Why do many economists believe that in developing countries a large surge of capital inflows, such as Official Development Assistance, will lead to a ‘Dutch Disease’, and not development? What, exactly, is a ‘Dutch Disease’ and why is it considered to be invariably detrimental to development?1 This brief paper attempts to address these issues.
The advocacy of the U.N. Millennium Project for a large scaling up of Official Development Assistance to reach the Millennium Development Goals has raised fears about a new epidemic of ‘Dutch Disease’ among developing countries. However, recent research by the International Monetary Fund has helped contribute to a more sensible, balanced evaluation than before of the validity of such fears (IMF 2005a and Gupta et al. 2005).
If ODA is effective, it should lead to a transfer of real resources to a developing-country recipient. And these resources should, it is assumed, contribute to improved human development and enhanced prospects for domestic capital accumulation and sustained economic growth. However, even if there were a real transfer of resources in the short term, such success would not lead necessarily to sustained growth and human development. These two issues are separable. This paper addresses primarily the short-run dynamics and focuses on the effects of ODA on growth.2
Until recently, ODA has been falling as a share of the gross national income of recipient countries and as share of their gross capital formation (Table 1). In low-income countries, for example, aid accounted for about 12 per cent of gross capital formation in 2000-2003, which was down from almost 14 per cent in the early 1990s. In sub-Saharan Africa, this share declined
from almost 41 per cent in the early 1990s to 27 per cent in 2000-2003.
The term ‘Dutch Disease’ was used to describe the adverse impact of a discovery of natural gas on Dutch
manufacturing because of a surge in income and consequent appreciation of the real exchange rate.
ODA could be used for multiple desirable purposes. It could prevent a decline in human development, such as
combating the HIV/AIDs epidemic. It could directly promote human development, such as improving child nutrition. Or it
could contribute to domestic investment, such as in infrastructure or human technical capabilities, which should
accelerate economic growth. This paper concentrates on the last aspect.