DO FOREIGN AID AND REMITTANCE INFLOWS HURT COMPETITIVENESS OF EXPORTS OF PACIFIC ISLAND COUNTRIES? AN EMPIRICAL STUDY OF FIJI

Abstract

(ProQuest: ... denotes formulae omitted.)1. INTRODUCTIONSince their independence in the second half of the last century, the Pacific island countries (PICs)1 have been receiving generous foreign aid. Besides supplementing domestic savings, they have been adding to real resources of PICs, as they are in foreign exchange. In recent years, steadily rising inward remittances sent by migrant islanders residing and working in Australia, New Zealand, United States and Europe, have exceeded aid inflows. Aid and remittance flows into PICs have been observed to be relatively more stable and larger in terms of percentages of gross domestic product (GDP) when compared to those of other developing countries.Expectedly, they have been raising concerns whether these inflows are hurting the export competitiveness of the island nations, a phenomenon known as Dutch disease,2 which seems to be responsible for continuing stagnation in export earnings as reflected in their ratios to respective GDPs of the concerned PICs, and generally decreasing trend in export growth rates. Decline in export competiveness is associated with appreciation of currencies, which is identified as one of the side effects of capital inflows.There are a number of publications on PICs, beginning from the path breaking sixvolume study conducted by Hilarian Codipilly of World Bank (1993), which pointed out to the Pacific paradox of plentiful aid with no growth, by attributing to the ineffective use of aid, studies by IMF including Browne (2006) and Avalos (2013) of UN ESCAP (2013). These studies hinted at the possibility of Dutch Disease. However, there has been no definitive empirical study. Most of the empirical studies undertaken so far have been cross-sectional studies employing panel data. They came invariably to an identical conclusion that the results obtained were of ambiguous nature and that occurrence of a Dutch disease was conjectural. These empirical studies include Fielding (2007a, 2007b, 2010), Brown (2008).The reason behind the ambiguous nature of results appears to be due to inadequacies. In the first place, the period studied for countries included in the panel was short; the number of variables chosen for study did not go beyond exchange rate, aid and remittances and inflation, since data on other contingent factors influencing growth process were not available for the same period for all countries concerned. To the best of knowledge of the authors, there is no study undertaken so far of any specific PIC in this regard. This paper seeks to fill the gap by taking up Fiji, which among all PICs, has a fairly longer database offering sufficient scope for an intensive study by focusing on contingent factors as well.The paper is organized on the following lines: whilst the next section presents a brief summary of the literature on the Dutch disease; the third section reviews the trends in aid and remittance inflows received by PICs in general and Fiji in particular; the fourth section outlines the methodology adopted for the empirical investigation; the fifth section reports the results; and the last section presents conclusions with policy implications.2. A BRIEF REVIEW OF LITERATURE ON DUTCH DISEASEOne of the earliest contributions to the literature on the impact of steady inflows of aid was that of Professor Corden (1984). Focusing attention on the effect of capital inflows on domestic relative prices and output, Corden (1984) called the small states as price takers, since prices of all traded goods are fixed in world markets. Therefore, increase in domestic expenditure would result only in the rise of the prices of goods that are not internationally traded. The resultant relative price change would lead to a change in the composition of output, with the traded goods sector contracting. The aggregate output falls, justifying the description of the relative price effect as 'Dutch disease'.Fielding (2007a) explains that in the basic Dutch disease model, the nature of the exchange rate regime makes little difference to the effects of an increase in foreign exchange income. …