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International Development Aid
Xavier Sala-i-Martin
Columbia University
March 2007
Empirical Evidence
• There was little consensus by the early
literature on whether economic growth
was correlated with international aid.
• One prominent view was that during the
cold war, most international aid had little to
do with real development. It had to do with
politics, military and strategic geography.
• But the empirical evidence was mixed.
Empirical Evidence
• Then a very Influential paper was written by
Burnside and Dollar (2000):
   0  1 X   2 AID   3 AID * GoodPolicies  
• They find α2 close to zero and α3>0. That is, AID
has a positive effect on growth ONLY if the
country at the receiving end conduct good policies.
• After this paper was published, IFIs and the whole
world demanded more international aid and
conditionality on good policies.
Empirical Evidence
• Problems with the paper: it is NOT robust
to the definition of “aid”, “growth”, or “good
policy” (Easterly, Levine and Rodman
(2003).
Empirical Evidence
• Definition of Aid:
– Burnside and Dollar use “Grant Aid” (excluding
subsidized loans and debt rescheduling).
– Normal definition (called ODA) includes
subsidized loans and debt rescheduling.
– The two measures are highly correlated (0.933)
– But when Easterly et all use this second
measure, α3 becomes insignificantly different
from zero.
Empirical Evidence
• Definition of Good Policy:
– Burnside and Dollar construct a measure which is an
average of inflation, fiscal deficit and a measure of
openness (originally proposed by Sachs and Warner
1995)
– Easterly et al use TRADE/GDP instead of SachsWarner qualitative measure, they add “Black market
premium” and “financial depth” (ratio of M2/GDP
which is a measure of financial development) and…
– … the coefficient α3 becomes insignificantly different
from zero.
Empirical Evidence
• Definition of growth
– Burnside and Dollar use 4 year averages
– Easterly et al criticize this because it contains
business cycle noise.
– If use 10-year averages… α3 becomes
insignificantly different from zero.
Source: Easterly (2003), JEP
Source: Rajan and Subramanian (2005)
Notes on Causality
• Aid could systematically go to countries that are in
trouble (like a natural disaster): if natural disasters tend
to generate low (or negative) growth, this will tend to
generate a negative association between growth and
aid.
• Aid could systematically go to “reward” countries that did
things well in the past. If growth persists, then there will
be a positive association even though aid does not really
cause positive growth.
• In order to solve this problem, econometricians use
“instrumental variables”. IV estimates are supposed to
see the correlation between exogenous aid and growth
Source: Rajan and Subramanian (2005)