Empirical Methods in Development Economics Lecture 9 - Université Paris 1 …remi.bazillier.free.fr/AidEffectiveness.pdf · 2016-11-14 · 1. Legitimacy crisis of aid in the 90s

Empirical Methods in

Development Economics

Lecture 9 - Foreign Aid

Lisa Chauvet

[email protected]

Fall 2016

1. Legitimacy crisis of aid in the 90s

Changes in international environment (end of cold war):

transformed political foundation of bilateral aid which

was considered as an instrument for promoting the

political and geostrategic interests of donor countries

Economic crisis and strong budgetary constraints

weighing on several donor countries, notably European

countries in the Euro zone: led to a brutal fall in aid flows

to developing countries

Introduction

1. Legitimacy crisis of aid in the 90s

Problems of increasing debt in recipient countries and

successive financial crises opened a debate over the

reform of international financial architecture and the role

of multilateral institutions. Metzler report (2000): reduced

role for the IMF (LT loans) & focus on grants for the WB

Economic foundations and the justification of

development aid were attacked by numerous very critical

studies emphasizing the absence of macro-economic

effectiveness (Boone, 1996; Mosley et al. 1987) and the

failure of conditionalities (Guillaumont, 1995; Collier,

1997)

Introduction

1. Legitimacy crisis of aid in the 90s: IMPLICATIONS

Shortage in aid resources

Conditionalities do not work

Aid is only effective under certain conditions

How to allocate aid to the countries in which it is

effective? Which criteria?

Debate in terms of geographical aid re-allocation

Introduction

0

20000

40000

60000

80000

100000

120000

140000

160000

180000

-24%

Total Net Official Development Assistance, million USD (100=2014)

Boone 1996

B&D 1997

B&D AER 2000

Introduction

2. The MDGs and the scaling up of aid

Change in context : • a new political foundation for aid = fight against terrorism (‘there is no wall’)

• MDGs: new consensus of the international community regarding the main

objectives of aid

Scaling up aid: IMPLICATIONS • New set of issues relating to a large increase in foreign aid: macroeconomic

volatility, Dutch disease

• Will developing countries be able to absorb large amounts of aid?

No longer a debate in terms of ‘how to better allocate aid given the shortage

of resources’ but rather ‘given that aid is going to increase, how can we

avoid the adverse effects of aid’

Is aid the best way of financing the MDGs? Complementarities of aid with

other sources of external financing?

Introduction

0

20000

40000

60000

80000

100000

120000

140000

160000

180000

-24%


Boone 1996

B&D 1997

B&D AER 2000

Introduction

0

20000

40000

60000

80000

100000

120000

140000

160000

180000

+115%


Boone 1996

B&D 1997

B&D AER 2000

B&H IMF 2003

R&S IMF 2005

Introduction

2. The MDGs and the scaling up of aid

Change in context : • a new political foundation for aid = fight against terrorism (‘there is no wall’)

• MDGs: new consensus of the international community regarding the main

objectives of aid

Scaling up aid: IMPLICATIONS • New set of issues relating to a large increase in foreign aid: macroeconomic

volatility, Dutch disease

• Will developing countries be able to absorb large amounts of aid?

No longer a debate in terms of ‘how to better allocate aid given the shortage

of resources’ but rather ‘given that aid is going to increase, how can we

avoid the adverse effects of aid’

Is aid the best way of financing the MDGs? Complementarities of aid with

other sources of external financing?

Introduction

3. New challenges: 2008 financial crisis & SDGs

Total net ODA

(2014 mn dollars)

0

20000

40000

60000

80000

100000

120000

140000

160000

180000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Introduction


Introduction


Introduction

Orders of magnitude of required investments

Oceans

Forests

Biodiversity

Climate change attenuation

Climate change adaptation

Universal access to energy

Renewable energy

Energy efficency

Land and agriculture

Infrastructure (exc. energy)

MDGs

Annual required investments (in billion dollars per year)

UN special task team, reference document 1; horizontal axis: logarithmic scale

Definitions of aid

Official Development Assistance (ODA): OECD definition: flows

(grants and loans) to developing countries provided by official

agencies:

Main objective is the promotion of the economic development and welfare of

developing countries

Concessional i.e. have a grant element of at least 25%

Grant element: reflects the financial terms of a transaction (interest

rate, duration). Measured as an opportunity cost to the lender:

Interest charged – Return that the lender could have expected from another

investment of the capital

Reference rate of interest: 10%

GE = 0 if interest rate = 10%; GE = 100% for a grant.

