A recent World Bank publication, Assessing Aid: What Works, What Doesn't, and Why?, argues that international aid only works hand in hand with sound economic policy. However, aid itself can have a strong influence on policy especially when channeled through the government thus affecting the budget. The amount of money donated may vary from one year to the next making financial planning tricky, and budget deficits more likely. Furthermore, financial aid is often intended for investment but investors lose confidence if donations are irregular. Instability in aid receipts, if it undermines investment or budget planning, could have negative effects on economic performance. DFID-backed research carried out by the University of Nottingham examined the relationship between aid instability and economic growth in a sample of 88 developing countries.

Many countries in the South are subject to economic uncertainties, events that are difficult to predict and that undermine economic performance. Famine or flood are examples of such uncertainty. Drastic price fluctuation is another that can be very unsettling, especially when linked to an export commodity on which a country may be heavily reliant. The greater the shock the greater the potential for negative impact on economic performance. Such economic instability, in turn, tends to attract offers of aid. Thus from year to year aid instability is likely to be greater for countries subject to more uncertainty. Measuring uncertainty is not easy, but aid instability is a useful indicator.

Aid instability can affect economic performance in two ways. Firstly, it may indicate that the country is susceptible to economic uncertainty. Secondly, instability can undermine policy and investment. In both cases, and this is supported by empirical analysis, aid instability tends to be associated with lower rates of economic growth.

Principal research findings include indications that:

• uncertainty has a negative association with economic growth: countries with higher levels of aid instability appear to have lower growth rates.
• the level of aid has a positive effect on economic growth, as long as we control for the instability of aid receipts.
• the positive effect of aid on growth arises through a positive effect of aid on investment.
• uncertainty reduces the effectiveness of aid.

Policy implications suggest that:

• aid instability may be a cause of poor policy in recipient countries
• countries susceptible to shocks are more likely to have lower economic growth rates
• aid is less effective in countries susceptible to shock
• stable donor-recipient relationships may improve aid effectiveness
• donors should pay special attention to countries that are vulnerable to uncertainty, especially terms of trade shocks.

Source(s):
Uncertainty of Aid Inflows and the Aid-Growth Relationship, CREDIT Research Paper > 9/3, University of Nottingham, by R. Lensink and O. Morrissey, 1999 > Full document.

Funded by: Department for International Development, UK

id21 Research Highlight: 13 August 1999

Further Information:
Oliver Morrisey
Centre for Research in Economic Development and International Trade
School of Economics
University of Nottingham
Nottingham
NG7 2RD
UK

Tel: +44 (0)115 951 5475
Fax: +44 (0)115 951 4159
Contact the contributor: oliver.morrissey@nottingham.ac.uk

University of Nottingham

DSA Conference 1999

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