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Aid, Nontraded Goods, and the Transfer Paradox in Small Countries
Abstract
This paper constructs a model of the transfer paradox for a small open economy with nontraded goods. It demonstrates that increased production of nontraded goods can change their domestic price so as to offset the otherwise beneficial effect of aid and, under certain conditions, to create a transfer paradox even in a small country. The model is estimated with time-series data for 44 aid-dependent countries for the period 1970-90. The results support the model and show that the nontraded goods expansion effect is more likely to cause immiserization than Harry G. Johnson's (1967) tariff-distorting export-displacement effect.
... In this theory, the productivity differential was the channel. The last one was developed rather recently by Yano and Nugent [1999] to explain how capital inflows and mainly foreign aid can affect the real exchange rate. In this theory, the impact of capital inflows on the allocation between the tradable and non-tradable goods was the channel. ...
... In this theory, the impact of capital inflows on the allocation between the tradable and non-tradable goods was the channel. The transfer problem as a form of the Dutch disease has two channels: The one described by Keynes [1929] and the other described by Yano and Nugent [1999]. We will elaborate on each channel in section II. ...
... In other words, the effects of foreign aid, foreign direct investment, and remittances ultimately depend on the sector that they are spent on. This is consistent with the study by Yano and Nugent [1999]. Empirically, we estimate the key equation in the paper by using recent advances in time series and panel econometrics techniques. ...
This paper studies a form of Dutch disease known as the Transfer problem in developing countries. On the theoretical side, we propose a model which unifies the channel proposed by Keynes (1929), Balassa (1964) and Samuelson (1964), and Yano and Nugent (1999). The real exchange rate dynamic is decomposed in three components: the productivity differential, the terms-of-trade, and international transfer. The effects of international transfer on the real exchange rate depend mainly on the propensity of governments to subsidize the tradable or the nontradable sectors. In the empirical section we take into account the heterogeneity of the sample, the dynamic of the real exchange rate and the non stationary nature of the data. Furthermore, we demonstrate empirically that the channels identified by Balassa, Samuelson and Keynes are the main driving forces of real exchange rate movements in developing countries. The Balassa-Samuelson effect by itself accounts for 57% of RER variations while capital inflows account only for 19% of RER variations. The Transfer problem through capital inflows is not rejected but its impact on RER movements in the LDCs is weak.
... The seminal contribution in this respect is Johnson (1967a) who showed that an exogenous increase in the stock of a domestic resource (as for instance aid tied to this resource) may bring a welfare loss in a tariff ridden small open economy if it exacerbates the overproduction of the tariff protected import competing industry. Recently this analysis was extended by Yano and Nugent (1999), emphasizing the importance of "non-traded goods " effects, meaning an expansion of the non-traded sector entailed by foreign aid . In particular they underline again the possibility of an immiserizing transfer if non-traded goods are net substitute to the tariff ridden importable goods. ...
... In such a case, the decline in the relative price of the non-traded good resulting from the aid-induced expansion of the non-traded sector, tends to reduce the "already too low" level of imports of the recipient economy leading therefore to increased distortions in the economy. Yano and Nugent (1999) then go on presenting empirical evidence suggesting that their "non traded" good effect seems to be more important than the standard Johnson effect in generating the possibility of a welfare worsening impact of foreign aid in small open economies. Schweinberger (2002) extends their analysis by showing how different assumptions about the mobility or immobility of factors across industries effect the sign and magnitude of the Johnson and the non-traded goods effects. ...
The purpose of this paper is to provide a theoretical and empirical background overview of the interactions between aid and foreign direct investment (FDI) policies, and trade flows and policies, taking the perspective of outcomes from the point of view of the recipient developing country. A first element that seems quite robust is the identification of a complementarity between trade and FDI flows and policies. There are theoretical arguments for this and it appears as quite robust in the few empirical papers addressing directly this issue. An important policy implication is however the fact that there is a risk of a two-tier system: between emerging developing countries on the one hand, and less developed economies on the other. The literature so far does not provide straightforward and robust results regarding a complementarity between aid and trade flows. There is though a presumption of the possibility of a complementarity between aid and a policy that would reduce domestic distortions in the developing country (provision of a public good, domestic market reforms).
... Empirical researchers have searched for the Dutch Disease in various ways, corresponding to different links in the argument. Some results on aid dependence and the relative price of nontraded goods, or the share of manufacturing exports in total exports, can be found in Arellano et al. (2009) and Yano and Nugent (1999). The cross-country study by López, Molina, and Bussolo (2008) finds that a surge in worker remittances does indeed cause an appreciation in the real exchange rate. ...
... For more discussion of the transfer problem, see Bhagwati et al. (1985), Bhagwati, Panagariya, and Srinivasan (1998, Chapter 16), Eaton (1989), and Suwa-Eisenmann and Verdier (2007). Yano and Nugent (1999) analyse a model where aid augments the productive potential of either an importcompeting sector or a nontraded sector, in the presence of tariffs. This can lead to a nonclassical, small-country transfer paradox even when world prices are unchanged, using logic similar to the analysis of immiserizing growth. ...
