Aid, Policies, and Growth in Developing Countries: A New Look at the Empirics

Abstract

The relationship between foreign aid and economic growth has been the subject of much controversy. A recent theme suggesting that aid promotes growth, but only in a good policy environment has ratcheted up that debate. In this paper, we assess the importance of policy and aid in generating growth when the aid, policy, and growth relationship is nonlinear. This allows us to examine the varying effects of aid and policy in different data segments, which we do without imposing any particular structure on the underlying relationship. We find that policy is an important determinant of growth. We also find partial corroboration of the view that aid is growth enhancing in a good policy environment, and some evidence of diminishing returns to aid. These findings suggest that nonlinearities if not appropriately addressed fail to capture the detailed underlying dynamics and thereby mask some key features of the aid‐policy‐growth relationship.

The Impact of Foreign Aid on Economic Growth in Africa: Empirical Evidence from Low Income Countries

“…In light of this, they concluded that it is important to condition aid on these good policies to ensure that aid works better for growth. Later on, Alvi et al (2008) also partially confirmed that aid positively affects growth in good policy conditions but with some degree of diminishing returns to aid.…”

“…While the average positive impact of aid on growth is fairly recognized, the contrasting view that the positive impact of aid on growth depends on certain conditions or good policies in recipient countries should not be ignored. The aid conditionality argument is believed to be fairly propagated by Burnside and Dollar (2000) and subsequent studies (Alvi et al, 2008;Dutta et al, 2015). Burnside and Dollar (2000) tested the aid conditionality hypothesis using panel data form 56 major aid-recipient countries over the 1970-1993 period.…”

“…So far, empirical evidence on the link between foreign aid and growth remains mixed and contradictory, giving two lines of debate on this nexus: aid effectiveness and aid ineffectiveness. The aid effectiveness theses argue that aid positively affects growth without conditions (Arndt et al, 2015;Clemens et al, 2012;Juselius et al, 2013) and under certain policy conditions (Alvi et al, 2008;Burnside and Dollar, 2000;Dutta et al, 2015). On the contrary, a strand of literature on the aid ineffectiveness theses documented that the impact of aid on growth is either negative (Adedokun and Folawewo, 2017;Boone, 1996) or null/insignificant (Dreher and Langlotz, 2017;Rajan and Subramanian, 2008).…”

Assessing the economic impacts of foreign aid expenditure in West Africa: An empirical analysis of the effects of aid expenditure on economic growth

“…In an attempt to identify reasons why the literature had been so inconclusive, Doucouliagos and Paldam (2006) averred that much of the differences between studies are as a result of data and specification differences. Kourtellos et al (2007) and Alvi et al (2008) argued that the impact of foreign aid on growth differ among previous studies due to existing endogeneity resulting from the exclusion of important control variables. They also argued that the relationship between aid and growth is non-linear.…”

Does Foreign Aid Have an Expected Role in the Economic Growth of Bangladesh? An Analysis in ARDL Approach

“…A good number of studies disclosed that foreign Aid plays a significant positive role in the economic development of a country (Dalgaard et al, 2004;Fayissa and El-Kaissy, 1999;Feeny, 2007;Gomanee et al, 2005;Islam, 1992;Juselius et al, 2014). Some empirical studies reveal that foreign aid has no impact on economic growth (Alvi et al, 2008;Herzer and Morrissey, 2013;Mallik, 2008;Ovaska, 2003;Papanek, 1973;Svensson, 1999). Moreover, some studies documented that the effect is mixed (Babalola and Shittu, 2020;Sultana, 2019).…”