Half Empty or Half Full

• Author: Andrew Berg and Luis-Felipe Zanna
• Position: an Assistant Director and Luis-Felipe Zanna is a Senior Economist in the IMF's Research Department.

WHETHER foreign aid helps poor countries grow is a matter of dispute. Although there is evidence that aid has a positive effect on social indicators such as infant mortality and primary school enrollments, its effectiveness on growth is an unresolved matter among economists. “It is difficult to discern any systematic effect of aid on growth,” Rajan and Subramanian (2008) concluded, for example, while Arndt, Jones, and Tarp (2009) found that “aid has a positive and statistically causal effect on growth over the long run.”

Less controversial is the view that aid flows, and in particular aid surges, can have both positive and negative effects on recipient countries. Aid surges may induce real exchange rate appreciation, which hurts growth-promoting exporting industries (see Rajan and Subramanian, 2010), but they may also help finance much-needed public investment in infrastructure, which is necessary for growth (see Collier, 2006). What makes the mixed empirical evidence unsurprising is that the final growth impact of aid is likely to depend on a number of country-specific factors, such as the macroeconomic policy response, the uses to which the aid is put, the efficiency of public investment, and various structural characteristics of the economy.

Scenario assessments

We have embraced this country-specific view in a joint project of the IMF and the United Nations Development Programme (UNDP) that provides macroeconomic assessments of scenarios that involve increases in aid for several African economies. The IMF was asked to provide macroeconomic assessments of scenarios that correspond to the commitments made by the Group of Eight industrial countries (G-8) at Gleneagles, Scotland, in 2005 to double aid to Africa by 2010. The scenarios and spending plans are based on sector-level analyses that the UNDP prepared in coordination with the World Bank, the African Development Bank, and country authorities. So far, 10 scenarios have been conducted—for Benin, Central African Republic, Ghana, Liberia, Niger, Rwanda, Sierra Leone, Togo, Tanzania, and Zambia. Five more assessments are to be completed in the coming months. (Three of these cases are available at www.imf.org/external/np/pp/eng/2008/091908a.pdf; the rest will be published soon.)

The assessments use a common framework that was developed at the IMF (see Berg and others, 2010). The framework is based on a dynamic small-open-economy quantitative model that can be useful for both policymakers and IMF staff by supporting more coherent policy discussion and macroeconomic analysis. The model is designed to capture the main mechanisms and policy issues in low-income countries experiencing aid surges. The framework focuses on the short- and medium-term macroeconomic effects of aid surges to shed light on aggregate measurements such as inflation and real exchange rate and medium-term...