Re-examining the relationship between domestic investment and foreign aid: does political stability matter?

Abstract

While past studies had conflicting conclusions regarding the impact of foreign aid on growth and development of a nation, recent studies have tried to delve deeper into the question, 'what makes aid work?' (see, Dutta, Leeson, and Williamson, 2013; Dollar, 2000, 2004;Svensson, 1999). This paper tests how political stability (vis-à-vis political instability) affects the relationship between domestic investment and foreign aid. Applying dynamic panel estimators, our results show that political stability affects aid's effectiveness on domestic capital formation. The paper considers alternative measures of political stability (vis-à-vis instability), focusing on the political characteristics of a system that have the potential to make a nation stable. Political stability affects policy selection by the government positively and, thus, public resources such as foreign aid are put to the desired use. The estimated marginal impacts show that foreign aid enhances domestic investment in the presence of a stable political climate, but there is a diminishing return to aid.

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

“…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.…”

“…Furthermore, a strand of literature has shown that aid works differently across different circumstances. These include studies that found: first, the positive effect of aid on growth differs across countries with aid exhibiting diminishing returns at higher level due to 'timing aid effect' and types of aid (Clemens et al, 2012;Doucouliagos and Paldam, 2010;Dutta et al, 2015). Second, the effect of aid on growth differs when disaggregating the sample into different regions/sub-regions where aid has a significant positive impact on growth in Africa but not in Asia, Latin America and the Caribbean (Ekanayake and Chatrna, 2010).…”

“…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).…”

World Economic Outlook, April 2018

“…Tandis que les études de régression sur la croissance au sens large ont mis en doute l'efficacité de l'aide aux pays émergents (par exemple Rajan et Subramanian, 2008), les nouvelles stratégies de répartition de l'aide des bailleurs de fonds produisent des résultats positifs dans certains cas. L'aide étrangère peut stimuler les transferts de technologie et la productivité dans les pays à faible revenu par différents canaux : (Burnside et Dollar, 2000 ;Collier et Dollar, 2002 ;Dutta, Mukherjee et Roy, 2015).…”

World Economic Outlook, April 2018

“…Исследования показали, что на макроэкономическом уровне иностранная помощь может способствовать передаче технологий и повышению производительности в странах с низкими доходами. Например, в работе Walley and Cushing (2013) (Burnside and Dollar, 2000;Collier and Dollar, 2002;Dutta, Mukherjee, and Roy, 2015).…”