If GE > 25% the face value of the loan is counted as ODA (FV x GE = Grant

equivalent)

Definitions of aid

Effective Development Assistance (EDA): see Chang et al. (1998):

Sum of grant elements of all financial flows:

• EDA excludes technical assistance

• The reference rate of interest to calculate GE = market rate

ODA over-represents loans which have a GE > 25% (but still need to be

repaid) and under-represents loans which have a GE < 25 %

Note: EDA data: up to 1995, no update.

Face Value GE ODA EDA

Loan 100 30 100 30

Loan 100 20 0 20

Grant 100 100 100 100

Definitions of aid

Source : Chang et al. 1998, page 36, figure 4.5

Harrod-Domar model: growth rate of income is a

function of capital accumulation: gt = skt

• where s is the share of national income saved and k is the

output-capital ratio (Yt/Kt)

• Foreign aid increases capital accumulation by adding to

domestic saving. Foreign aid finances the saving gap of

developing countries

Two-gap model (Chenery and Strout, 1966):

• Saving gap

• Foreign exchange or trade gap (gap between imports

necessary for growth and foreign exchange from exports)

• Aid fills the two gaps

Theoretical foundations: the financing gap

Theoretical foundations: Why aid may not

have a positive impact?

1. Aid does not convert into investment

• Service delivery and embezzlement/corruption

• Leakage of aid through consumption

• Note: even if aid does not convert one for one into saving/investment,

it may still increase economic growth (see below)

2. Political motivations in the allocation of aid

• Donor countries give aid primarily because it is in their political,

strategic or economic self-interest to do so

• Bilateral aid flows mainly determined by (Alesina and Dollar, 2000)

• Camp David partnership (US with Egypt and Israel)

• Colonial relationship (France, UK, Portugal, ...)

• Common language



2. Political motivations in the allocation of aid

• Economic growth is not the sole objective of foreign aid, aid in some

cases it is not the objective at all (humanitarian aid, support to

democracies, political interest of donors, promotion of language –

French)

• Sources of distortions: tied aid

• Aid is tied either on trade, projects

or technical assistance (experts service from

developed countries, scholarships)

• Tied aid is aid given on the condition that the

recipient will use it to purchase goods and

services from suppliers based in the donor country



3. Resources are not everything

The binding constraint (reason for low investment) may be

elsewhere:

• bad government (Easterly)

• absence of complementary inputs (aid may finance schools

and textbooks but education will not improve unless teachers

and students show up regularly

Adverse effects of aid:

• On incentives: Samaritan Dilemma

• On competitiveness: Dutch Disease

The B&D analysis occurred during the ‘aid fatigue’

(decreasing amounts, lack of effectiveness, conditionality)

Its main implication was a selectivity principle

Heterogeneity in the impact of aid has not been much

discussed (selectivity), but the conditions affecting aid

effectiveness have been

Non-linearities in the aid-growth relationship introduced to

account for the heterogeneity of the impact of aid

Starting point = Boone (1996): Whether or not political

regimes are more open does not seem to influence the

impact of aid.

