I think a large part of aid that isn’t given in the form of money is being left out of the discussion. Specifically I’m thinking of human resources and loans. Coincidently, these are the two things I believe developing countries need more of, that is – high skilled labour & access to capital.

All the volunteers and development workers on the ground have the potential to build systems and empower residents living within the country. This money paid would normally go into the same pockets, the difference is that the work these people do is now in another country rather than in the west where they came from.

On the loans, I feel its fairly self-explanatory, the business/individual that receives a loan is now able to invest in opportunities. The money that comes in goes back and there is no net change in national accounts (save the interest).

Maybe this all falls under whats already been said, but I feel its worth mentioning.

Your point re: budget support is well taken. I wasmaking a comparison to project support, but what you say re: it’s comparison with BoP support is true.

As far as demand stimuli go, I again agree that this would best be done by domestic expenditure; that said, it is still possible through aid, though dependent on multiplier effects and consequently weakened. the big issue is whether the production process can be changed using aid, and we agree on this one, it seems. Thanks again,

Ranil

If the inflow is immediately converted to imports (e.g. through assistance in kind) it has an economic effect solely through the value and/or usefulness in production of the goods purchased (which is not necessarily a bad thing: as early as 1954 or so, Michal Kalecki was arguing that imports of capital goods are necessary for economic development in the modern world). If however, the inflow is used to generate goods and services domestically in the first instance, with the foreign currency sold to someone else, then there is an additional benefit of stimulating the production process locally; similarly, if it is used to make changes to the production process directly, it may have significant effects in support of the local economy.

Ultimately, that all foreign inflows fund imports is almost irrelevant to the aid effectiveness debate: the real problems lie when the immediate impact of the money coming in is negligible or negative. And I’m not sure anyone is claiming that budget support is better for the balance of trade: the benefits lie in the ability it gives to a Government to pursue its own development objectives with fewer restraints, which assumes that this will allow for a more efficient and developmental process for using and allocating aid.

Ranil: Thanks for taking the time to respond. I think we agree that the fact that all aid ends up as imports is less interesting than the question of which people or institutions are given the value of the claim on those imports; and the question of what constraints donors put on how those resources are used (eg. in the extreme, by providing the aid in kind).

I am not sure that you are correct that the Government receiving budget support can “pursue its own development objectives with fewer restraints”, at least when compared to the old balance of payments support. In the old days, a government simply had to produce receipts for the oil or machine parts that it had imported with the foreign currency it was given: donors had no say over how the government allocated its resources. Today, the government faces a barrage of commentary, advice and restrictions from donors on how they should use the budget support – all predicated on the change of name, even though the economics is no different. Budget support may give governments more flexibility than donor-managed projects (though much of this is an illusion, given that projects are almost as fungible as programme aid), but they have arguably less flexibility than in the days of balance of payments support.

Thanks for the response. I think that’s a sensible answer, but I’m not so sure that the “premature appreciation of the real exchange rate” is such an unmitigated gift. Even if aid was sustained and predictable, I think it’s worth asking how a particular aid recipient’s economy will adjust to premature appreciation, but this raises some difficult questions about when and how economies adjust in a beneficial fashion, and when adjustment can entail things getting worse. (and also some questions about the relationship between the exchange rate, exports and growth). I don’t even have a clear enough grasp of the question to be able to say much about it, let alone sketch any answers; I think adjustment is one of the most poorly understood areas of economics (not just in the context of developing countries; it is also evident in our poor grasp of how the economy is responding to the current financial crisis). I’m really not sure how a real world donor might go about thinking through the likely forms of adjustment to premature appreciation in any given country.

(I’m sure you’re as familiar with the lit. on Dutch Disease and such like as I am … nonetheless you might like this: Session IV here, has some interesting discussion.)

The effect on domestic producers is the real world counterpart of the appreciation of the real exchange rate.

My view is that sustained, long-term predictable aid is the gift of a premature appreciation of the real exchange rate, which should be embraced.

The problem comes when volatile or temporary aid from capricious donors drives up the real exchange rate, putting out of business exporters and firms competing with imports, and then disappears, leaving the country with neither the aid to pay for the imports they need and want, nor the domestic industries needed to export or to substitute for imports.

Owen

Would you say that an additional consequence is that donors should always think about what imports are likely to displace?

For example, if donors were giving a country free imports of food or clothing, it would be natural to think about the implications for the domestic food and clothing industries. If donors are giving dollars intended to pay the salaries of teachers and nurses, it might not be so natural to think about the implications for the domestic food and clothing industries, but depending on what the relevant import demand elasticities are, those aid dollars may still be spent on importing food and clothing.

[I'm not sure about this myself; I think it's a reasonable point, but I haven't really thought through what it would mean in real world situations]

You are the Aid Explainer!

Surely, central banks do need to moderate the real exchange appreciation that results from large aid inflows? Yes it can be costly. And in the end absorption of the aid inflows will require some real appreciation. But too quick an appreciation would make life difficult for tradables producers. A group which in most aid dependant countries includes the rural poor–coffee, cocoa, cotton, tobacco farmers and the like.

Owen replies: I should have made this clear. I don’t mean that all sterilization is a bad idea. Where aid is volatile, it makes perfect sense to smooth it to prevent gyrations in the real exchange rate, as you imply. But aid is the gift of a premature real exchange rate appreciation, and permanent, long-lasting increases in aid should feed through into changes in the real exchange rate and current account, otherwise it isn’t being used.