This chapter examines the conditions under which foreign aid will be effective in raising growth, reducing poverty, and meeting basic needs in areas such as education and health. The primary aim is not to draw policy conclusions, but to highlight the main questions that arise, the contributions of the academic literature in addressing them, and the areas where much remains unknown. After describing some key concepts and trends in aid, the chapter examines the circumstances under which aid might transform productivity, and when it can achieve things that private capital flows cannot. The chapter reviews the relevant theory and evidence. Next, it turns to some of the other considerations that might form part of a structural model linking outcomes to aid. These include Dutch Disease effects, the fiscal response to aid, and the important connections between aid and governance, both positive and negative.The second half of the chapter examines when donors should attach conditions to aid. It reviews the debates on traditional policy conditionality, and potential alternatives, including the ideas underpinning the new “partnership” model. This model gives greater emphasis to a combination of autonomy and accountability, for countries where governance is strong. In other cases, donors may seek to attach conditions based on governance reform, and introduce new versions of traditional policy conditionality. The chapter also discusses controversies over the appropriate role of country ownership of aid programs. It goes on to discuss some donor failings, the future roles of randomized trials and evaluation, and the scope for aid to meet basic needs. The chapter ends with a discussion of some of the most innovative ideas for the reform of aid, and a summary of the main conclusions.
... In addition to this, they showed that a transfer can increase or decrease world welfare, thus improving or worsening the welfare of both countries. Yano and Nugent (1999) examined the impact of development aid on the welfare of a small open economy in presence of nontraded goods (as a signi…cant amount of aid is spent on nontraded infrastructures) and demonstrated that welfare paradox can take place. They claimed that the expansion of nontraded sectors can outweigh the bene…ts of aid and therefore could result in welfare paradox. ...
... However, Choi (2003) indicated, in a set up with two factors two tradeable goods and a nontraded good, the terms of trade for a small economy cannot be deteriorated. Thus he claimed that Yano and Nugent (1999) condition on nontraded good sector is not necessary. ...
This paper investigates the impact of foreign aid on foreign investment when foreign aid is used to finance a public consumption good. By formulating and analyzing a three-good general equilibrium model, we show that such foreign aid could crowd out foreign investment, given a factor intensity condition.
... Samuelson (1947) further theoretically proved that as untied aid increases, the welfare of recipients would increase as well. On the other hand, theoretical models of Bhagwati et al. (1983) and Yano and Nugent (1999) state the small country transfer paradox; untied aid may result in the welfare loss of recipients when import tariff is present. As the multifarious relationship between foreign aid and economic development may result from mixed or unknown external forces, this research narrows down the spectrum of both foreign aid and economic development to test the aid effectiveness. ...
Paris Declaration on Aid Effectiveness held in 2005 emphasized the role of Aid for Trade (AFT) on capacity building of developing nations. Past literature showed mixed results regarding the aid effectiveness of foreign aid both theoretically and empirically. To test the impact of foreign aid thoroughly, we first focus on the AFT which purposes are not only stimulating the volume of trade flow but also facilitating the construction of robust infrastructure and environment for developing nations to participate in the global economy independently. Second, we disaggregate bilateral trade into the extensive and intensive margin of international trade to examine whether AFT affects more on the new products traded or incumbent good. Lastly, we conduct Poisson pseudo maximum likelihood (PPML) estimation to control for zero-value observations and possible heteroskedasticity stemming from the sample. With different sample groups, the results indicate that AFT overall benefits the exports of aid recipients. Particularly, AFT from European Union (EU) shows the most considerable and consistent effect on both the new export and incumbent relationships. Furthermore, AFT from the EU facilitates the new export relationship between developing nations with other developing nations, specifically with those without a Free Trade Agreement (FTA) relationship, indicating that the aid from the EU is relatively effective in establishing new trade partners.
... However, a transfer paradox -a situation in which a transfer of endowments between two agents results in a welfare loss for the recipient and a welfare gain for the donor -is well-known among economists. Based on a small open economy model, Yano and Nugent (1999) demonstrate that increased production of nontraded goods can change the domestic price so as to offset the benefits of aid and create such a transfer paradox. Morales (2021) uses an NEG model to show that even a slight income transfer between two symmetric regions may deindustrialize the recipient region and reduce the nominal wages of workers in the recipient region when trade costs of the manufactured goods are low. ...
One of the unsatisfactory aspects of spatial economics is the role ascribed to the agricultural sector. To study how economic activities are impacted by the falling trade costs of manufactured goods, it is convenient to assume that the agricultural sector has only one homogeneous product and that it is traded costlessly. This paper reports how these oversimplified assumptions can be improved and what new results are derived regarding the nonmanufacturing sectors. In particular, we survey how to apply this general-equilibrium approach to clarify the role of trade costs in disclosing some well-known puzzles, including the resource curse, Dutch disease, and transfer paradox.
... This states that foreign aid can be beneficial to a donor and detrimental to a recipient, and this result is mediated by trade ( Martínez-Zarzoso et al. 2014 ). All the more, it is surprising that empirical evidence on this issue is rather limited and has produced conflicting results ( Papanek 1972 ;Bauer 1981 ;Yano and Nugent 1999 ). ...
