Foreign Aid, the Real Exchange Rate, and Economic Growth in the Aftermath of Civil Wars

Posted: 16 Jun 2008

See all articles by Ibrahim Elbadawi

Ibrahim Elbadawi

World Bank - Economic Development Institute

Linda Kaltani

International Monetary Fund (IMF)

Klaus Schmidt-Hebbel

Central Bank of Chile

Date Written: 2008

Abstract

Foreign aid, the real exchange rate (RER), and economic growth are three key variables that shape the aftermath of civil wars in many developing countries. Panel estimations drawn from a sample of 39 conflict and 44 nonconflict countries between 1970 and 2004 indicate that although postconflict countries receive larger aid flows and exhibit moderate RER overvaluation after peace is attained, overvaluation cannot be traced to aid. Yet foreign aid is among the significant determinants of the equilibrium RER. Aid is also an important determinant of economic growth, particularly after peace is reached. Aid exhibits decreasing returns, however, and interacts negatively with RER overvaluation. RER overvaluation reduces growth, but this effect is ameliorated by financial development. Postconflict policies should therefore aim to use aid prudently, avoid RER misalignment, and support financial and capital market development to achieve high and stable growth in the aftermath of war and beyond.

Keywords: F5, F3, F43

Suggested Citation

Elbadawi, Ibrahim and Kaltani, Linda and Schmidt-Hebbel, Klaus, Foreign Aid, the Real Exchange Rate, and Economic Growth in the Aftermath of Civil Wars (2008). The World Bank Economic Review, Vol. 22, Issue 1, pp. 113-140, 2008. Available at SSRN: https://ssrn.com/abstract=1146330 or http://dx.doi.org/lhm024

Ibrahim Elbadawi (Contact Author)

World Bank - Economic Development Institute ( email )

1818 H Street
Washington, DC 20433
United States

HOME PAGE: http://econ.worldbank.org/staff/ielbadawi

Linda Kaltani

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Klaus Schmidt-Hebbel

Central Bank of Chile ( email )

Agustinas 1180
Santiago
Chile
(56-2) 670-2386, 670-2586 (Phone)
(56-2) 670-2836 (Fax)

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