Aid and the Dutch Disease in Low-Income Countries: Informed Diagnoses for Prudent Prognoses

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper demonstrates that the Dutch disease need not materialize in low-income countries that can draw on their idle productive capacity to satisfy the aid-induced increased demand. Diagnoses on, and prognoses for, the Dutch disease should take into account country-specific circumstances to avoid ill-advised policies. The paper emphasizes that using public resources inefficiently can be more painful than real exchange rate appreciations, which may not necessarily embody the Dutch disease.

Foreign Transfers and Real Exchange Rate Adjustments in a Financially Constrained Dependent Economy

“…However, they find that aid improves growth and exports in the other half of the sample, suggesting that not all countries are plagued with the Dutch disease. Nkusu (2004) argues that the Dutch disease need not occur in low-income countries that can draw upon their idle productive capacity to satisfy the aid-induced increased demand. In contrast, Rajan and Subramanian (2005) do find evidence of the Dutch disease leading to adverse effects on growth, even for economies adopting "good policies" in the Burnside-Dollar (2000) sense.…”

Do large capital inflows hinder competitiveness? The Dutch disease in Ethiopia

“…However, the core model can easily be adapted to demonstrate the potential impact of a surge in aid inflows, rather than an energy boom (see Nkusu, 2004). Foreign aid can be seen as a real income transfer that will raise the demand for both tradable and non-tradable goods produced in the economy.…”

Dutch Disease in Central and Eastern European Countries

“…Despite this reality, we should also consider that the transmission effect caused by the RER appreciation can be changed in less developed economies, in both sectors, the tradable and non-tradable (Torvik, 2001). The application of the funds generated by the boom in infrastructure and education investments, especially in those economies, as well as the possibility of the production being located to the left of the production possibilities frontier, may also lead to the conclusion that the effects of DD are not fully verified (Nkusu, 2004;McKinley, 2005).…”

“…Also of note is that these studies involve poor countries with low and very low levels of human capital. The contribution of (Nkusu, 2004) summarises the studies with conflicting results on the effects of foreign aid. In this respect, the author draws attention to the adverse effects of aid and emigrants' remittances in poor countries through the RER appreciation, but insists that using public resources inefficiently is more onerous than the negative effects of RER appreciation.…”