Donor ideology and types of foreign aid

We examine how donor government ideology influences the composition of foreign aid flows. We use data for 23 OECD countries over the period 1960–2009 and distinguish between multilateral and bilateral aid, grants and loans, recipient characteristics such as income and political institutions, tied and untied aid, and aid by sector. The results show that leftist governments increased the growth of bilateral grant aid, and more specifically grant aid to least developed and lower middle-income countries. Our findings confirm partisan politics hypotheses because grants are closely analogous to domestic social welfare transfer payments, and poverty and inequality are of greatest concern for less developed recipient countries.     

Trade elasticity of substitution and equilibrium dynamics

The empirical literature provides a wide range of estimates for trade elasticities at the aggregate level. Recent contributions in international macroeconomics suggest that low (implied) values of the trade elasticity may play an important role in understanding the disconnect between international prices and real variables. However, a standard model of the international business cycle displays multiple locally isolated equilibria if the trade is sufficiently low. The main contribution of this paper is to compute and characterize some dynamic properties of these equilibria. In simulations, the presence of multiple equilibria is shown to imply a volatile and persistent real exchange rate.     

The effect of foreign aid on corruption: A quantile regression approach

This paper investigates the effect of foreign aid on corruption using a quantile regression method. We show that foreign aid generally reduces corruption, and its reduction effect is greater in less corrupt countries. Moreover, this effect is different by different donor countries.     

The impact of the Interaction between institutional quality and aid volatility on growth: theory and evidence

We analyze both theoretically and empirically, the effect of aid volatility and its interaction effect with institutional quality on per capita economic growth. Our theoretical model, in which an aid-recipient government, operating in an institutional environment of some given quality (making choices over the distribution of aid), predicts that a negative effect of aid volatility on growth is mitigated by stronger institutional quality. We use panel data covering the period 1984–2004 for 78 countries to test this theoretical prediction. Using Generalised Methods of Moments (GMM) we find the relationship between growth and aid volatility is significantly negative and depends on institutional quality. Our baseline results are robust to various computations of aid volatility and foreign aid, time periods, sub-samples and additional covariates.     

Changing aid regimes? U.S. foreign aid from the Cold War to the War on Terror

This paper explores how U.S. bilateral economic aid has changed over time, focusing on how the recent era-in which the War on Terror has played a prominent role in the Bush administration's aid policy-differs from previous eras. In particular, has the renewed geopolitical role of aid coincided with a reduction of aid to the poorest countries or less weight on need in U.S. aid allocation decisions? We start with an analysis of annual U.S. aid budgets from 1955 to 2006. Controlling for domestic political and economic conditions, we find that the War on Terror's effect on the aid budget is significantly larger than is immediately apparent. To explore how the emphasis on need may have changed over time, we use country-level panel data on aid allocations to 119 countries across the same time period. This shows that U.S. aid flows-for the poorest as well as other developing countries-increased with the War on Terror. However, after rising for 35 years, the emphasis placed on need has been falling steadily for core aid recipients during the War on Terror.     

The coordination channel of foreign exchange intervention: A nonlinear microstructural analysis

Taylor (1994, 1995) [Taylor, M.P., 1994. Exchange rate behaviour under alternative exchange rate regimes. In: Kenen, P. (Ed.), Understanding Interdependence: The Macroeconomics of the Open Economy. Princeton University Press, Princeton; Taylor, M.P., 1995. The economics of exchange rates. Journal of Economic Literature 33, 13-47] has proposed the coordination channel as a means by which foreign exchange market intervention may be effective, in addition to the traditional portfolio balance and signalling channels. If strong and persistent misalignments of the exchange rate are caused by nonfundamental influences, such that a return to equilibrium is hampered by a coordination failure among fundamentals-based traders, then official intervention may act as a coordinating signal, encouraging stabilising speculators to re-enter the market at the same time. We develop this idea in the framework of a simple microstructural model of exchange rate movements, which we then estimate using daily data on the dollar-mark exchange rate and on Federal Reserve and Bundesbank intervention operations. The results are supportive of the existence of a coordination channel of intervention effectiveness.     

On the provision of official and private foreign aid

The provision of official relative to private foreign aid varies considerably between donor countries. We explain the variations in terms of country size, household composition, income distribution, and the government's ability to commit to aid, and derive inter alia the results: (1) official aid crowds out private aid, (2) total aid and official aid collected from each household are lower in more populous countries, (3) total aid is lower if (i) the distribution of income favors the more altruistic households, and (ii) the government can credibly commit to a certain level of aid. Evidences suggest that the theoretical results can explain stylized facts.     