In this study we compare the impacts of official finance coming from the largest donors of African countries on bilateral trade flows between the donor and the recipient. Applying a gravity model approach, we distinguish between development finance and other official flows. We find that official finance from all the donors stimulates export of goods to Africa, while trade flows in the opposite direction are fostered in the case of China and Europe, but not for the US. Despite some claims in the literature that aid from China aims at securing import of natural resources, we find evidence that countries receiving Chinese aid raise their bilateral export of manufactured goods and not of primary commodities. Finally, while for Europe and the US official flows other than development assistance play a bigger role in shaping trade flows, China primarily uses highly concessional and development oriented flows.
... The theory suggests that sustained international (intergovernmental) transfers to a country (region) may produce negative effects on dynamic sectors such as manufacturing through an increase in the price of non-tradable relative to tradable goods. Empirical studies are consistent with the theory (Yano and Nugent, 1999;Rajan and Subramanian, 2008;Doucouliagos andPaldam, 2009, Rajan andSubramanian, 2011;Papyrakis and Raveh, 2014). 5 Inspired by the Argentine case, where intergovernmental fiscal transfers are among the main sources of regional financing, our paper contributes to both literatures. ...
Freely available (up to 100 downloads) at: https://www.tandfonline.com/eprint/xD6s4SrGWfpB4bWKgnMR/full?target=10.1080/13597566.2017.1333959 *** The effect of changes in the distribution of top-to-bottom intergovernmental transfers on the location of manufacturing production is analysed using a modified version of the footloose capital model. An increase in the share of transfers received by a region increases its share of manufacturing production the larger are transaction costs; the larger is the share of transfers going directly to consumers; the larger is the share of manufacturing consumption vis-à-vis non-tradable consumption; and the easier consumers can substitute among manufacturing varieties. Using data for Argentina for 1983-2005, the empirical analysis appears to support the existence of two distinctive regimes, with smaller/poorer provinces benefiting in terms of the location of manufacturing production as a response to an increase in transfers. Also, for these provinces, the benefits are greater if they are politically aligned with the federal government, especially through the receipt of discretionary transfers. For large/rich provinces, the evidence is less conclusive.
... 19 One problem is that all empirical work in this area is plagued by severe measurement problems, both of the real exchange rate itself and across alternative concepts of tradable and non-tradable goods. 20 Yano and Nugent (1999) find mixed econometric evidence on the relationship between aid, real exchange rates, and the structure of production among a set of 44 aid-dependent countries during . For Uganda, they find that although aid is associated with a depreciation of the shilling rather than appreciation during the period concerned, the non-traded goods sector expanded sufficiently as to give rise to immiserization. ...
Case study for the OECD Policy Dialogue with Non-Members on Aid for Trade: From Policy to Practice, 6-7 November 2006, Qatar. OECD, Paris.
... Elbadawi (1999) presents results from a panel of 62 developing countries (28 of them from Africa). He finds that, apart from the degree of openness, all other variables contribute to the overvaluation of the RER, namely: ratio of ODA to GNP, ratio of net foreign income to GNP, index of productivity, terms of trade, and the ratio of government consumption to GDP. Yano and Nugent (1999) argue that aid flows are associated with an expansion of the non-traded sector, thus explaining the transfer paradox. Mongardini and Rayner (2009) They use fixed-effects as well as Arellano-Bond's GMM estimator. ...
This paper investigates the determinants of the real exchange rate (RER) in Ethiopia. In particular, it assesses whether large capital inflows (e.g. foreign aid and remittances) have an impact on the RER. This empirical exercise tries to improve the current literature in a number of ways: (i) the use of quarterly data provides a larger sample size and enables the modelling of important intra-year dynamics, which should lead to better model specifications; (ii) the use of several cointegration approaches allows interesting methodological comparisons; and (iii) the use of a time series model (Unobserved Components) provides a new empirical approach and a robustness check on the econometric models. The results suggest two main (long-run) determinants of the RER in Ethiopia: trade openness is found to be correlated with RER depreciations, while a positive shock to the terms of trade tends to appreciate the RER. Foreign aid is not found to have a statistically significant impact, while there is only weak evidence that workers’ remittances could be associated with RER appreciations. The lack of empirical support for the Dutch disease hypothesis suggests that Ethiopia has been able to effectively manage large capital inflows, thus avoiding major episodes of macroeconomic instability.
... Elle est aussi cohérente en sens contraire, c'est-à-dire que les économies qui dépendent de l'aide peuvent recevoir des flux massifs d'aide justement parce que le secteur des produits d'exportation y est en déclin. Yano et Nugent (1999) constatent aussi dans leur étude sur le paradoxe du transfert, que les données économétriques sont plutôt contrastées sur la relation entre les flux d'aide, les taux de change réels et la structure de la production sur un échantillon de 44 pays dépendants de l'aide, entre 1970 et 1990. La dépendance à l'égard de l'aide signifie ici que le pays bénéficiaire reçoit plus de 5 % de son PIB par an en aide. ...
... or price rigidities are present. Without either party changing its point of view, Keynes and Ohlin focused on the terms-of-trade effect of a transfer in the presence of non-traded goods, as did the subsequent literature on the transfer problem analyzing non-traded goods, see e.g. McDougall (1965), Samuelson (1971), Chipman (1974), and Jones (1975). Yano and Nugent (1999) analyse the small-country case in which prices of international goods are given. In this case transfer paradoxes can arise if tariffs are introduced as an additional distortion. They show that in practice transfer paradoxes are unlikely in these special cases. This paper presents and investigates the non-traded goods and unemployment co ...
