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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): 0 1 X 2 AID 3 AID * GoodPolicies • They find α2 close to zero and α3>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, α3 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 SachsWarner qualitative measure, they add “Black market premium” and “financial depth” (ratio of M2/GDP which is a measure of financial development) and… – … the coefficient α3 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… α3 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)