Counting Chickens when they Hatch: The Short-Term Effect of Aid on Growth

Abstract

Recent research yields widely divergent estimates of the cross-country relationship between foreign aid receipts and economic growth. We propose and test two reasons for this divergence, both of which relate to the timing of effects between aid and growth. First, these studies have insufficiently considered the lag with which aid might affect growth, particularly certain kinds of aid. Second, they have sought to reduce the bias from contemporaneous reverse causation with the use of instrumental variables that appear to be invalid, weak, or both. We reanalyze data from the three most influential published aid-growth studies, strictly conserving their regression specifications, adding sensible assumptions about timing and avoiding questionable instruments. With these changes, the research designs from all of these studies yield one finding: that increases in aid have been followed on average by modest increases in investment and growth. The most plausible explanation is that aid causes some degree of growth in recipient countries, though the magnitude of this relationship is modest, varies greatly across recipients, and diminishes at high levels of aid.

Aid and Economic Growth in Pacific Island Countries: An Empirical Study of Aid Effectiveness in Fiji

“…nomic growth. Recent research studies Clemens et al 2004;Rajan and Subramanian 2005) have attempted to capture this phenomenon by incorporating aid into a well-established aid-growth regression using the per capita real GDP (PCGDP) as the dependent variable. We used data covering a 33-year period , which are available on a consistent basis.…”

“…Under certain circumstances with the rise in the volume of aid there were diminishing returns along with the presence of a conditional, positive relationship. While Clemens, Radelet, and Bhavnani (2004) indicated the existence of a positive relationship between aid and growth, a study by Rajan and Subramanian of IMF (2005) found no evidence of aid having either a positive or a negative effect on growth. This study, along with another study by Raghuram and Subramanian (2005), indicated that aid-receiving countries would have been under the influence of the well-known "Dutch disease effect," which is reflected in the appreciation of real exchange rate, adversely affecting the competitiveness of exports, thereby weakening their economic growth.…”

Anti-Poverty Psychology

“…As a caveat, Banerjee et al also caution that the time-frame was only 15-18 months. This is likely to be insufficient for health, education, and gender empowerment effects to show up (Clemens et al 2004). So the evidence itself is probably inconclusive.…”

“…So too is economic growth. In a noted review of aid's effectiveness, Clemens et al (2004) divided it into: longer term (like aid to support democracy) versus shorter term (like building and other infrastructure projects). The review focused on shorter term aid.…”

Foreign Aid and the Human Development Indicators in Sub-Saharan Africa

“…Good policies in this context refer to low infl ation, increased trade openness and small budget defi cits or surpluses. Indeed, the BD study has stimulated further researches such as Clemens, Radelet and Bhavnani (2004), Collier and Dehn (2001), Dalgaard and Hansen (2001), Guillaumont and Chauvet (2004). Another recent study by Mwanza and Selin (2004) have also introduced the idea that deeper fi nancial markets or in other words, fi nancial development in aid-recipient countries facilitate the management of aid fl ows, 4 thereby enhancing absorption capacity and hence better aid effectiveness.…”