Dutch Disease and Foreign Aid

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.