Why is ‘The Dutch disease’ always a disease? the macroeconomic consequences of scaling up ODA

Abstract

This working paper examines the validity of the claim that ‘scaling up’ ODA in developing countries will cause ‘Dutch Disease’ effects that slow growth and human development. The most common concerns are increased inflation and exchange-rate appreciation. Consistent with a recent IMF re-appraisal, the paper maintains that such problems can be mitigated if ODA is properly ‘spent’ and ‘absorbed’. However, many governments either do not spend ODA (because of the fear of inflation) or do not ‘absorb’ it (because of the fear of appreciation). The paper argues that the critical issues are whether 1) increased government spending is focused on public investment and 2) increased imports are focused on capital goods. A central point is that in many developing countries, under-utilized productive capacities can readily respond to rising government demand for domestic goods and services. The paper ends with the warning that although the short-run macroeconomic impact of ODA can be managed, its longer-term impact could, indeed, be adverse if it reduces efforts to mobilize domestic resources, such as public revenue and national savings.