The Burnside-Dollar debate:

A conditional impact of aid on growth

A. Burnside and Dollar analysis 1997: World Bank WP; 2000: published AER; 1998: WB report on

“Assessing Aid”. NOTE: Dollar & Svensson (1998, 2000) on meso-

data

B&D estimate a growth equation of the following form:

git = yitby + z’itbz + aitba + p’itbp + aitp’itbap + dt + eit

56 countries, 1970-73 1990-93, OLS and 2SLS

dgit/dait = ba + bappit => bap > 0 indicates that aid is more effective in

countries with sound economic policies

Instrumentation of aid: ln(pop), arms imports(t-1), dummies for

Egypt, Franc zone, Central America + ln(y.p.c.)xpolicy,

ln(pop)xpolicy, arms x policy, [ln(y.p.c.)]2xpolicy, [ln(pop)]2xpolicy

…assume policy exogenous and population excludable


Construction of a POLICY index:

pit = 1.28 + 6.85xBS –

1.40xinflation + 2.16xopenness

Multilateral aid is better targeted and used

Multilateral aid is better targeted and used

A. Burnside and Dollar analysis Implications: performance-based allocation (PBA), selectivity

principle (IDA, DfID, MCC)

Arguments (and assumptions) in favour of a selectivity

principle:

• Aid should create incentives to improve policy

• Aid has no impact on policy

• Aid is fungible

The weaknesses of their econometric analysis

• Assume policy exogenous

• Are the instruments exogenous (c.f. Tavares 2003)?


B. Alternative factors of aid effectiveness 1. Marginal diminishing returns

Hadjimichael et al. (1995) + Hansen andTarp (2000, 01):

A* = 25% of GDP

Durbarry et al. (1998) + Lensink and White (2001):

A* > 40% of GDP

Argument of Hansen and Tarp (2000): AxPOL is a proxy for A2

See also Hansen and Tarp (2001)


Growth

A* Aid

Hansen and Tarp (2000)

B. Alternative factors of aid effectiveness 2. Vulnerability to external shocks

Structural vulnerability (Guillaumont and Chauvet, 2001)

• Measure of structural vulnerability: • Exposure to shocks (population)

• Trade shocks: trend in ToT and instability of exports

• Climatic shocks (instability of agricultural value added)

• Aid is more effective in countries vulnerable to external shocks (aid

compensates)

• Implications: an alternative concept of performance?

Commodity price shocks (Collier and Dehn, 2001)

• Aid dampens the negative impact of negative price shocks

on growth


Guillaumont and

Chauvet (2001)

2. Débats sur l’efficacité de l’aide

Collier and

Dehn (2001)

B. Alternative factors of aid effectiveness 3. Geographic factors

The impact of aid depends on underlying structural

characteristics (Dalgaard, Hansen and Tarp, 2004)

To avoid endogeneity issues => climatic circumstances

(fraction of land in tropical areas)

Aid is less effective in the geographic tropics

Model outperforms A x POL and A2

Interpretation:

• Climate may matter directly for productivity

• Climatic circumstances may have influenced other slow-moving

characteristics (institutions)


Dalgaard et

al. (2004)

B. Alternative factors of aid effectiveness 4. Political institutions

Boone (1996): the impact of aid does not vary according to whether

the recipient governments are liberal democratic or highly

repressive (BUT liberal political regimes and democracies have on

average 30% lower infant mortality than the least free regimes)

Kosack (2003): though aid does not affect quality of life (HDI) in the

aggregate, it is effective when combined with democracy, and

ineffective (and possibly harmful) in autocracies

Angeles and Neanidis (2009): characteristics of the political elite

matter

Wright (2008): time-horizon of dictators matters


Boone

(1996)

Kosack (2003)

Angeles and Neanidis (2009)

Wright (2008)

Step 1: estimations

of the time horizon

(probability of failure)

of the autocrats

Step 2: growth

estimation with aid

instrumented and

interacted with

probability of failure

Effect of aid driven

by Jordan

Comment by Kilby and Kline (2012)

The positive effect of aid

in long-term horizon

dictatorships disappears

B. Alternative factors of aid effectiveness 5. Post-conflict situations

Aid effectiveness is higher than normal in post-conflict situations

(first decade of peace), notably around 4-5 years of peace (Collier

and Hoeffler, 2004)


C. Robustness checks 1. Easterly, Levine and Roodman (2004)

Extend the database up to 1997

More countries (62 instead of 56)