In the famous debate between Keynes and Ohlin on the transfer problem, the interaction between non-traded goods and unemployment complicates the analysis considerably. We analyze these issues using four different models to conclude that Keynes's concern regarding the large burden imposed on Germany was justified. Simultaneously, we show that Ohlin's presumption that a transfer does not affect the donor's terms-of-trade either favourably or unfavourably was also justified. Moreover, Ohlin was also right in asserting that a transfer tends to lower the price of non-traded goods for the donor and raise them for the recipient.
... For example, tariffs distort the importable sector of the economy. In this setting, as shown by Ohyama (1974), Jones (1985) and Yano and Nugent (1999), transfers can lower the recipient's welfare because it aggravates the tariff distortion in the importable sector. ...
In this paper we examine the impact of tied aid on capital accumulation and welfare in the presence of a quota on imports. Using a simulation model we establish that tied aid can lower the relative domestic price of the manufactured good and therefore reduce the stock of capital. In the presence of a strong production externality from capital accumulation and high tying ratio, tied aid may immiserize the recipient country.
... Elle est aussi cohérente en sens contraire, c'est-à-dire que les économies qui dépendent de l'aide peuvent recevoir des flux massifs d'aide justement parce que le secteur des produits d'exportation y est en déclin. Yano et Nugent (1999) constatent aussi dans leur étude sur le paradoxe du transfert, que les données économétriques sont plutôt contrastées sur la relation entre les flux d'aide, les taux de change réels et la structure de la production sur un échantillon de 44 pays dépendants de l'aide, entre 1970 et 1990. La dépendance à l'égard de l'aide signifie ici que le pays bénéficiaire reçoit plus de 5 % de son PIB par an en aide. ...
... First, many tourism services are located on high mountains and long beaches, which are not suitable for agricultural production. Second, Tokarick (2006) suggests that a three-factors-three-goods model is more reasonable than the two-factors-three-goods model employed by Yano and Nugent (1999), who found that aid from one country to another may reduce the recipient's welfare (known as the transfer paradox) by a general equilibrium model incorporating a nontraded good sector. ...
Tourism generates considerable income and employment in host countries and regions, which substantially improves local economies. Meanwhile, the manufacturing sector remains the most important part in regional and national economies. This paper investigates their interdependence through a general-equilibrium analysis. On the one hand, a tourism boom is pro-industrialization because the income generated by tourism attracts more manufacturing firms and, on the other hand, de-industrialization for attracting labour from the manufacturing sector. We clarify conditions of trade balances in three sectors. The welfare analysis clarifies conditions for the smaller country to be better off, and conditions for the equilibrium to be optimal.
... This early literature is referred to by Burnside and Dollar (2000). Further extensions include Yano and Nugent (1999) and Tokarick (2008) ...
While the welfare effect of foreign aid has been extensively analyzed, the impact on the distribution of income has received less attention. At the same time, there has been recent work on tourism where it is complementary to aid in improving welfare. By combining these two strands, this paper concentrates on wage inequality in developing countries. We find that an increase in aid in the form of tied aid can lower the relative price of nontraded goods. The rent extracted from tourists declines, reducing welfare of domestic residents. In addition, the fall in the nontradable price can widen the wage inequality between skilled and unskilled workers. Thus, increased foreign aid may have detrimental effects on national welfare and the distribution of income. Rising wage inequality is confirmed by numerical simulations. Copyright © 2010 Blackwell Publishing Ltd.
Professor Ronald W. Jones is one of the greatest general equilibrium theorists, who has illustrated the economic force underlying a general equilibrium adjustment in a very elegant manner. With his friendly personality, at the same time, he has made an enormous contribution to Asian Pacific economic research and the formation of a strong network of economists in our region. This essay intends to explain what I think of as the essence of his economics and his contributions to Asia Pacific economics.
This paper studies the effect of income transfers on the distribution of economic activity through a modified FE model. The model incorporates some key features of the Dutch disease literature: sectorial mobility and non-tradable goods. If foreign competition is high (high trade openness), transfers could cause a Dutch disease in the short and long runs. For intermediate levels of foreign competition, Dutch disease appears only in the short run. And, for low levels, the recipient region always benefits from the income transfers. Additionally, when economies of scale are large, the transfers could perpetuate a core–periphery structure.
In this chapter, we consider the neutrality theorem in the presence of public inputs with positive spillover effects. We use a model consisting of two regions, two tradable goods, two primary factors of production, and public inputs to analyze the effects of an interregional transfer that takes the form of the primary factors of production. In this setting, Warr’s neutrality theorem does not fully hold. Although the total provision of public inputs is independent of the distribution of primary factors, the transfer of primary factors may change the welfare level. Furthermore, the possibility of the transfer paradox cannot be excluded. In addition, we show that a Pareto-improving redistribution of the primary factors is possible even if only one region is a non-contributor.
The transfer paradox describes the situation in which transfers of initial endowments within competitive market make the donor better off and (or) the recipient worse off. Advantageous redistribution, strong transfer paradox, and Chichilnisky paradox are the three cases of the transfer paradox in a stable equilibrium, wherein each case produces a different welfare outcome. This paper shows that the three paradoxes are concretely related by applying Kaldor welfare measure.
