15 (2) where _i_ and _t_ are country and time indexes, respectively; _y_ is per-capita GDP growth; _A_ is ODA as a share of GDP,<sup>27</sup> RERMIS is RER misalignment, _PC_ is a vector of three post-conflict period variables ( _Peace Onset_ takes the value of 1 if the year of peace falls within that period, _Post-conflict 1_ takes the value of 1 if the war ended in the previous period, and _Post-conflict 2_ takes the value of 1 if the war ended two periods before); _FD_ is a measure of financial development, _CV_ is a set of standard control variables that are robustly associated with cross-country growth (initial per capita GDP, initial GDP cyclical component, inflation, government expenditure as a share of GDP, human capital investment, a rule of law index, and a measure of trade openness); and<sup>μ</sup> _t_<sup>andη</sup> _i_<sup>are time</sup> and country fixed-effects, respectively.

Policy fundamentals are likely to be jointly determined with growth as well as responsive to future anticipated growth performance. Therefore, to properly account for endogeneity and country-specific unobserved characteristics, we use the Generalized Method of Moments (GMM) system dynamic panel estimation method. We apply it to a world data panel of 78 countries, comprised by post-conflict and other developing economies, as well as industrial countries, for 5-year non-overlapping averages spanning the period 1970 until 2004. The system GMM (developed in Arellano and Bover, 1995 and Blundell and Bond, 1997) implemented here, uses lagged values of the dependent and independent variables as instrument (called ‘internal instruments’) and combines regressions in differences with the regressions in levels to better address the issue of weak instrumentation often attributed to the older, difference estimator. Under the assumed moment conditions, the system GMM accounts for the combined problems of endogeneity and unobserved country effects. The consistency of the GMM system estimator is assessed by two specification tests. The Sargan test of overidentifying restrictions tests the overall validity of the instruments. Failure to reject the null hypothesis gives support to the model. The second test examines the null hypothesis that the error term is not serially correlated. Again, failure to reject the null hypothesis gives support to the model. Rejecting the null hypothesis would imply that the instruments are inappropriate and would call for higher-order lags of the variables to be used as instruments.

The regression results along with the Sargan and the serial-correlation tests are reported in Table 5. The first column reports the results of estimating equation (2) excluding the interaction terms, the second column reports the results using the full specification, and

> 27 The values for official development assistance are set equal to zero for the OECD countries. Aid is measured at the beginning of each period as it is believed to be more relevant for current growth because the overwhelming evidence (reviewed in the previous section) seems to suggest that recipient countries tend to absorb and/or spend aid with some time lag. Beginning of period aid is also likely to be exogenous because aid is partially responsive to recipient countries’ past economic performance, including past growth.