Vulnerability, aid and accelerated growth

UNU-WIDER / Aug 2012

In the recent UNU-WIDER working paper 'Aid and Growth Accelerations: Vulnerability Matters' Patrick Guillaumont and Laurent Wagner aim to address the shortcomings they see in the current literature on growth accelerations, periods where growth speeds up, and the relationship between aid and growth. The literature on growth acceleration fails to take into account both the role aid inflows may play in prompting and sustaining growth episodes and the influence a country’s vulnerability may have on these episodes. The aid-growth literature does not adequately capture the dynamic relationship aid has on growth; if aid is successful in promoting growth it will gradually become redundant.

To fill this hole in the existing literature the authors formulate and test two hypotheses:

1. Aid can have a positive (catalytic) effect on the launching of growth episodes, as well as their duration.
2. This effect will be more significant in countries that have faced intense exogenous shocks.

The aid-growth relationship: a dynamic perspective

Important progress has been made on research into the relationship between aid and growth, as evidenced by the paper 'Aid Growth and Development: Have We Come Full Circle' by Arndt, Jones, and Tarp which reviews the literature and finds that aid does have statistically significant causal effect on growth. However, most models of this relationship still fail to capture its dynamic nature. If aid is successful in promoting sustained economic growth then over time it should become redundant. A country that is experiencing a growth episode, perhaps prompted partly by aid, is less likely to have its growth further increased by aid and so the impact of this assistance may begin to appear neutral or even negative.

The fact that some of the world’s fastest growing economies do not receive aid is sometimes pointed to as evidence of aid not being an effective tool in spurring growth. However if aid has the identified dynamic effect this can be looked at in another way. The question then becomes whether these countries previously received aid and whether that aid contributed to launching their growth.

It is interesting to note that while much literature exists on the topic of growth acceleration very little attention has been paid to the role that aid plays in them. The authors set out to rectify this and assess both whether aid has contributed to launching growth and whether aid effects the duration of a growth episode.

Vulnerability as an obstacle to growth accelerations: how it can be reduced with aid

Despite considerable evidence that vulnerability is an obstacle to growth this issue has not been addressed in depth in the growth acceleration literature. However it has been argued in the aid-growth literature that development aid will have a greater impact in countries with vulnerable economies due to aid's stabilizing impact. The stability aid provides leads to shocks having a less negative impact on growth than they would otherwise. This stabilizing impact may well also increase the likelihood of growth episodes.

Results

The authors' findings provide support for both of their initial hypotheses:

1. Aid has an impact on both the probability of occurrence of growth spells and the durations of these spells.

Guillamont and Wagner found that the impact of aid on the probability of growth occurrences was particularly significant in countries where an increase in aid leads to a large increase in the ratio of aid to GDP. The impact was less significant in countries which had been receiving high and stable level of aid over a number of years. Thus there is a double impact; both the level of aid and the rate at which aid is increased are important determinants of aids impact on periods of growth.

2. This double impact is higher in countries that are structurally vulnerable, as indicated by the Economic Vulnerability Index.

Aid considered alone does not have a significant impact on the duration of growth episodes. However when combined with a countries exposure to shocks the impact is significant. Both the exposure to shocks and the size of the shocks have a positive effect on the likelihood of a country experiencing a growth episode but only exposure is relevant when considering the duration of such an episode.

Guillamont and Wagner point out that their results should encourage policy makers to use an index of vulnerability, such as EVI, as a criterion for aid allocation: structural vulnerability reflects not only the need for assistance––a handicap to be compensated––but it is also a factor of aid effectiveness. They conclude by suggesting that further research is needed in two directions. First, more work needs to be done on the technical definition of aid. Second, and more importantly, the author suggests a more detailed study of the dynamics of the aid-growth relationships is needed. Such a study would focus on the channels through which aid can help to launch and sustain growth in such a way that this growth can continue after the withdrawal of aid. The UNU-WIDER paper 'Aid Effectiveness: Opening the Black Box' does an excellent job addressing some of these issues.

This report by James Stewart summarizes UNU-WIDER working paper no. 2012/31, 'Aid and Growth Accelerations: Vulnerability Matters' by Patrick Guillaumont and Laurent Wagner.