The effects of foreign aid, foreign direct investment and domestic investment on economic growth in African countries: Nonlinearities and complementarities

Abstract

This paper examines the relationship between foreign aid (AID), foreign direct investment (FDI) and domestic investment (DI) and its effects on economic growth in 41 African countries. Annual panel data from 1990 to 2016 are examined using fixed-effects (FE) and system-GMM estimators. We test the existence of nonlinearities and complementarities in the relationship between AID-FDI, AID-DI, FDI-DI, and AID-FDI-DI. Empirical results confirm the existence of a nonlinear relationship between AID, FDI, DI, and economic growth. Besides, the results show that AID and FDI have a significant positive complementing effect on economic growth. It is shown also that FDI complements DI, while the coupled effect of AID and DI remains weak in catalyzing growth. Moreover, the results indicate that the complementarity between AID-FDI-DI positively influence economic growth, revealing that AID and FDI work as a complement factor to DI and enhance its effectiveness in promoting economic growth. These insights have important policy implications. Policy-makers in African countries are well advised to implement concrete policy measures suitable for building on the growth momentum created by foreign capital inflows, like FDI, AID as well as remittance. countries to recipient countries, which include both grants and loans from bilateral and multilateral official agencies, are considered as important sources of funds for capital expenditures and could contribute to the immiserizing growth of developing countries (Tim et al., 2004). However, the interaction between AID, FDI, and DI is considered the topic to be studied in developing economies. While, FDI inflows to developing economies remains stable, growing to $706 billion, with significant differences among regions, Africa recorded the largest amount ($45.5 billion) of FDI flows in 2016 (UNCTAD, 2016). The rise in FDI was mainly due to the continuance of resource-seeking investments, and a more than doubling of FDI flows to South Africa (from $2.0 billion to $5.3 billion). Similarly, about AID, it is shown that official development assistance (ODA) receipts of developing countries increased significantly during the decade of the 2000s. However, based on AID recipient data, Africa recorded the highest ($49,954 million) of net ODA recipients in 2016, following by Asia with $43,516 million (World Bank, 2016). Against this background, net flows of ODA continue to be distributed more evenly across different developing countries than other official flows, such as FDI. This is true, despite the fact that donors' aid allocation is not only affected by country needs, but also by additional factors ranging from geopolitical considerations to historical and cultural ties, especially in the case of bilateral flows (Alesina & Dollar, 2000; Anderson, 2008). Though the literature is full of studies investigating the impacts of AID, FDI, and DI on economic growth, it is still inconclusive, with differences in empirical findings in terms of set of countries, data and estimation techniques. While there i...

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