Measuring absorptive capacity constraints to foreign aid

To assist with progress towards the United Nations Millennium Development Goals (MDGs) in developing countries, the international community is scaling-up foreign aid to record levels. Concurrently, there are concerns that additional aid will not be used effectively due to a problem of absorptive capacity in recipient countries. Empirical studies lend support to these concerns with many finding that there are diminishing returns to foreign aid. This paper reviews the extensive aid effectiveness literature to identify the various dimensions of absorptive capacity. It proceeds by devising a composite index of absorptive capacity for individual recipient countries which can assist policymakers in guiding the allocation of their aid. The relevance of the index is confirmed through its employment in a standard empirical model of aid effectiveness. The paper highlights the developing countries that currently receive high levels of aid relative to their estimated level of absorptive capacity.     

Company interests and foreign aid policy: Playing donors off against one another

The evidence on conditionality indicates that this instrument sometimes works, and sometimes does not work. We suggest that third parties to the donor-recipient relationship influence the aid disbursement. The halt in aid that should follow non-compliance could trigger the recipient to cancel contracts with companies from donor countries, which creates incentives for the companies to put pressure towards aid disbursement. We use a multi-agent triadic model of the relationships between a recipient and two donors and two companies to illustrate that recipients may act strategically to make third parties (like companies and others) influence the disbursement decision. Failing to take account of third parties’ role yields the opposite result; conditionality becomes successful.     

In or out? The welfare costs of EMU membership

Sweden and the UK have repeatedly refused to join the European and Monetary Union (EMU). Surprisingly, there is very little work on the welfare consequences of the loss of monetary policy flexibility for these countries. This paper fills this void by providing a framework to evaluate quantitatively the economic costs of joining the EMU. Using a two-country dynamic general equilibrium model with sticky prices we investigate the economic implications of the loss of monetary policy flexibility associated with the EMU for each country. The main contribution of our general equilibrium approach is that we can evaluate the effects of monetary policy in terms of welfare. Our findings suggest that these economies may experience sizable welfare losses as a result of joining the EMU. Results show that the cost associated with the loss of the monetary policy flexibility is higher in the presence of persistent government consumption shocks and small trade shares with the EMU.     

What determines foreign aid? The donors' perspective

This paper examines the factors affecting the support for foreign aid among voters in donor countries. A simple theoretical model, which considers an endogenous determination of official and private aid flows, relates individual income to aid support and also suggests that government efficiency is an important factor in this regard. The empirical analysis of individual attitudes, based on the World Values Surveys, reveals that satisfaction with own government performance and individual relative income are positively related to the willingness to provide foreign aid. Furthermore, using actual donor country data we find that aid is adversely affected by own government inefficiency.     

Aiding violence or peace? The impact of foreign aid on the risk of civil conflict in sub-Saharan Africa

This paper considers the impact of foreign aid flows on the risk of civil conflict. We improve on earlier studies on this topic by addressing the problem of the endogenous aid allocation using GDP levels of donor countries as instruments. A more structural addition to the literature is that we efficiently control for unobserved country specific effects in typical conflict onset and conflict continuation models by first differencing. The literature often overlooks the dynamic nature of these types of models, thereby forcing unlikely i.i.d. structures on the error terms implicitly.¹ As a consequence, malfunctioning institutions, deep-rooted political grievances, or any other obvious, yet unobserved and time persistent determinants of war are simply assumed away. We find a statistically significant and economically important negative effect of foreign aid flows on the probability of ongoing civil conflicts to continue (the continuation probability), such that increasing aid flows tends to decrease civil conflict duration. We do not find a significant relationship between aid flows and the probability of civil conflicts to start (the onset probability).     

Does exchange rate variability matter for welfare? A quantitative investigation of stabilization policies

This paper studies what degree of exchange rate stabilization is optimal for several types of open economies. This is accomplished through a quantitative evaluation of optimal monetary policy rules in a two-country sticky-price model. First, a calibrated benchmark model with incomplete asset markets supports past conclusions from simpler models, emphasizing inflation stabilization rather than exchange rate stabilization. It also highlights that the utility gains from optimal stabilization policy are small. Second, while an economy extended to include consumer habits implies greater sensitivity by households to consumption variability, it has only minor effects on the benchmark conclusions and benefits. Finally, these conclusions are altered under an alternative environment where international asset markets exhibit asymmetry in the form of “original sin.” Such countries can benefit from policies that aggressively stabilize the exchange rate, with utility gains larger than the previous cases.     

Modeling services liberalization: The case of Kenya

This paper employs a 55 sector small open economy computable general equilibrium model of the Kenyan economy to assess the impact of the liberalization of regulatory barriers against foreign and domestic business service providers in Kenya. The model incorporates foreign direct investment in business services and productivity effects in imperfectly competitive goods and services markets endogenously, through a Dixit–Stiglitz framework. The ad valorem equivalent of barriers to foreign direct investment have been estimated based on detailed questionnaires completed by specialists in Kenya. We estimate very substantial gains to Kenya from regulatory liberalization in business services, and additional gains from uniform tariffs. The estimated gains increase to 50% of consumption in the long run steady state model, where the impact on the accumulation of capital from an improvement in the productivity of capital is taken into account. Decomposition exercises reveal that the largest gains to Kenya will derive from liberalization of costly regulatory barriers that are non-discriminatory in their impacts between Kenyan and multinational service providers.     