2. Roodman (2004, 2007)

(1) B&D, (2) C&D, (3) C&D*, (4) C&H, (5) H&T, (6) D,H&T, (7) G&C

1. Changing the control set (4 different control sets)

2. Redefining aid (ODA vs EDA and GDP PPP or not)

3. Redefining good policy (B&D vs (inflation + openness) vs CPIA)

4. Changing periodization (4-year vs 12-year)

5. Removing outliers (Hadi procedure)

6. Expanding sample up to 2001 (except G&C)


ELR (2004)

C. Robustness checks 1. Easterly, Levine and Roodman (2004)

Extend the database up to 1997

More countries (62 instead of 56)

2. Roodman (2004, 2007)

(1) B&D, (2) C&D, (3) C&D*, (4) C&H, (5) H&T, (6) D,H&T, (7) G&C

1. Changing the control set (4 different control sets)

2. Redefining aid (ODA vs EDA and GDP PPP or not)

3. Redefining good policy (B&D vs (inflation + openness) vs CPIA)

4. Changing periodization (4-year vs 12-year)

5. Removing outliers (Hadi procedure)

6. Expanding sample up to 2001 (except G&C)


Tests 1, 2 & 3: C&H

and DH&T do best

Test 4: not shown: failure of

all models

Test 5 : C&H do best

Test 6: failure

D. Aid effectiveness conditional on donors’ performance 1. Donors fragmentation (Djankov et al., 2009)

FRAG = 1 – SNpi2 (pi: share of donor i in receiving country, cf

Herfindahl-Hirschman) => Donfrag (0=1donor; 1=high level of frag)

Instrumentation of aid using similar instruments as D&B

Finding: the presence of multiple donors in a given country renders

aid less effective

Explanation: fragmentation increases corruption, because:

• Fragmentation increases recipient governments’ negotiation power

• Donors become less demanding in selecting and supervising projects and thus

it is easier for corrupted officials to appropriate resources

2. Presentation: Aid and Trust in Country Systems (Knack and

Eubank, 2009)







aid less effective





2. Presentation: Aid and Trust in Country Systems (Knack and

Eubank, 2009)


High values of Cor1, Cor2 and Cor3

indicate less corruption






aid less effective






D. Aid effectiveness conditional on donors’ performance 2. Ideological proximity (Dreher et al, 2015)

Increases trust

decreases transaction costs


1. Fixed-effects + lag 1. Clemens et al. (2012, also WP2004)

Improvements in identification strategy

2. Supply-side IV 1. Rajan and Subramanian (2008, also WP2005)

10-year sub-periods (1960-2000)

Instrumentation of aid using supply-side determinants (in the

tradition of Tavares 2003)


Note on Tavares (2003) (Economic Letters)

Looks at the impact of aid on corruption: finds that aid

decreases corruption

New set of instruments for aid (supply-side):

1. Compute for each pair DC/donor four variables

that capture geographic and cultural proximity

(inverse of bilateral distance, common land

border, same majority religion, same official

language)

2. Take the constant US$ value of aid outflows of the

donor countries and multiply it by 1.

3. The sum all outflows is the instrument for aid (x4)


10-year sub-period (1960-2000)



Find no positive impact of aid on growth

Decomposition of aid into bilateral/multilateral, social/economic

sectors, late-impact and early-impact (Clemens et al., 2004)

Look at long period / short period of time

No systematic effect



10-year sub-period (1960-2000)



Find no positive impact of aid on growth

Decomposition of aid into bilateral/multilateral, social/economic

sectors, late-impact and early-impact (Clemens et al., 2004)

Look at long period / short period of time

No systematic effect


3. Quasi-experiments 1. Werker et al (2009)








Note on Nunn and Qian 2014 (AER)

