Journal Article

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

Ibrahim A. Elbadawi, Linda Kaltani and Klaus Schmidt-Hebbel

in The World Bank Economic Review

Volume 22, issue 1, pages 113-140
Published in print February 2008 | ISSN: 0258-6770
Published online February 2008 | e-ISSN: 1564-698X | DOI: http://dx.doi.org/10.1093/wber/lhm024
Foreign Aid, the Real Exchange Rate, and Economic Growth in the Aftermath of Civil Wars

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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

Journal Article.  10134 words.  Illustrated.

Subjects: Development Planning and Policy

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