Does foreign aid play a role in the maintenance of economic growth? A non-linear analysis

Abstract

Should donors keep scaling up foreign aid or should they be more cautious because of the recipient country's limited absorptive capacity? This paper investigates the non-linearity hypothesis between foreign aid and economic growth for 25 developing countries during the period from 1984 to 2008. By using state space system equations, we provide a new insight to estimating the Panel Smooth Transition Regression Model (PSTR). This method identifies the estimated coefficients at each point of time and determines endogenously an appropriate threshold level. For upper middle countries, we recognise the positive impact of aid flows on economic growth but with diminishing returns while lower middle and least developed countries support the big push concept.

Evaluating the impacts of foreign aid on low-income countries in Sub-Saharan Africa

“…Aid is either misallocated (donors give aid for strategic reasons to the wrong recipients) or misused (recipient, being governments, pursue non-developmental agendas) such as was the case in Ghana and Malawi (Rena, 2013). In Ghana for example, aid came from multiple donors -USAID, DFID and World Bank -and the government was reaping the benefits though the GDP growth was stagnant (Rena, 2013;Harb & Hall, 2019). Countries depending on foreign aid with minimal corruption, public officials are less likely to misuse public funds, and in such, aid is utilized efficiently and effectively (Okada & Samreth, 2012).…”

“…All of these are intended to result in the recipient countries' sustainable development; however, foreign aid has led to a dependency syndrome instead of the intended economic growth (Ogundipe et al, 2014). Foreign aid is also perceived to encourage corruption, highly inefficient and ineffective government, stall democracy and hinder economic and investment growth (Harb & Hall, 2019).…”

Foreign financial flows, human capital and economic growth in African developing countries

“…Previously, Snyder (1990) showed that foreign aid has a crowd‐out effect on domestic savings in recipient countries. Harb and Hall (2019) pointed out the presence of the threshold effect of foreign aid on economic growth in developing countries. Maruta et al (2020) found that the effectiveness of foreign aid is conditional on the institutional quality of recipient countries.…”

Macroeconomic Effect of Foreign Aid

“…Other than the available statistics indicting foreign aids against development in Nigeria, empirical investigations into this issue have produced a mixed result. While findings from the works of Burnside and Dollar (2000); Chauvet and Ehrhart (2018); Harb and Hall (2018) present that foreign aid positively motivate growth and development, evidences from works of Djankov et al (2008) claim that foreign aid has a negative effect on institution and development in general. In fact, they assert that foreign aid is a bigger curse than oil in developing countries.…”

“…This paper is unique because, to the best of knowledge, it is the first paper to looks at the short-run and longrun symmetric and asymmetric impact of foreign aid on macroeconomic variables like real GDP per capita growth, Investment, inflation and interest rate at disaggregate level. Although, scholars like Djankov et al (2008) (on 108 countries) and Harb and Hall (2018) (0n 25 developing countries) examined the asymmetry effect of aids, their studies focus on aids at panel level, making it difficult to assess the individual effect of aid on the countries assessed.…”