Measuring the Cost of Aid Volatility

36 Pages Posted: 21 Aug 2008

Date Written: July 31, 2008

Abstract

Flows of official development assistance (ODA) to recipient countries have been highly volatile and this reduces their value. At the macro level, empirical evidence suggests that volatile ODA can negatively impact growth through several channels. At the micro level, volatility can affect fiscal planning and the level and composition of investment. This working paper develops a simple financial metric that policy makers can use to estimate (and reduce) the cost of aid volatility. Unlike other estimates, our measure does not depend on parameter estimates from cross-country regressions, nor on country-specific model simulations.

We treat aid flows as the uncertain return on an unobserved asset of global goodwill held by developing countries. We then calculate the certainty equivalent value of the volatile aid flows as well as an associated dead weight loss, using a capital asset pricing model. Our measure of the deadweight loss per dollar provided in aid permits a comparison of costs across donors and over time. We find that the costs of volatility rose steadily until 2002, and have since fallen.

Aid volatility is similar for low and middle income countries; weak states and strong states; aid dependent and low-aid countries; and across regions. Aid volatility differs substantially, however, by donor. We infer that donor policies contribute to volatility and that they should make reducing volatility a strong priority.

Keywords: foreign aid, aid volatility, development

Suggested Citation

Kharas, Homi, Measuring the Cost of Aid Volatility (July 31, 2008). Wolfensohn Center for Development Working Paper No. 3. Available at SSRN: https://ssrn.com/abstract=1238066 or http://dx.doi.org/10.2139/ssrn.1238066

Homi Kharas (Contact Author)

The Brookings Institution ( email )

1775 Massachusetts Ave., NW
Washington, DC 20036
United States

HOME PAGE: http://www.brookings.edu/experts/kharash.aspx

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
125
Abstract Views
704
rank
237,034
PlumX Metrics