This chapter analyses links between budget and external deficits with reference to the dependent economy approach based on the dichotomy between internationally tradable and non-tradable goods and services.
Many low-income countries need to substantially increase expenditure to meet universal coverage goals for essential health services but, because they have very low-incomes, most will be unable to raise adequate funds exclusively from domestic sources in the short to medium term. Increased aid for health will be required. However, there has long been a concern that the rapid arrival of large amounts of foreign exchange in a country could lead to an increase in inflation and loss of international competitiveness, with an adverse impact on exports and economic growth, an economic phenomenon termed 'Dutch disease'. We review cross-country and country-level empirical studies and propose a simple framework to gauge the extent of macroeconomic risks. Of the 15 low-income countries that are increasing aid-financed health spending, 7 have high macroeconomic risks that may constrain the sustained expansion of spending. These conditions also apply in one-quarter of the 42 countries not presently increasing spending. Health authorities should be aware of the multiple risk factors at play, including factors that are health-sector specific and others that generally are not. They should also realize that there are effective means for mitigating the risk of Dutch disease associated with increasing development assistance for health. International partners also have an important role to play since more sustainable and predictable flows of donor funding will allow more productivity enhancing investment in physical and human capital, which will also contribute to ensuring there are few harmful macroeconomic effects of increases in aid.
A financial transfer of wealth between countries necessitates adjustments in expenditure, production, and relative prices that collectively comprise the transfer problem. Since the 1920s the transfer problem arising from war reparations and other unrequited transfers has occupied the attention of Keynes, several Nobel laureates, and other distinguished economists. The early literature centred on static two-country models of transfers, while more recent research has highlighted the intertemporal dimension of the transfer problem.
The distinction between internationally tradable and non-tradable commodities lies at the heart of the reason for the development of the theory of international trade as an area of economics distinct from the general theory of value. The existence of nontradable commodities as well as tradable commodities implies that some markets are domestic while others are international. Connections between the prices of these two sets of commodities have been the subject of the famous factor-price equalization and Stopler–Samueslon theorems. Non-tradable goods play a prominent role in the analysis of many problems, such as tariff reform, exchange rates and international transfers.
With the improvement of relationship with the Western countries after the demise of the Old Order regime of President Soekarno, Indonesia received a large volume of foreign aid that played a crucial role in the recovery of the economy. Indonesia remained a significant recipient of foreign aid throughout the 1970s and 1980s. However, no systematic study has been done so far on the effectiveness of foreign aid in Indonesia. This paper, thus, attempts to examine the historical significance and effectiveness of aid flows to Indonesia. The correlation between aid and economic growth was found to be positive, but low. However, aid flows were crucial for maintaining development and social expenditure, especially at times of crises. In addition, aid flows smoothed out balance of payments problems and played an important catalyst for policy reforms; but there were also evidence of reversing reforms. The certainty of aid flows helped the government to follow the balanced budget principle, but made the government lazy in terms of domestic resource mobilization. As a result, despite significant progress, Indonesia's external debt burden remains high, and it has little ability to handle crisis without substantial foreign aid. Because of a weak domestic revenue base, the uncertainty regarding fiscal sustainability remains unresolved.
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.
The interest in predicting stock prices or returns is probably as old as the markets themselves. Fama (1970) reviews early work and provides some organizing principles. This article concentrates selectively on developments following Fama’s review. In that review, Fama describes increasingly fine information sets in a way that is useful in organizing the discussion. Weak-form predictability uses the information in past stock prices. Semi-strong form predictability uses variables that are obviously publicly available, and strong form uses anything else. While there is a literature characterizing strong-form predictability (for example, analysing the profitability of corporate insiders’ trades), this article concentrates on the first two categories of information.
We present a parametric example of three-country advantageous redistribution with two Cobb-Douglas utility functions and one CES utility function for which the elasticity of substitution is 1/2. This paper indicates that the possibility of advantageous redistribution strongly depends on the three countries’ taste patterns, endowment distributions, and the elasticity of substitution. In particular, we will show with specific examples that greater difference between the donor and recipient’s taste patterns and a lower elasticity of substitution can increase the chance of advantageous redistribution.
Aid donors and recipients have long been concerned that aid inflows may lead to an appreciation of the real exchange rate and an associated loss of competitiveness. This paper provides new evidence of the dynamic effects of aid on the real exchange rate, using an identification strategy that exploits the long delays between the approval of aid projects and the subsequent disbursements on them. These disbursement delays enable the isolation of a source of variation in aid inflows that plausibly is uncorrelated with contemporaneous macroeconomic shocks that may drive both aid and the real exchange rate. Using this predetermined component of aid as an instrument, there is little evidence that aid inflows lead to significant real exchange rate appreciations.
The sources of the balance of payments imbalances in the Euro area can be characterized by a combination of four phenomena: (i) the credit imbalances between the core and the periphery of the Economic and Monetary Union (EMU) (ii) the credit misallocation between the tradable and the nontradable sectors in the periphery (iii) the rapid increase in the output and the price of nontradable goods in the periphery since the beginning of the EMU and (iv) the current account imbalances within the EMU. This paper explains all four of these stylized facts within a single model as a result of the interaction between the common monetary policy, inflation heterogeneity and a relaxation of the credit constraint in the nontradable sector of the periphery. When nontradable goods are used as collateral, an increase in their prices can initiate an overborrowing spiral and lead to a balance of payment imbalances. Furthermore, the model endogenizes differences in unit labor costs between the core and the periphery of the Euro area.
