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Aid Volatility and Poverty Traps

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Author Info
Pierre-Richard Agénor
Joshua Aizenman

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Abstract

This paper studies the impact of aid volatility in a two-period model where production may occur with either a traditional or a modern technology. Public spending is productive and "time to build" requires expenditure in both periods for the modern technology to be used. The possibility of a poverty trap induced by high aid volatility is first examined in a benchmark case where taxation is absent. The analysis is then extended to account for self insurance (taking the form of a first-period contingency fund) financed through taxation. An increase in aid volatility is shown to raise the optimal contingency fund. But if future aid also depends on the size of the contingency fund (as a result of a moral hazard effect on donors' behavior), the optimal policy may entail no self insurance.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13400.

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Date of creation: Sep 2007
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Handle: RePEc:nbr:nberwo:13400

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Find related papers by JEL classification:
F35 - International Economics - - International Finance - - - Foreign Aid
H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures
O19 - Economic Development, Technological Change, and Growth - - Economic Development - - - International Linkages to Development; Role of International Organizations

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  1. Stéphane Pallage & Michel A. Robe & Catherine Bérubé, 2004. "On the Potential of Foreign Aid as Insurance," Cahiers de recherche 0404, CIRPEE. [Downloadable!]
  2. John Hudson & Paul Mosley, 2007. "Aid Volatility, Policy and Development," Working Papers 2007015, The University of Sheffield, Department of Economics, revised Oct 2007. [Downloadable!]
    Other versions:
  3. Pierre-Richard Agénor & Devrim Yilmaz, 2008. "Aid Allocation, Growth and Welfare with Productive Public Goods," Centre for Growth and Business Cycle Research Discussion Paper Series 95, Economics, The Univeristy of Manchester. [Downloadable!]
  4. Chatterjee, Santanu & Sakoulis, Georgios & Turnovsky, Stephen J., 2003. "Unilateral capital transfers, public investment, and economic growth," European Economic Review, Elsevier, vol. 47(6), pages 1077-1103, December. [Downloadable!] (restricted)
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  5. Cristina Arellano & Aleš Bulir & Timothy D. Lane & Leslie Lipschitz, 2005. "The Dynamic Implications of Foreign Aid and Its Variability," IMF Working Papers 05/119, International Monetary Fund. [Downloadable!]
    Other versions:
  6. Santanu Chatterjee & Stephen J. Turnovsky, 2005. "Financing Public Investment through Foreign Aid: Consequences for Economic Growth and Welfare," Review of International Economics, Blackwell Publishing, vol. 13(1), pages 20-44, 02. [Downloadable!] (restricted)
  7. Alberto Chong & Mark Gradstein, 2006. "Policy Volatility and Growth," RES Working Papers 4481, Inter-American Development Bank, Research Department. [Downloadable!]
  8. Kyriakos C. Neanidis & Dimitrios Varvarigos, 2007. "The Allocation of volatile aid and economic growth: Evidence and a suggestive theory," Discussion Paper Series 2007_07, Department of Economics, Loughborough University, revised Mar 2007. [Downloadable!]
  9. Pierre-Richard Agénor, 2006. "A Theory of Infrastructure-led Development," Centre for Growth and Business Cycle Research Discussion Paper Series 83, Economics, The Univeristy of Manchester. [Downloadable!]
  10. Stefan C. Norrbin & F. Pinar Yigit, 2005. "The Robustness of the Link between Volatility and Growth of Output," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 141(2), pages 343-356, July. [Downloadable!] (restricted)
  11. Fielding, David & Mavrotas, George, 2005. "The Volatility of Aid," Working Papers DP2005/06, World Institute for Development Economic Research (UNU-WIDER). [Downloadable!]
  12. Bekaert, Geert & Harvey, Campbell R. & Lundblad, Christian, 2006. "Growth volatility and financial liberalization," Journal of International Money and Finance, Elsevier, vol. 25(3), pages 370-403, April. [Downloadable!] (restricted)
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  13. Turnovsky, Stephen J. & Chattopadhyay, Pradip, 2003. "Volatility and growth in developing economies: some numerical results and empirical evidence," Journal of International Economics, Elsevier, vol. 59(2), pages 267-295, March. [Downloadable!] (restricted)
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  14. Philippe Aghion & George-Marios Angeletos & Abhijit Banerjee & Kalina Manova, 2005. "Volatility and Growth: Credit Constraints and Productivity-Enhancing Investment," NBER Working Papers 11349, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  15. Blackburn, Keith & Pelloni, Alessandra, 2004. "On the relationship between growth and volatility," Economics Letters, Elsevier, vol. 83(1), pages 123-127, April. [Downloadable!] (restricted)
  16. Pierre-Richard Agénor, 2006. "A Theory of Infrastructure-led Development," The School of Economics Discussion Paper Series 0640, Economics, The University of Manchester. [Downloadable!]
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