How aid supplies from donor countries respond to economic crisis.

Author:Gravier-Rymaszewska, Joanna

The strong interdependent relationship between the developed and developing countries made itself visible again with the recent economic downturn. Due to the now truly global character of the economy, the crisis did not only affect the North, where the first signs of crisis were seen in 2007, but also the South through decreasing trade volumes and investments. Concurrently, Official Development Assistance (ODA) is subject to a pro-cyclical trend. That is, it falls when the donors encounter an economic recession. In the presence of crisis, developing countries rely crucially on aid for their expenditures, while developed countries reduce aid volumes.

The interconnected crises of climate change and food provision also continue. The resulting self-amplifying triple crisis (finance, climate and food) confronts and overwhelms the South with economic hardship, rising food prices and more frequent climatic events like droughts and floods. The South increasingly relies on aid, and ODA remains the main channel for donor countries to assist development in the South. For the donors, the financial aspect of the triple crisis is crucial for their decisions on aid budgets. Aid is often one of the first items to be cut during fiscal restraint in donor countries.

It is important to understand how the crisis affects aid flows, and determine how financial, political and social forces within donor countries influence budgetary decisions on development aid.

The recent UNU-WIDER working paper 'How Aid Supply Responds to Economic Crises: A Panel VAR Approach' explores the channels and behavioural consequences of unexpected financial shocks on aid budgets. A simple theoretical consumption model is proposed to capture donor decisions on aid disbursements versus other variables: domestic social needs, financial conditions and political preferences. The evolution and magnitude of the response of aid flows to shocks applied to various macroeconomic variables including GDP, fiscal balance, unemployment, financial volatility, trade, etc can be observed due the dynamic approach taken. The study aims at determining whether the dynamics of aid vary for crises of differing severity, or before and after the crises, and if the relationship is purely economic or is also directly influenced by politics.

It is found that crises affect development aid budgets and their trend. This influence takes place through two channels: directly via lower revenues, and indirectly; by...

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