Comments on: Aid, income and dutch disease

By: Cain Pence

Cain Pence — Fri, 12 Feb 2010 21:16:59 +0000

As a fellow wanderer, I appreciate your insights. Your blog was quoted on Robert Swope (Iraq analyst and defense guru) in his weekly roundup. Here is the link:

http://www.robertswope.com/home/2010/2/12/d3-weekly-link-roundup.html

Keep up the good work…may your travels be many and your travails few.

By: Luis Enrique

Luis Enrique — Fri, 05 Feb 2010 11:02:45 +0000

The following comment, even if it’s correct (which I’m not at all sure about – I always get in a muddle with this stuff) might just be a semantic nit-pick …

“So the ratio of imports to exports must rise compared to what it would have been without the aid: there is no way to stop this other than to stop giving or using aid. It also means that exports must fall as a share of GDP as a direct result of the aid”

That’s gross domestic product. If you are thinking about total quantity of resources at the disposal of the recipient country, then you’d be right: free gifts of imports (aid) would necessarily decreases the share of this total accounted for by exports (or the income from sale thereof). But (I think) imports are not part of GDP. If Rajan and Subramanian are measuring GDP, then increases in aid/imports do not mechanically (arithmetically) reduce the share of exports in GDP. That is to say, the imports that constitute aid are not counted in the denominator GDP. (If they were, you’d really have a job on your hands explaining why cross country regressions don’t pick up an increase in GDP resulting from aid).

Owen replies: That’s right: GDP includes exports net of imports. Aid would count directly in GNI.

By: Justin Kraus

Justin Kraus — Fri, 05 Feb 2010 01:23:41 +0000

I’ll admit to be completely out of my depth when it comes to dealing with economic statistics. But this particular part of your critique does not seem quite right to me and thankfully I don’t think it is a matter of stats. You state “For a country to be made worse off by an increase in aid of 5% of GDP, domestic production would need to fall by at least 5% (so that the loss of income from lower domestic production exceeds the benefit to incomes of the aid).”

This statement is obviously correct from a technical, short term, economic point of view. But I think it misses something. Because Aid is ideally temporary and domestic production, again ideally, not, I would suggest that if Aid has ANY (or least a decent measurable amount after accounting for the “denominator effect”) negative impact on domestic production, then we have a problem. Using aggregate GDP is misleading because it ignores the importance of the character of the different elements of which that GDP is made. When Aid inflows end it may not be possible for the domestic production to “bounce back” and so in the long term that Aid may have contributed to lowering a country’s domestic production and in general have a distorting effect on the composition of its economy. You might argue that economies need such distorting, but given the track record of Aid economists, I am a little skeptical that they know how to poke and prod correctly. Increasing domestic production is ESSENTIAL (that is one of the few things that we do know) for any country’s long term health, economic and otherwise, and we should be very careful that Aid doesn’t stand, even a little bit, in the way of that. In sum I think our “do no harm” standard should be a lot higher than being okay with a 5% Aid inflow that leads to a 4.9% decrease in domestic production.
And this is probably unfair but many African countries have been receiving Aid continuously for 40 years. So even if we use your aggregate demand standard, it is possible that they are worse off.
Let me know if I am missing something, the math makes my head hurt.

Owen replies:

Justin – you are right. But this is because I am not making the point sufficiently clearly. The point I am making is that aid has a direct benefit (extra income) which needs to be taken into account and is often forgotten in assessing the effect of aid.

Consider this example. There is a lottery advertised on British TV at the moment which pays out £40K a year for the rest of your life. Suppose you won that lottery and, as a result, you decided to work part time because you wanted to voluntary work instead; and so your salary goes down by £10K a year reflecting your shorter hours. In this case, it would be very odd to say that you are “worse off” because your salary has gone down. Your total income is higher AND you are able to spend more time doing the things you want to do.

Now of course, aid isn’t a permanent, guaranteed income for life. If you gave up work because you thought you had won the lottery, and then the lottery company went bust, you might end up worse off (depending how easy it is to get back in to work).

So you are right that to say there is a fundamental difference between the income obtained from your own production and the uncertain aid from capricious donors. But my point, which is also true, is that at any given time, you are only “worse off” in terms of your income if your production has fallen by more than the value of the aid you are receiving.

I hope that makes it clear?

By: David Roodman

David Roodman — Thu, 04 Feb 2010 22:50:06 +0000

Owen, I think this needs one correction, and it is actually in favor of your conclusion. As I explain in my post about this paper, and as Rajan & Subramanian well understand, the paper is only capable of discerning relative impacts on exporting sectors. As I wrote, "As far as this study goes, it is entirely possible that aid raised growth in all industries---just not quite as much in the most export-oriented ones....One could with equal logic celebrate this study for showing that aid is good for non-tradeable industries." The reason it can only discern relative effects is that it includes fixed industry and country effects (to get technical). It should be said that this is also be a strength of the paper, because having these fixed effects makes it more conservative than most cross-country growth regressions. It is of course hardly iron clad.