Volatility of Development Aid: From the Frying Pan into the Fire?

Abstract

Summary The paper, building on the authors’ previous analysis, examines the relative volatility of aid flows into developing countries and their domestic revenue, using new data, and three alternative measures of aid instability (relative volatility vis-a-vis fiscal revenue, unpredictability of aid disbursement relative to commitments, and failure of aid to smooth fluctuations in aggregate income). It finds that the volatility of aid flows is still much greater than that of domestic revenue and that this difference is not decreasing. Especially in very poor, aid-dependent countries, this high volatility of inflows makes the macroeconomy hard to manage. Further, the influence of aid has been procyclical and not countercyclical: aid has failed to act either as a stabilizing force or as an insurance mechanism. We argue that, to counter these unwelcome trends, donors need to be able to respond more speedily and effectively to large adverse shocks, and their conditionalities need to become more flexible—possibilities explicitly discussed elsewhere in this Special Section.