3. Quasi-experiments 2. Galiani et al (2016)


3. Quasi-experiments 2. Galiani et al (2016)


4. Purging the effect of aid on growth

1. Bruckner (2014)

Two steps: 1. What is the response of aid to growth, with growth instrumented by rainfall and commodity

price shocks

2. Residual variation in aid (part not explained by exogenous growth) used as an instrument for

aid in a growth equation

TSLS, Dlog(yi,t) instrumented

with rainfall and price shocks

TSLS, Dlog(aidi,t)

instrumented with residual of

first-step Dlog(aidi,t)* :

Note: sample = 47 LDCs


4. Purging the effect of aid on growth 1. Bruckner (2014): step 1

A 1% increase in per

capita GDP growth is

associated with an

average reduction in aid of

over 4%


4. Purging the effect of aid on growth 1. Bruckner (2014): step 2

A 1% increase in aid is

associated with an

average increase in per

capita GDP growth of

around 0.1-0.2%.


5. Filtering the effect of aid on growth

1. Rajan and Subramanian (2011): their model:

growthij = a + ei + ej + b wij + g aj.ei + uij

growthij = annual average rate of growth of value added of

industry i in country j

ei + ej = industry and country fixed effects

wij = Industry i’s share of manufacturing in country j in initial

period

aj = Aid to country j (A/GDP)

ei = exportability (sensitivity of industry i to ER appreciation)

DATA: Industrial statistics database (UNIDO)

32 DCs in the 80s and 15 DCs in the 90s. 28 industries


Aid has a

detrimental impact

in industries

sensitive to ER

IV = fitted aid from a

gravity model (cf Rajan

and Subramanian, 2008)

Conclusion

A positive impact of aid… depending on recipient

countries’ characteristics as well as aid

characteristics. But no consensus on which

conditions matter most

A criticized literature:

Important policy implications…

…despite unreliable econometric results (sample

dependence, periodization, causal relationships?)

Recent improvements in identification strategies

An emerging consensus on a small and positive

effect of aid

Angeles L. and K. C. Neanidis, 2009. Aid Effectiveness: The Role of the Local Elite. Journal of Development Economics 90,

120–134.

* Boone P., 1996. Politics and the Effectiveness of Foreign Aid. European Economic Review 40, 289-329.

* Burnside C. and D. Dollar, 2000. Aid, Policies and Growth. American Economic Review 90, 847-868.

Bruckner M., 2013. On the simultaneity problem in the aid and growth debate. Journal of Applied Econometrics 28, 126-150.

Burnside C. and D. Dollar, 1997. Aid, Policies and Growth. Policy Research Working Paper 1777, World Bank Development

Research Group, Washington D.C.

Chauvet L. and P. Guillaumont, 2004. Aid and Growth Revisited : Policy, Economic Vulnerability and Political Instability. in

Tungodden B., N. Stern and I. Kolstad (eds). Toward Pro-Poor Policies. Aid, Institutions and Globalization. World Bank et

Oxford University Press.

Chenery H.B. and A.M. Strout, 1966. Foreign Assistance and Economic Development. American Economic Review 56(4), Part

1, 679-733.

* Clemens M. A., S. Radelet, R. Bhavnani, S. Bazzi 2012. Counting Chickens When They Hatch: Timing and the Effect of

Aid on Growth. Economic Journal 122, 590-617 2012.

Collier P. and J. Dehn, 2001. Aid, Shocks and Growth. World Bank, Development Research Group, Washington D.C.

Collier P. and A. Hoeffler, 2004. Aid, Policy and Growth in Post-Conflict Societies. European Economic Review 48, 1125-1145.

Dalgaard C-J, H. Hansen and F. Tarp, 2004. 0n the Empirics of Foreign Aid and Growth. Economic Journal 114(496), 191–216.

Djankov S., J.G. Montalvo and M. Reynal-Querol, 2009. Aid with multiple personalities. Journal of Comparative Economics 37,

217-229.

Dollar D. and J. Svensson, 2000. What Explains the Success or Failure of Structural Adjustment Programs ? Economic Journal

110, 894-917. (also WB WP 1998)

Dreher A. et al. (2015) Government ideology in donor and recipient countries: Does ideological proximity matter for the

effectiveness of aid? European Economic Review 79: 80-92.