This dissertation analyzes how developing countries could attract more private capital flows and benefit from these flows with higher productivity levels while avoiding some negative effects such as the appreciation of the real exchange rate. The first part of the dissertation analyzes the determinants of private flows from a macroeconomic perspective. The results show that infrastructure and financial development positively affect FDI and portfolio investment and that lax monetary policy significantly reduces portfolio investment (chapter 2). A firm-level analysis of the determinants of FDI strengthens the macroeconomic findings (chapter 3) and shows that better infrastructure, finance, and institutions stimulate FDI in the manufacturing sector. Human capital constraints are major obstacles for foreign firms exporting their production while financing constraints have more effect on foreign firms supplying the local market. In contrast with other developing countries, tax incentives do not seem to be successful in attracting capital flows to the manufacturing sector in Sub-Saharan African countries. The second part of the dissertation shows that public and private capital flows appreciate the real exchange rate, reducing countries' competitiveness (chapter 4). Among private flows, the real appreciation is higher for short-term flows such as portfolio investments than long-term flows (FDI and remittances). Exchange rate flexibility helps countries to dampen the appreciation of the real exchange rate stemming from capital inflows. A better investment climate for foreign firms significantly explains their higher productivity compared to local companies (chapter 5). Aggregate productivity would be significantly boosted if all firms face the investment climate of foreign firms. Finally, local firms supplying foreign companies with intermediate inputs exhibit higher productivity, highlighting the importance of vertical spillovers through backward linkages.
This paper proposes a new measure of competitiveness based on the ratio of non-tradable goods and services prices to tradable goods and services prices. It first presents a straightforward framework for understanding how key macroeconomic variables determine this alternative competitiveness measure with reference to output and expenditure behaviour in a two sector open economy. It then econometrically examines its most significant determinants with reference to private and public sector consumption and investment in Australia. Results based on quarterly data from 1998 to 2013 suggest that government expenditure on non-tradable goods and services was the most significant factor to worsen Australia's competitiveness. This provides an alternative perspective on the efficacy of fiscal policy to those previously advanced in standard international macroeconomic models.
We explore the welfare effects of tariffs and investment taxes for a small open economy in the presence of tourism. Inbound tourism converts local non-traded goods into tradeable, generating a tourism terms-of-trade effect. Because of this favourable “expenditure-shifting” effect when goods are substitutes, increases in import tariffs and investment taxes can actually improve welfare of domestic residents. We establish that for a small open economy with tourism, free trade is not the first-best policy. The optimal rates of tariffs and investment taxes are then derived and simulated for the economy with tourism.
This paper proposes a straightforward model for analysing the impact of export commodity price fluctuations on open macroeconomies with particular reference to Australia and New Zealand, major commodity exporters in the Asian region. It extends the dependent economy approach, first by re-specifying goods and services production as either exportable, importable or non-tradable, and second by adding a monetary sector to highlight key linkages between commodity prices, the exchange rate, price level, national output and trade account. The framework sheds new light on the phenomenon of 'commodity currencies', how exchange rate movements shield national output from terms of trade shocks, the importance of economic openness in this process, and the significance for monetary and exchange rate policy of short term, versus sustained, commodity price movements.
This paper analyses the policy effectiveness of government spending in a two-sector open economy whose output and expenditure is comprised of tradables and non-tradables. This framework reveals that government spending on either tradables or, more normally, on non-tradables widens the external deficit, yet how the real exchange rate behaves depends, in the first instance, on in which sector the public spending occurs. It also shows that, irrespective of where government spending falls, there appears to be no significant short run boost to overall output and hence employment a priori, although empirically actual impact would depend on the elasticities of tradable and non-tradable output with respect to the real exchange rate. Furthermore, fiscal stimulus is shown to be unambiguously ineffective if deemed unsustainable by foreign lenders, or implemented under a fixed exchange rate regime with limited capital mobility.
Global poverty is still an ongoing problem, leading to human tragedies and various related problems. Rich nations become rich faster than the poor nations develop. As a result, despite large efforts in the development aid sector, inequality in the world has increased over the last decades and the absolute share of poor nations in a growing global population remains high. A new paradigm is needed that goes beyond current improvements being made in the development aid sector. Based on the new insights presented in this research, it is proposed to innovate the development aid sector by adopting the Global Poverty framework (GPF) in combination with the Cyclic Innovation Model (CIM). With these two theoretical frameworks in mind, the actors in the development aid sector are recommended to start a fundamental reform of their organizations worldwide. It is shown that this reform can take place by integrating a nonlinear poverty forecast with a shared ambition and transition path for developing nations, leading to development programs and its projects. This research also provide an effective communication system between world institutions, national governments, NGOs, companies and consumers to improve collaboration to accelerate the reduction of global poverty.
