Chapter 15 Infrastructure Aid and Deindustrialization in Developing Countries

Purpose – This chapter investigates the role of infrastructure aid to developing countries for determining the effect on national income and consumer welfare. The chapter further demonstrates the conditions for the Dutch disease effect by decomposing the output effects of infrastructure aid into the initial factor-saving effect, factor-substitution effect and nontraded good effect. Methodology/approach – This chapter extends the Heckscher−Ohlin model to a 3×2 case with two traded goods and a nontraded good, and derives comparative static results on factor prices, the price of nontraded goods, foreign exchange rate, sectoral outputs, and national income and consumer welfare. Findings – It is shown that for a recipient country, infrastructure aid to either the export or import sector necessarily raises national income and consumer welfare, whereas the same aid to the nontraded good sector does not affect national income but raises consumer welfare. Infrastructure aid may lead to a Dutch disease effect via its three effects on industrial outputs: the initial factor-saving effect, factor-substitution effect and nontraded good effect. Research limitations/implications – This chapter considers infrastructure capital as a public input, but it is devoid of analysis of inter-industrial spillover effects that the infrastructure capital generates to other sectors. Practical implications – This chapter reveals several aspects of infrastructure aid that the practitioners of aids must consider.