Foreign aid and economic growth in the developing countries - a

ABSTRACT OF THE THESIS

Using cross-country data, I examine how foreign aid affects economic growth in developing countries over the period from 1975 to 2000. I find evidence that foreign aid significantly and negatively correlates with growth in developing countries. However, foreign aid to inland countries as well as to South Asian countries during the period of 1992-2000 is found to have a positive impact on growth. In addition, a strong divergence trend is found among countries in the data set. The results suggest that (i) there may be problems in the present aid providing system, where aid hinders growth of developing countries (ii) the successful experience of some inland countries and South Asian nations during the period of 1992-2000 could be a good lesson for other developing countries. Finally, a strong evidence of divergence implies that if the condition is not improved in the least developing countries, there would be a large income dispersion among developing countries in the future.

Chapter I

Introduction

1.1. Background

Foreign aid is usually associated with official development assistance, which in turn is a subset of theofficial development finance, and normally targeted to the poorest countries (World Bank,1998).

How does foreign aid affect the economic growth of developing countries? This is a question which has drawnthe attention of many scholars over time. Papanek (1972) finds a positive relation between aid and growth. Fayissa and El-Kaissy(1999) show that aid positively affects economic growth in developing countries. Singh (1985) also finds evidence that foreignaid has positive and strong effects on growth when state intervention is not included. Snyder (1993) shows a positiverelation between aid and growth when taking country size into account. Burnside and Dollar (1997) claim that aid works well inthe good-policy environment, which has important policy implications for donors community, multilateral aid agencies andpolicymakers in recipient countries. Developing countries with sound policies and high-quality public institutions have grownfaster than those without them, 2.7% per capita GDP and 0.5% per capita GDP respectively. One percent of GDP in assistance normallytranslates to a sustained increase in growth of 0.5% per capita. Some countries with sound policies received only small amount ofaid yet still achieved 2.2% per capita growth. The good-management, high-aid groups grew much faster, at 3.7% per capita GDP (WorldBank, 1998).

By contrast, other people find foreign aid has negative impact on growth. Knack (2000) argues that high levelof aid erodes institutional quality, increases rent-seeking and corruption, therefore, negatively affects growth. Easterly, Levineand Roodman (2003), using a larger sample size to reexamine the works of Burnside and Dollar, find that the results are not asrobust as before. Gong and Zou (2001) show a negative relation between aid and growth.

Pedersen (1996) argues that it is not possible to conclude that the foreign aid has a positive impact ongrowth. Morrisey (2001) claims that aid works well conditional on other variables in the growth regression. Many other authors findno evidence that aid affects growth in developing countries.