## What Undermines Aid’s Impact on Growth?

_IMF Working Papers, June 1, 2005_

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## Bibliographic details
- Authors: Arvind Subramanian, Raghuram Rajan
- Published: June 1, 2005
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451861457.001

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### Summary
- Authors: Arvind Subramanian, Raghuram Rajan
- Date: June 1, 2005
- Core question: Why is it hard to find a robust effect of aid on the long-term growth of poor countries, even those with good policies?
- Approach: Exploits both cross-country and within-country variation to search for offsets to the beneficial effects of aid.

### Key findings
- Aid inflows have systematic adverse effects on a country's competitiveness.
- Manifestation: A decline in the share of labor intensive and tradable industries in the manufacturing sector.
- Evidence suggests these adverse effects stem from the real exchange rate overvaluation caused by aid inflows.
- Private-to-private flows like remittances do not seem to create these adverse effects.
- The paper offers an explanation for the difference between aid and remittances and concludes with policy implications.

### Methodology (brief)
- Utilizes variation across countries and within countries to isolate the effects of aid inflows on sectoral composition and competitiveness.

### Mechanism identified
- Real exchange rate overvaluation caused by aid inflows is the likely channel through which aid undermines competitiveness.
- Resulting sectoral impact: lower share of labor-intensive and tradable manufacturing industries.

### Comparison: Aid versus Remittances
- Aid inflows: associated with real exchange rate overvaluation and adverse effects on competitiveness and manufacturing composition.
- Remittances (private-to-private flows): do not exhibit the same adverse effects on competitiveness or sectoral shares.

### Policy implications (as discussed in the paper)
- Need to recognize and address the competitiveness effects of aid-induced real exchange rate overvaluation.
- Policy responses should account for differential impacts of public aid versus private transfers (remittances) on tradable and labor-intensive sectors.
- The paper concludes with a discussion of specific policy implications based on the identified mechanism.

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