This paper constructs a general equilibrium model of North-South tradein which the North continually introduces new goods. The rate at whichtechnology diffuses to the South is a function of differences in the cost of production in the two regions. The key result of the model is that labor force growth in the South initially increases real wages inthe North (a standard result in classical trade models), but in the long run reduces Northern wages by accelerating the transfer of technology and drawing capital out of the North as well.

In Burnside and Dollar (2000) we used standard regression techniques from the growth literature to measure the effect of foreign aid on growth. The main finding in our paper was that the effect of foreign aid on growth depended on the macroeconomic policies of recipient countries. In this issue, William Easterly et al. (2004), challenge the robustness of our result to new data. Before commenting on their findings it is useful to review the basis of our original findings. Our paper focused on three versions of a panel growth regression, estimated using data for 51 countries, and six four-year periods, from 1970 to 1993. These regressions may be summarized as:

This paper uses a new database on foreign aid to examine the relationships among foreign aid, economic policies, and growth of per capita GDP. We find that aid has a positive impact on growth in developing countries with good fiscal, monetary, and trade policies but has little effect in the presence of poor policies. Good policies are ones that are themselves important for growth. The quality of policy has only a small impact on the allocation of aid. Our results suggest that aid would be more effective if it were more systematically conditioned on good policy.