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The New Palgrave Dictionary of Economics pp 3116–3124Cite as

Palgrave Macmillan

Dutch Disease and Foreign Aid

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Abstract

Academic and policy debates on aid effectiveness frequently emphasise the vulnerability of recipients to the Dutch Disease, through which aid inflows appreciate the real exchange rate, thereby taxing the tradable export sector with potentially deleterious effects on growth. Fear of the Dutch Disease is remarkably pervasive, even though there is little decisive evidence that aid-induced Dutch Disease effects are either large or widespread amongst poor countries, at least against most plausible counterfactuals. The lack of strong evidence reflects a variety of factors, including problems of measurement, but is primarily due to the fact that aid flows are often purposive – designed to address pre-existing distortions in the recipient economy – and are accompanied by policy measures specifically designed to mitigate latent Dutch Disease effects. Although the conventional macroeconomic transmission channels may therefore be weak, the language of the Dutch Disease continues to be used as a metaphor for the wide range of political economy concerns associated with aid surges.

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Notes

  1. 1.

    Traded goods, consisting of importables and exportables are those goods produced and consumed in world markets. Domestic demand and supply conditions therefore have no impact on the (world) price of tradables. Non-tradable or domestic goods, on the other hand are only produced locally; their price is determined by domestic market conditions. By definition, donor aid can only consist of traded goods (e.g. food aid) or a claim over traded goods (i.e. a dollar flow of aid).

  2. 2.

    On the link between aid and (legal and illegal) capital flight see Ndikumana and Boyce (2003).

  3. 3.

    If aid flows are temporary a high rate of (official) saving may be consistent with efficient expenditure smoothing. But see Buffie et al. (2010) on how ‘use it or lose it’ constraints on aid flows affect recipients’ monetary and fiscal policy choices.

  4. 4.

    These are, of course, relative growth rates; without controlling for the relative size of sectors it is not possible to infer the impact on aggregate output growth.

  5. 5.

    Very similar models appear in Torvik (2001), Agénor et al. (2008), and Berg et al. (2010).

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Acknowledgments

I thank Radhika Goyal for excellent research assistance and the Oppenheimer Fund of the Department of International Development, University of Oxford for financial support.

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  1. http://link.springer.com/referencework/10.1057/978-1-349-95121-5

    Christopher Adam

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Adam, C. (2018). Dutch Disease and Foreign Aid. In: The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-349-95189-5_2864

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