Dealing with aid volatility

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Homi Kharas, a Senior Fellow at Brookings, has produced an interesting analysis on Measuring the Cost of Aid Volatility. He takes a page from finance theory to try to put an estimate on the cost associated with the capriciousness of official development assistance. This is no small matter - as Kharas puts it:

[T]he aid system has generated the same negative shocks to per capita developing countries, and with more frequency, as the two World Wars and the Great Depression generated in developed countries.

Kharas estimates a deadweight loss of about $16 billion, or 15 to 20 percent of the total value of aid. And the table below lists the aid donors in order of the dead weight loss associated with their respective official development assistance (the three columns represent different ways to measure the dead weight loss):


While Kharas's application of modern finance theory to measuring the cost of aid volatility is an excellent approach, I think his paper would have benefitted from an additional consideration. As "Table 5" shows, U.S. official development assistance comes out as having the worst deadweight loss. However, as you can see from this post by Chris Blattman on The privatization of foreign aid, official development assistance from the U.S. in 2006 was 'only' $23.5 billion, compared to $34.8 billion of private philanthropy. Remittances from the U.S. and many other OECD countries were also pretty substantial.

Kharas demonstrates in his paper that official development assistance tends to aggravate economic cycles in developing countries. However, without taking into account private philanthropy and remittances - in particular, if and how they respond to flows of official development assistance - it's difficult to be certain whether the volatility of official development assistance really carries the costs Kharas suggests. Do remittances pick up the slack when official development assistance falls off? But that, I suppose, is a topic for another paper.   


Ryan Hahn

Operations Officer

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