Sub-national differentiation and the role of the firm in optimal international pricing

We illuminate the relationship between optimal firm pricing and optimal trade policy by exploring a generalized model that accommodates product differentiation at both the national and sub-national (firm) levels. We assume monopolistic competition in the differentiated products at the sub-national level. When the national and sub-national substitution elasticities are similar we find little opportunity for small countries to improve their terms of trade through trade distortions, because firms play an important preemptive role in optimally pricing unique varieties. We contrast this with standard applications of perfect-competition Armington models, which exhibit high optimal tariffs—even for relatively small countries.     

The U.S. trade imbalance and real exchange rate: An application of the heterogeneous panel cointegration method

The United States economy suffers from persistent trade deficits, arising from the so-called ‘global external imbalance’. Can the depreciation of the US dollar improve this phenomenon? This study for the first time applies the heterogeneous panel cointegration method to examine the long-run relationship between the real exchange rate and bilateral trade balance of the U.S. and her 97 trading partners for the period 1973–2006. Using new annual data, the empirical results indicate that the devaluation of the US dollar deteriorates her bilateral trade balance with 13 trading partners, but improves it with 37 trading partners, especially for China. In the panel cointegrated framework, a long-run negative relationship between the real exchange rate and the bilateral trade balance exists for the U.S.     

Economic and environmental impacts of trade liberalization: The case of Indonesia

In recent years, there has been a growing interest in the environmental impacts of trade liberalization. This paper provides further discourse in this area with a study on Indonesia and its trade agreements with Japan (IJEPA) and ASEAN (AFTA). A static global CGE model, known as the Global Trade Analysis Project, was used to project the Indonesian economy to the year 2022, with and without tariff reforms agreed under the agreements. Environmental impacts are assessed using different pollution indicators—air, water and waste. The study suggests that Indonesia would grow rapidly over the period considered with a large deterioration in its environment. Following these, however, the agreements only have a marginal positive impact on Indonesia's output but with a noticeable increase in trade flows and signs of trade diversion. Overall AFTA has a greater impact on the Indonesian economy compared to IJEPA. Similarly, the impact of trade liberalization on the environment is marginal. On the whole, tariff reform is inducing air pollution and reducing water pollution. In conclusion, the study suggests that Indonesia's participation in the AFTA and IJEPA agreements is not likely to bring drastic changes to her economic and environmental performance.     

The behaviour of relative prices in the European Union: A sectoral analysis

Using multivariate unit root test methods, this paper investigates the Purchasing Power Parity (PPP) hypothesis at the sectoral level across six European countries over the last 17 years. Evidence of mean reversion towards PPP is found for the relative prices of some sectors and countries. Mean reversion in relative prices is explained by cross-country and cross-sectoral characteristics such as the distance between countries, nominal exchange rate volatility, differences in GDP per capita, non-tariff barriers, research and development, advertising, industrial concentration and tradeability of the products.     

The business cycle implications of the euro adoption in Poland

This article analyses the macroeconomic impact of the loss of autonomous monetary policy after the euro adoption in Poland. Using a two-country Dynamic Stochastic General Equilibrium (DSGE) model with sticky prices and wages, we find that the euro adoption will have a noticeable impact on the magnitude of economic fluctuations. In particular, the volatility of output, interest rate, consumption and employment is expected to increase while the volatility of inflation should decrease. Also, in order to quantify the effect of the euro adoption, we compute the welfare effect of this monetary policy change. Our findings suggest that the welfare cost is not large.     

Income and consumption smoothing and welfare gains across Pacific Island Countries: The role of remittances and foreign aid

We examine the potential welfare gains and channels of income smoothing for Pacific Island Countries (PICs) and find that, under full risk sharing overall welfare gains across all PICs (particularly, Kiribati, Palau, and Papua New Guinea) are at desirable levels. However, for Australia, the potential welfare gain from risk sharing is almost similar to the gain it obtains if Australia attains full risk sharing with the rest of the OECD countries or with New Zealand alone. We also break down output using the framework of Sørensen and Yosha (1998) to quantify the extent and channels of risk sharing across PICs. For PICs, income-smoothing channels (net factor income and current transfers) play a significant role in buffering the output shock compared to the performance of those channels on smoothing the output shock for OECD countries. Domestic savings also smooth a fair portion of shocks to output, but the extent is much lower compared to that of OECD countries. Further, we analyze the effect of remittances and foreign aid on income smoothing for the PICs excluding Australia and New Zealand. Income smoothing via remittances is highly volatile and significant in recent years, while foreign aid seems to be a stronger and more stable channel for smoothing domestic output shocks for PICs.