In 2009-10 governments around the world implemented unprecedented fiscal stimulus in order to counter the impact of the Global Financial Crisis of 2008-09. This paper analyses the impact of fiscal stimulus using a dynamic open economy, overlapping generations model that allows for feedback effects of fiscal stimulus on private sector expenditure via changes in the tax rate and the interest rate. There are two types of goods – traded (T) and non-traded (N) goods, which differ in their capital intensities. The main qualitative result is that the dynamic output gains from fiscal stimulus depend on the productivity of the initial stimulus spending, on the speed of repayment of debt, on the sensitivities of the interest rate to government debt and of labour supply to the tax rate. Also, the overlapping generations framework allows an intergenerational welfare analysis. Among the biggest winners from stimulus are those about to retire. The biggest losers are those near the start of their working lives when the stimulus is implemented.
This article investigates whether large inflows of foreign aid and remittances have had a damaging impact on the Ethiopian Real Exchange Rate (RER). We improve the current empirical literature by: (i) compiling a unique quarterly dataset to provide a larger sample size and enable the modelling of important intra-year dynamics – which should lead to better model specifications; (ii) providing a new empirical approach (Unobserved Components (UC)) to test the ‘Dutch disease’ hypothesis; and (iii) using several cointegration approaches to further test the robustness of our conclusions. Our results suggest that there are two main long-run determinants of the RER in Ethiopia: trade openness is found to be correlated with RER depreciations, while a positive shock to the terms of trade tends to appreciate the RER. Foreign aid is not found to have a statistically significant impact, while there is only weak evidence that remittances are associated with RER appreciations. The lack of empirical support for the ‘Dutch disease’ hypothesis suggests that Ethiopia has been able to effectively manage large capital inflows, thus avoiding major episodes of macroeconomic instability. We believe that most African countries will therefore be able to absorb large inflows of foreign capital without damaging their external competitiveness.
Purpose – This chapter examines whether a small open economy in the presence of a nontraded good produced under a monopolistically competitive market and foreign capital inflow can raise its national welfare by adopting trade liberalization coupled with foreign economic aid.Methodology/approach – The chapter employs a general equilibrium, comparative static analysis of a small open economy involving two factors and two industries.Findings – It is shown that an import tariff can raise the welfare of a country or impoverish it, depending on the production and trade structures and preferences of the country, but foreign economic aid is always welfare enhancing. Thus, even when a tariff reduction reduces national welfare, the government still has an incentive to adopt the policy combination of trade liberalization and foreign economic aid.Originality/value of paper – The results obtained explain a widely recognized fact that economic aid by developed donor countries, trade liberalization and capital market liberalization typically take place simultaneously in developing recipient countries.
In a simple two-sector dynamic model with learning by doing and growth promoting and welfare enhancing tied-aid policies are investigated. Two new forms of tying, grant aid and loan aid are considered in the paper. Granting food aid are shown to have negative impact on growth, while providing capital transfers to manufacturing sectors with learning by doing gives a big-push to accelerated growth. It is shown that loan aids to manufacturing sector may lead to higher intertemporal welfare compared to grant loans in the absence of international capital markets. The existence of international trade and international capital markets matter for the tied aids to be effective.
This article examines empirically the proposition that aid to poor countries is detrimental for external competitiveness, giving rise to Dutch disease type effects. At the aggregate level, aid is found to have a positive effect on growth. A sectoral decomposition shows that the effect is (i) significant and positive in the tradable and the nontradable sectors, and (ii) equally strong in both sectors. The article thus provides no empirical support for the hypothesis that aid reduces external competitiveness in developing countries. A possible reason for this finding is the existence of large idle labour capacity that prevents the real exchange rate from appreciating.
This paper investigates the role of the real exchange rate in determining the effects of foreign transfers. If capital is
perfectly mobile between sectors, a pure transfer has no long-run impact on the real exchange rate. A decline in the traded
sector occurs because the transfer, being denominated in traded output, substitutes for exports in financing imports. While
a pure transfer causes short-run real exchange appreciation, this response is temporary and negligibly small. Transfers allocated
to productivity enhancement do generate permanent real exchange rate adjustments in response to the sectoral reallocation
of productive factors. The analysis, which employs extensive numerical simulations, emphasizes the tradeoffs between real
exchange adjustments, long-run capital accumulation, and economic welfare, associated with alternative forms of transfers.
We examine the effects of aid on the growth of manufacturing, using a methodology that exploits the variation within countries and across manufacturing sectors, and corrects for possible reverse causality. We find that aid inflows have systematic adverse effects on a country's competitiveness, as reflected in the lower relative growth rate of exportable industries. We provide some evidence suggesting that the channel for these effects is the real exchange rate appreciation caused by aid inflows. We conjecture that this may explain, in part, why it is hard to find robust evidence that foreign aid helps countries grow.
The possibility of transfer paradoxes or immiserizing growth in tariff ridden, small, open, developing countries with a nontraded goods sector is analysed in four models: a (short-run) sector-specific factor model, a dual economy model (capital is mobile between some but not all sectors), a long-run model (factors are mobile between all sectors) and a model with public goods. Several results of the received literature on transfer paradoxes and/or immiserizing growth in distorted small open economies are generalized to nontraded private and public goods (allowing for intersectoral factor mobility or immobility).
