External Aid: Help or Hindrance to Export Orientation in Africa?

The central proposition of this paper is that African countries should start thinking through undertaking an orderly transition from the current high dependence on foreign aid for financing economic and social development. Aid dependency should be reduced not because the international development community believes it will eventually happen, but because such dependence on foreign aid could substantially impair Africa's export competitiveness and therefore derail the Continent export-oriented development strategies. A combination of further debt relief, reforms of the current aid regime and enhanced policy environment should allow a managed transition to a mixed menu of official development assistance (ODA) and private capital flows. However, the attempt by Africa to increase its share of investments from international private capital markets should be firmly anchored to the basic tenets of an export-based development strategy. To provide the basis for these policy conclusions, I estimate the relationship between ODA, real exchange rates (RER) and non-traditional exports for a panel of 62 developing countries, including 28 from Africa. Unsustainable ODA flows were shown to have caused substantial partial RER overvaluation in many African and non-African countries. Moreover, exceptionally high aid-dependent African countries have either experienced, or are likely to experience, overall RER overvaluation. Conditional on absence of RER overvaluation--a proxy for good policy environment of relevance to export performance--a robust Laffer curve-type relationship exists between aid and non-traditional exports through the misalignment of RER relative to its equilibrium. The Laffer curve relationship justifies a "precise" concept of aid dependency, based on the extent to which excessive ODA flows exceeded the threshold beyond which more ODA actually hinders rather than helps export expansion. According to this concept, several African countries were characterised as being "aid dependent". Copyright 1999 by Oxford University Press.