WPS4187 <mark>P</mark> OST <mark>-C</mark> ONFLICT <mark>T</mark> RANSITIONS <mark>W</mark> ORKING <mark>P</mark> APER <mark>N</mark> O <mark>. 3</mark>

# **Post-Conflict Aid, Real Exchange Rate Adjustment, and Catch-up Growth (*)**

Ibrahim A. Elbadawi Development Economic Research Group World Bank, Washington DC email: <u>ielbadawi@worldbank.org</u> Linda Kaltani Development Economic Research Group World Bank, Washington DC email: <u>lkaltani@worldbank.org</u> Klaus Schmidt-Hebbel Banco Central de Chile email: <u>kschmidt@bcentral.cl</u>

## **<u>Abstract</u>**

Post-conflict countries receive substantial aid flows after the start of peace. While post-conflict countries’ capacity to absorb aid (i.e., the quality of their policies and institutions) is built up only gradually after peace onset, the evidence suggests that aid tends to peak immediately after peace is attained and decline thereafter. Aid composition broadly reflects post-conflict priorities, with large parts of aid financing social expenditure and infrastructure investment. While moderate RER overvaluation is observed in postconflicts, it cannot be traced down to the aid flows. The empirical evidence on world growth reveals new findings about the pattern of catch-up growth during post-conflicts and the role of key growth determinants on post-conflict growth. Aid is an important determinant of growth, both generally and more strongly during post-conflict periods. Because RER misalignment reduces growth, RER overvaluation during post-conflicts reduces catch-up growth. Aid and RER overvaluation combined also lower growth. However, the negative growth effect of RER overvaluation declines with financial development.

## World Bank Policy Research Working Paper 4187, April 2007

_The Post-Conflict Transitions Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about post-conflict development (more information about the Post-Conflict Transitions Project can be found at http://econ.worldbank.org/programs/conflict_ ). _An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in these papers are entirely those of the authors. They do not necessarily represent the views of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org ._ (*) A preliminary version of this paper was presented at the first collaborative research project workshop on “Political Institutions, Development and a Domestic Civil Peace: PIDDCP”, Oslo, Norway, June 19-20, 2006, organized by the Development Economic Research Group (DECRG) of the World Bank; The Centre for the Studies of the African Economies (CSAE), University of Oxford, and the International Peace Research Institute (PRIO) of Oslo. The authors thank Paul Collier and Majak d’Agoot, and workshop attendants for valuable comments and suggestions. Also Ibrahim Elbadawi and Linda Kaltani would like to thank Norman Loayza and Aart Kraay for helpful discussions. The views expressed in this paper are not necessarily those of the Banco Central de Chile or of the World Bank, its Board of Directors or affiliated organizations. The authors acknowledge the valuable research support of Nahla Hilmi and Marcelo Ochoa.