International Aid, Policy Transfer and Local Economic Development in North Montenegro

Early attempts to theorize the relationship between international aid and economic growth of poor countries assumed that aid inflows would fill a savings ‘gap’ and would lead to increased levels of investment that would boost growth and lift poor countries out of underdevelopment and poverty. In the 1990s a number of empirical studies cast doubt on this optimistic picture and appeared to show that there was little relationship between aid and economic growth (Boone 1996). This was explained by the argument that aid donations tend to be converted into higher public or private consumption rather than being channeled into increased investment. Subsequently, Burnside and Dollar (2000) showed that the effect of aid on growth depended on the macroeconomic policies of the recipient countries. In countries with ‘good’ fiscal, monetary and trade policies, aid was shown to have a positive effect on growth. This gave rise to the argument that aid should be targeted on countries that followed so-called ‘good’ policies. As Easterly (2003) has shown, donor governments have adopted this framework to target growth where it is expected to be most effective. Critics of the approach have argued that there are diminishing returns to aid even in countries which pursue good policies (Dalgaard and Hansen 2001; Hansen and Tarp 2001). This implies that even where good policies are adopted, there is a point beyond which aid loses its effectiveness.