Promises, Promises: Aid Volatility and Economic Growth

Empirical contributions show that there is robust statistical evidence that aid volatility tends to have an adverse effect on economic growth. However, the channels through which such volatility operates have not been fully articulated in endogenous growth models. Dwelling on a recent analytical contribution, this brief describes how, by creating uncertainty about the net return to education, a high degree of aid volatility can mitigate agents' incentives to invest in skills. If savings and growth depend on the composition of the labor force, and if more skilled workers are more productive, aid volatility may therefore have an adverse effect on the average growth rates of investment and output.This Policy Brief is based on Agénor (2016), whose contribution is part of a research project which received financial support from the DFID-ESRC Growth Research Programme, under Grant No. ES/ L012022/1. The paper, and other contributions to the project, can be also downloaded at http://www.socialsciences.manchester.ac.uk/subjects/economics/our-research/cgbcr/esrc-dfid-project/.