Aid and Oil

• Author: Rabah Arezki and Ritwik Banerjee
• Position: a Senior Economist in the IMF's Research Department, and is a Ph.D. candidate at Aarhus University.

Foreign aid has long been a sizable source of funding for developing economies. In 2012, major donors disbursed $127 billion, two-thirds of it to low-income countries in Africa and Asia. Foreign aid—more precisely official development assistance—is a drop in the bucket for donor countries, about 0.3 percent of their combined GDP. But it is a major source of funding for some developing economies—amounting to 15 percent of Liberia’s GDP and 5 percent of Burundi’s, for example (see chart).Â

Foreign aid comes in many guises, but the most prominent is development assistance, which advanced economies disburse to poorer economies to promote economic and social development and is measured by the Development Assistance Committee of the Organisation for Economic Co-operation and Development. The general long-run objective of development aid is the alleviation of poverty and promotion of welfare in low- and middle-income countries through budgetary assistance and access to technology—although there is no clear evidence yet to support a relationship between aid and economic performance (see box).Â

Aid’s effectiveness

Some analysts argue that aid can retard growth by driving up the value of the local currency, which makes the manufacturing

sector less competitive. Others argue that aid may reduce tax revenue mobilization and that the stringent conditions

imposed by donors may lead to excessive concentration of talent in aid administration. But there is also recent evidence

to support the notion that aid promotes economic growth. In general, this uncertainty about aid’s effectiveness has led to

demands to overhaul the existing aid framework. Some even call for an end to aid altogether.

In recent years, however, many developing economies, especially in sub-Saharan Africa, have found a new source of homegrown wealth that offers the same type of budgetary assistance as development aid—with none of the strings that donor countries often attach to how it can be used or reforms countries must make to continue receiving it. Across Africa, discoveries of large oil fields are changing the financial picture for many developing economies.Â

We will explore the impact of these discoveries on foreign aid. For example, do donors reduce their contribution when oil income rises? Or should they? That is, can foreign aid still play a constructive role in developing economies that strike it rich with oil?

Oil finds

In recent years, many developing economies, some of them major aid recipients, have discovered vast amounts of gas and oil. Although there have been some important finds in south Asia and Latin America, the...