports and exports to GDP. We cannot reject the hypothesis that aid is fully absorbed rather than used to build foreign reserves or exiting as capital flight, nor do we find evidence of Dutch Disease effects. Aid leads to higher consumption, while the evidence that it promotes investment is less robust.

Download the May 2015 version from IDEAS

Virtuous circles and the case for aid

Carter, Patrick and Temple, Jonathan R. W. (2016). Virtuous circles and the case for aid. IMF Economic Review, forthcoming.

It is sometimes argued that foreign aid leads to a virtuous circle in which growth becomes self-reinforcing. We study two versions of this argument, using a modified neoclassical growth model in which the effects of parameter changes and capital accumulation are amplified. Simulations are used to quantify the welfare benefits from aid transfers. We find that, contrary to expectations, amplification makes only a modest difference to the welfare benefits from aid. This is true even when aid allows a faster exit from a vicious circle or poverty trap.

Download earlier Bristol discussion paper version