|
The surge in aid inflows in Ghana, following the adoption of the Economic Recovery Program (ERP) in 1983, has been considerable. From about 3% of GDP before the beginning of the program, gross aid inflows have risen to an annual average of over 17% in the 2000-2006 period (Sanusi, 2009). The intention of these massive inflows of aid to Ghana, like in other Sub-Saharan African (SSA) reformers, was to support the economic reforms and fiscal responsibility. However, these massive aid inflows have raised concerns among both academic and policy circles about some potentially unintended adverse effects that these inflows may cause, especially on the economy’s external competitiveness. One of the earliest of this concern was expressed by Younger (1992) who argued that the massive aid inflows to Ghana hurt, instead of helping, the Ghanaian economy. The rise in aid inflows gives rise to macroeconomic management problems associated with high inflation, an appreciation of the Real Exchange Rate (RER) and tight credit to the non-bank private sector. This claim motivated a number of empirical works to examine the validity of this claim for Ghanaian and other SSA countries. Some of these studies include Jebuni (1994), Asea and Reinhart (1996), Nyoni (1998), Ogun (1998), Sacky (2001), Adam and Bevan (2003), Nkusu (2004a), Ouattara and Strobl (2004), and Iossifov and Loukoianova (2007). The debate that thrives in the literature is empirical in nature, and is divided into those studies that found the theoretically expected effects of aid inflows and those that found the contrary, i.e., rise in aid is associated with real depreciation of the currency.
On the one side of this debate, the so-called ‘Dutch Disease’ literature provides its theoretical basis for the rise in aid inflows that would cause the RER to appreciate, thereby hurting the economy’s fragile exports. Dutch Disease effects refer to the adverse effects of real exchange rate appreciations that a booming sector of an economy causes to other sectors and the rest of the economy. This effect is normally associated with a boom in natural resource exports, such as oil, where the booming oil export sector causes the real exchange rate to appreciate, thereby discouraging other exports. In the aid-Dutch Disease literature, foreign aid and other capital inflows are regarded as the booming sector. The argument is that as the aid money comes into the economy, it is spent either on imports or on domestic goods since it cannot be used to acquire foreign assets. In the case where the spending is on imports, there is no direct effect on money supply or aggregate demand1. If the expenditure is on domestic goods and services, several problems arise. First, the rise in aggregate demand will put pressure on domestic prices, if the aggregate supply responds sluggishly, inflation occurs. At the same time, monetary base will rise as the foreign exchange when changed into domestic currency further increases inflation. This higher inflation, relative to the rest of the world implies real appreciation of the exchange rate2 (Foster and Killick, 2006). The empirical support for the conventional appreciating effect of aid inflows was obtained by Opoku-Afari et al. (2004) for Ghana, Adenauer and Vagassky (1998) for the CFA zone, White and Wignaraja (1992) for Sri Lanka, and Elbadawi (1998) for a number of developing countries.
On the other side of the debate is the empirical finding that RERs of some African countries have either failed to appreciate or have instead depreciated in response to rising aid inflows. Such studies include Sacky (2001) for Ghana, Nyoni (1998) for Tanzania, Bandara (1995) for Sri Lanka, Ogun (1998) for Nigeria, and Ouattara and Strobl (2004) for CFA countries.
|
