DVM 3140 Chapter Notes - Chapter 1: Multivibrator, William Easterly, Aid Effectiveness

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January 21 Readings
Can Foreign Aid Buy Growth? By William Easterly
Aid has a positive impact on growth in developing countries with good fiscal policies, monetary
and trade policies but has little effect in the presence of poor policies
Good governance and a sound policy environment are the most important determinants of aid
effectiveness
Aid can help, but it should be concentrated on countries with good macroeconomic policy and
governments genuinely committed to improving public services and infrastructure and stamping
out corruption.
Mr. Dollar and Mr. Burnside suggest that 1% of GDP in aid given to poor but well-managed
country can increase in growth rate by sustained 0.5% points
Mr. Wolfensohn (president of WB): corruption, bad policies, and weak governance will make aid
ineffective.
Boone: aid financed consumption rather than investment
ODA: grants and concessional loans net of repayment of previous aid loans, a measure that treat
forgiveness of past loans as current aid
Standard model, “Two gaps”
The first gap in the model address the difference btw the amount of investment in an economy
that is necessary to attain a certain rate of growth and the available domestic savings. Essentially
the gap exists when the public does not save enough and there is not enough capital to invest.
The second gap is btw import requirements for a given level of production and foreign exchange
earnings.
The first gap, the “financing gap” makes two assumptions
1. A stable linear relationship btw investment and growth exists. For every dollar invested in an
economy, the economy sees a corresponding dollar in growth
2. Aid intended to fill the financing gap will actually finance investment rather than
consumption.
Easterly: if the cause of low investment in an economy are bc of poor incentive to invest then aid will not
increase investment.. In fact the author claims, aid could actually worsen incentives to invest which could
lead to economic contraction. Aid in this case will then finance consumption.
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