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The World Bank Economic Review Advance Access originally published online on February 7, 2008
The World Bank Economic Review 2008 22(1):113-140; doi:10.1093/wber/lhm024
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Right arrow D74 - Conflict; Conflict Resolution; Alliances
Right arrow F31 - Foreign Exchange
Right arrow F35 - Foreign Aid
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© The Author 2008. Published by Oxford University Press on behalf of the International Bank for Reconstruction and Development / THE WORLD BANK. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org

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

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

Ibrahim Elbadawi (corresponding author) is a lead economist in the Development Economics Research Group of the World Bank
Linda Kaltani is an economist at the International Monetary Fund. her email address is lkaltani{at}imf.org
Klaus Schmidt-Hebbel is professor of economics at the Catholic University of Chile; his email address is kschmidt{at}bcentral.cl. A preliminary version of this article was presented at the first collaborative research project workshop, "Political Institutions, Development and a Domestic Civil Peace," held in Oslo, June 19–20, 2006. The conference was organized by the Development Economic Research Group of the World Bank; the Centre for the Studies of African Economies, at the University of Oxford; and the International Peace Research Institute (PRIO), Oslo

Correspondence: his email address is ielbadawi{at}worldbank.org

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.

Key Words: F5 • F3 • F43


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