FOREIGN-AID, CAPITAL ACCUMULATION, AND DEVELOPING-COUNTRY RESOURCE EXTRACTION

We consider a developing country with a two-period horizon, which possesses a natural resource that can be extracted with or without extraction costs. A donor can affect extraction through aid which is either unconditional or conditional on resource extraction, and has a preference for extraction to be postponed, indefinitely or at least until period 2. We show that shifting unconditional aid from period 2 to period 1 can lead to postponement of extraction to period 2 given that the country chooses an internal solution with respect to extraction, and faces a binding resource constraint over the two periods. Aid conditional on resource saving in period 1 can, however, have greater effects, and be effective also when the country initially extracts all of the resource in period 1 or does not face a resource constraint. We also discuss the effects of capital accumulation and donor investment subsidies on the extraction profile, these are shown to be largely negative in our model, by promoting early extraction.