The transfer problem has attracted much attention in the literature of international trade theory since the famous controversy between Keynes and Ohlin in the late 1920s. Practically, the international transfer of purchasing power is widely observed in various guises such as private remittance, reparation, and economic aid. Theoretically, it poses an interesting question concerning the income effect of income transfers between countries. This question lurks also in the analysis of currency devaluation, often conceived as an attempt to affect the international terms of trade to create a trade surplus. Discussing the German reparation problem, Keynes (1929) held the position that the expenditure of the German people will be reduced, not only by the amount of reparation, but also by a decrease in their gold-rate of earnings. As Ohlin (1929) pointed out quickly, however, Keynes thereby failed to pursue the logic of his own argument: “if ₤ 1 is taken from you and given to me and I choose to increase my consumption of precisely the same goods as those of which you are compelled to diminish yours, there is no transfer problem.” (See Keynes 1929, p. 2.) Later analysis, notably Samuelson (1952, 1954) and Johnson (1955), elucidated the implications of this logic in the context of a two-country, two-commodity model of trade. They showed that the direction of change in the terms of trade depends crucially upon the relative magnitude of the marginal propensities to consume between the two countries. There is, however, no presumption about this relative magnitude under free trade with no trade impediments.
In many game-type situations, a global normal form game,u=U(), is not known, but the matrix of partial derivaties ofU(), denote it by U(
0), can be observed. To facilitate the analysis of such situations, this study builds a local theory on linear systemdu=(
0)d, which I call a local form game. I introduce core-like local solutions in order to explain the formation of an institution sustainable from a local theoretic viewpoint. I apply my method to the three-country transfer game and characterize locally sustainable transfer agreements in terms of conditions on the underlying economy.
A two good, two region and three income group macro model is constructed to explore possible effects of aid on distribution of welfare. One region, the North, has two income groups characterized by different endowments and proportions of consumption of the basic and the luxury goods. We study policies that result in transfers of goods from the high income group of the North to the South. In one case, the transfer is of luxury or investment goods; under the conditions, it is shown to produce a change in relative prices that induces an increase in the welfare of the North and decreases the welfare of the South, even under conditions of (Walrasian) stability of the markets. In a second case, the high income group in the North transfers, instead, basic goods to the South. It is shown that under the conditions an increase in welfare of the South can only occur at the expense of a decrease in welfare of the low income group in the North. Therefore, in general, aid in the form of commodity transfers cannot be relied upon to equalize overall welfare: under the conditions there is necessarily a trade-off between more North-South equality and greater equality within the North. When aid is endorsed to pursue NIEO objectives, a close examination of international and domestic markets seems in order, so as to avoid the conditions studied here. The formation of (international) coalitions among the different groups is also discussed.
Using the standard trade model with three countries, and allowing for substitutability in both production and consumption, this paper demonstrates that a country may gain by giving a transfer, that the receiver may lose, and that these two phenomena may appear at the same time. This result is an extension of Gale's example in a fixed-coefficient model, where he shows both transferer and transferee may become better off harming the third country; and it is contrasted with the traditional welfare proposition whereby a giver is immiserized and a recipient is enriched.
This paper shows that an international transfer payment may paradoxically immiserize the recipient country (or increase the donor country's welfare), even when world markets are stable, despite the traditional view that such a paradox theoretically requires market instability. To demonstrate this paradoxical possibility, the paper extends the conventional trade-theoretic analysis to admit exogenous distortions created by tax-cum-subsidies in domestic production, or endogenous distortions due to ‘additionality’ requirements imposed by the donor on the recipient. This analysis of immiserizing transfers from abroad immediately suggests significant implications for important policy issues, including the evaluation of real benefits from foreign aid.
Recent studies indicate the possibility that, in the more-than-two-country model, a coalition may block a competitive equilibrium by means of mutually advantageous transfers among its members. This study demonstrates that even the equilibrium which is to be established after a mutually advantageous transfer may be blocked. In order to form a blocking coalition, a country may take a strategic loss, i.e., give or receive a transfer which reduces its own utility. This provides a possible reason why a country may, not out of benevolence, give or receive a transfer which it knows to reduce its own utility. Copyright 1991 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
The paper derives an exact criterion for deciding if capital accumulation in a small, open economy where the only distortion is a tariff on imports will result in a loss of welfare–a possibility shown by Johnson. The relationship with a previous criterion derived by Bertrand and Flatters is discussed.
The literature on international trade theory contains a series of paradoxes in cases of tariffs, growth, and transfers. This paper discusses the key role of income (as opposed to substitution) effects in supporting such paradoxes, and suggests how the new welfare paradoxes in the three-agent transfer problem are related to the Metzler and Lerner tariff paradoxes, on the one hand, and that of immiserizing growth, on the other. The concluding section describes how far an optimal tariff policy can succeed in dispelling these paradoxes. -Authors
Analyses the effects on resource allocation, factoral income distribution and the real exchange rate of a boom in one part of the country's traded goods sector. In the simplest of the models considered, which assumed that only labour was mobile between sectors, de-industrialisation was shown to follow a fall in manufacturing output and employment, a worsening of the balance of trade in manufacturing and a fall in the real return to factors specific to the manufacturing sector. Furthermore, it was shown the boom gives rise to a real appreciation, i.e. a rise in the relative price of non-traded relative to traded goods. However, in later models, which allowed for intersectoral mobility of more than one factor, it was shown that some of these outcomes could be reversed.-from Authors