Does Aid Matter for Foreign Direct Investment in ECOWAS: Investigating The Infrastructure Channel?

Abstract

We ask the data whether and how aid targeted at specific sub-categories of economic infrastructure could assist ECOWAS economies to attract higher Foreign Direct Investment (FDI) inflow via improvement in infrastructure in Water Supply and Sanitation (WSS), energy, transport, and ICT. By relying on the 3SLS estimation technique that is able to explicitly account for dependencies between 3 structural equations on the allocation of targeted aid, the determinants of infrastructure, and the determinants of FDI – we found quite interesting results. First, aid targeted at infrastructure indicates strong positive effect on the countries’ infrastructure endowment, as expected. Second, there is robust evidence that aid promotes FDI but, surprisingly, not necessarily through the infrastructure channel. Targeted aid appears to exert a positive and direct knock-on effect on FDI - apparently, because investors anticipate the positive effect that targeted aid is almost always inclined to produce on host countries’ infrastructure endowment. Finally, aid allocation by Development Assistance Committee donors seems to have primarily been merit-based, followed by weaker evidence for ‘need’. Therefore, we recommend more need-based aid allocation particularly in economies where initial infrastructure endowment is minimal. There is also need for extended effort at index construction (e.g., index of infrastructure need) and data collection to drive country-case studies. This should identify the transmission channel from aid to FDI and how the associated binding constraints could be overcome.