Arvind Subramanian blogs an aid and Dutch Disease

Arvind Subramanian in The Effects of Foreign Aid: Dutch Disease:
"Manufacturing exports has been the predominant mode for escape from underdevelopment for many developing countries, especially in Asia. So, what aid does to manufacturing exports can be one key piece of the puzzle in understanding the aggregate effect of aid.

In this paper forthcoming in the Journal of Development Economics, Raghuram Rajan and I show that aid tends to depress the growth of exportable goods. This will not be the last word on the subject because the methodology in this paper, as in much of the aid literature, could be improved.

But the innovation in this paper is not to look at the variation in the data across countries (which is what almost the entire aid literature does) but at the variation within countries across sectors. We categorize goods by how exportable they could be for low-income countries, and find that in countries that receive more aid, more exportable sectors grow substantially more slowly than less exportable ones. The numbers suggest that in countries that receive additional aid of 1 percent of GDP, exportable sectors grow more slowly by 0.5 percent per year (and clothing and footwear sectors that are particularly exportable in low-income countries grow slower by 1 percent per year).

We also provide suggestive evidence that the channel through which this effect is felt is the exchange rate. In other words, aid tends to make a country less competitive (reflected in an overvalued exchange rate) which in turn depresses the prospects of the more exportable sectors. In the jargon, this is the famous “Dutch Disease” effect of aid."

Further discussion by David Roodman of Center for Global Development Does Aid Cause Dutch Disease? and Subramanian's response:
"Whether and how manufacturing exports can be an engine of overall growth is still debated. But the historical experience is strongly suggestive that if export sectors grow slowly or grow slower than other sectors, overall growth is affected. So, our paper could be interpreted not as a lament about the effects of aid on export sectors but as a celebration of its effects on non-export sectors. But, in my view and also in the historical record, between export and non-export sectors as an engine of growth, there is no contest."