Foreign aid and economic growth in the developing countries - a  (Page 2/21)

By and large, the relation between aid and economic growth remains inconclusive and is worth being studiedfurther. In addition, geography is found to be influential on economic growth but so far this factor normally is neglected in thegrowth analysis (Gallup, Sachs and Mellinger, 1999). My study departs from other works in model, data set and approach ofanalysis.

1.2. Research Objective

Using an endogenous growth model for a data set of 39 countries over the period from 1975 to 2000, I would liketo address the following questions (i) what is the relation between foreign aid and economic growth in developing countries? and (ii)how does this relation differ across regions? Due to the data limitation, only these 39 countries have been chosen. To certainextent, they represent various regions of the developing world with different characteristics and stages of development.

1.3. Organization of the Study

The study is organized as follows. Chapter II reviews the literature with various outcomes shown by differentauthors with different views and models. Chapter III provides an overview of the regions in the study. Chapter IV describes the dataand methodology. Empirical results and policy implications are discussed in chapter V. Chapter VI concludes the study.

Chapter II

Literature Review

In general, aid is found to have a positive impact on economic growth through several mechanisms (i) aidincreases investment (ii) aid increases the capacity to import capital goods or technology (iii) aid does not have an adverseimpact on investment and savings (iv) aid increases the capital productivity and promotes endogenous technical change (Morrissey,2001).

Papanek (1973), in a cross-country regression analysis of 34 countries in the 1950s and 51 countries in the1960s,treating foreign aid, foreign investment, other flows and domestic savings as explanatory variables, finds that foreign aid has asubstantially greater effect on growth than the other variables. He explains that “aid, unlike domestic savings, can fill the foreignexchange gap as well as the savings gap. Unlike foreign private investment and other foreign inflows, aid is supposed to bespecifically designed to foster growth and, more importantly, is biased toward countries with a balance-of-payment constraint”. Healso finds a strong negative correlation between foreign aid and domestic savings, which he believes co-contribute to the growthperformance.

Fayissa and El-Kaissy (1999), in a study of 77 countries over sub-periods 1971-1980, 1981-1990 and 1971-1990,show that foreign aid positively affects economic growth in developing countries. Using modern economic growth theories, theypoint out that foreign aid, domestic savings, human capital and export are positively correlated with economic growth in thestudied countries. This is consistent with the economic theory offoreign aid, which asserted that overseas development assistance accelerates economic growth by supplementing domestic capitalformation (Chenery and Strout, 1966).