Interesting paper from last year by Rajan and Subramanian that I didn’t encounter until today:

We examine one of the most important and intriguing puzzles in economics: why it is so hard to find a robust effect of aid on the long-term growth of poor countries, even those with good
policies. We look for a possible offset to the beneficial effects of aid, using a methodology that exploits both cross-country and within-country variation. We find that aid inflows have systematic adverse effects on a country’s competitiveness, as reflected in the lower relative growth rate of labor intensive and exporting industries, as well as a lower growth rate of the manufacturing sector as a whole. We provide evidence suggesting that the channel for these effects is the real exchange rate overvaluation caused by aid inflows. By contrast, private-toprivate flows like remittances do not seem to create these adverse effects, a finding for which
we offer an explanation…

We find strong evidence consistent with aid undermining the competitiveness of the labor-intensive (or alternatively traditional exporting) sectors. In particular, in countries that receive more aid, labor-intensive (or traditional exporting) sectors grow slower relative to capital-intensive (or non-exporting) sectors. As a result of the reduced competitiveness, employment growth in these sectors is slower, and these sectors account for a lower relative share of the economy in countries that get more aid.

We also provide evidence that the channel through which aid works is by inducing overvaluation of the real exchange rate. We demonstrate this by showing that: (i) aid and overvaluation are positively correlated across countries and that overvaluation is correlated with the exogenous components of aid, suggesting that aid does cause overvaluation; (ii) the exogenous (aid-related) component of overvaluation induces the same relative pattern of growth of the labor-intensive and exportable sectors in countries as does the exogenous component of aid; 2 and (iii) the independent effect of aid is attenuated in the presence of overvaluation.