Durbarry R., N. Gemmell and D. Greenaway 1998. New Evidence on the Impact of Foreign Aid on Economic Growth, Credit

Research Working Paper 98/8, University of Nottingham.

References (* required readings)

Easterly W., R. Levine and D. Roodman, 2004. New Data, New Doubts: A Comment on Burnside and Dollar’s ‘Aid, Policies, and

Growth,’ American Economic Review 94.

Galiani, S. S. Knack, L. C. Xu, B. Zou, 2016. The effect of aid on growth. Evidence from a quasi-experiment. NBER Working

Paper 22164.

Griffin K.B., 1970. Foreign Capital, Domestic Savings and Economic Development. Bulletin of the Oxford University Institute of

Economics and Statistics 32(2), 99-112.

Griffin K.B. and J.L. Enos, 1971. Foreign Assistance : Objectives and Consequences. Economic Development and Cultural

Change 18(1), 313.

Guillaumont P. et L. Chauvet, 2001. Aid and Performance: A Reassessment. Journal of Development Studies 37, 66-92.

Hadjimichael M.T., D. Ghura, M. Mühleisen, R. Nord and E.M. Uçer, 1995. Sub-Saharan Africa: Growth, Savings, and

Investment, 1986-1993, Occasional Paper 118, International Monetary Fund, Washington D.C.

Hansen H. and F. Tarp, 2000. Aid Effectiveness Disputed. Journal of International Development 12, 375-398 (also in Tarp F.

(ed). Foreign Aid and Development. Routeledge, Chap. 4).

Hansen H. and F. Tarp, 2001. Aid and Growth Regressions. Journal of Development Economics 64(2), 547-570.

Kilby C. and C. Kline, 2012. To Invest or Insure? A comment on Wright (2008). Villanova School of Business Economics

Working Paper 21.

Kosack S., 2003. Effective Aid: How Democracy Allows Development Aid to Improve the Quality of Life, World Development

31(1).

Lensink R. and H. White, 2001. Are There Negative Returns to Aid? Journal of Development Studies 37(6).

Mosley P., 1980. Aid, Savings and Growth Revisited. Oxford Bulletin of Economics and Statistics 42(2), 79-95.

Mosley P., J. Hudson and S. Horrell, 1987. Aid, the Public Sector and the Market in Less Developed Countries. Economic

Journal 97, 616-641.

Papanek G.F., 1973. Aid, Foreign Investment, Savings and Growth in Less Developed Countries. Journal of Political Economy

81(1), 120-130.


Papanek G.F., 1973. Aid, Foreign Investment, Savings and Growth in Less Developed Countries. Journal of Political Economy

81(1), 120-130.

Papanek G.F., 1972. The Effect of Aid and Other Resource Transfers on Savings and Growth in Less Developed Countries.

Economic Journal 82, 934.

* Rajan R. G. and A. Subramanian, 2008. Aid and Growth: What Does Cross-Country Evidence Really Show? Review of

Economics and Statistics 90(4), 643–665 (also IMF working paper, 2005)

Roodman D., 2007. The Anarchy of Numbers: Aid, Development, and Cross-country Empirics. CGDev Working Paper 32. (see

also 2004 version of the working paper)

Tavares J., 2003. Does Foreign Aid Corrupt?. Economics Letters 79: 9-106.

World Bank, 1998. Assessing Aid : What Works, What Doesn’t, and Why. Oxford University Presss, New York.

*Werker et al, 2009. How is foreign aid spent? Evidence from a natural experiment, AEJ: macro 1:2, 225-244.

Wright J., 2008. To invest or Insure? How Authoritarian Time Horizons Impact Foreign Aid Effectiveness. Comparative Political

Studies 41(7), 971-1000.


Documents

Empirical Methods in Development Economics Lecture 9 - Université Paris 1 …remi.bazillier.free.fr/AidEffectiveness.pdf · 2016-11-14 · 1. Legitimacy crisis of aid in the 90s