I discuss how aid can support growth in small, isolated economies. Small markets frustrate scale economies and competition. Combined with high transport costs, essential inputs become prohibitively expensive. Breaking the coordination problem requires pioneering investment. Since this generates externalities it will be undersupplied.
Donors have both the finance and the long-term relationships that could offset the externalities and political risks that impede pioneers. However, there are practical difficulties of how such support is best organized. In order of ambition these run from finance of infrastructure, through subsidized capital and political risk insurance, to long-term partnerships with private firms.
Collier, P. Aid as a catalyst for pioneer investment. UNU-WIDER, Helsinki, Finland (2013) 18 pp. ISBN 978-92-9230-581-9 [WIDER Working Paper No. 2013/004]