Foreign aid and economic growth in the developing countries - a  (Page 4/21)

Commonly, many authors find the positive impact of foreign aid on growth subject to certain factors.Burnside and Dollar (1997), in their well-known paper “Aid, Policies, and Growth”, find that aid has a positive impact ongrowth in developing countries with good fiscal, monetary and trade policies but has little impact on countries where such policies arepoor. They use data from 56 countries for six four-year periods from 1970-1973 until 1990-1993 and construct a growth convergencemodel, in which growth depends on the logarithm of real per capita GDP at the beginning of the period, incorporating the ratio of aidover GDP and an index measurement for macroeconomic policies in the right hand side of the equation. They explain that “aid can affectoutput only through its effect on the stock of capital, that is, to the extent that it is used for investment rather than consumption”.They argue that aid itself has small and insignificant impact but aid interacting with good policy has a significant positive impacton growth. In fact, policy seems more important for aid effectiveness in lower income countries. Moreover, they show thataid follows diminishing returns to scale. Another finding is that there is no tendency for total aid or bilateral aid to favor goodpolicy, while multilateral aid is allocated in favor of good policy.

Aid works well in a good policy environment and a poor country with good policy should get more aid, which isnot always the case in reality. A well-designed aid plan can support effective institutions and governance by providing moreknowledge and transferring technology and skills. It is recommended to decentralize the aid flows in recipient countries. Money aid isimportant but idea aid is even more important. Aid can be the midwife of good policy in recipient countries. In poor-policycountries, idea aid is especially more essential than money aid. This implies that in a good-policy environment, aid increasesgrowth via the investment channel whereas in a poor-policy environment, it nurtures the reforms through policymakers trainingor knowledge and technology transfer. These non-money effects are believed even more important and viable than the money value ofaid. Aid works much better where the reform is initiated or internalized by local government rather than when it is imposed byoutsiders. Therefore, aid is normally more effective when it facilitates efficiently and timely reforms triggered by the localauthority (World Bank, 1998).

Foreign aid has a strong positive impact on economic growth in less developed countries (LDCs) for both periods1960-1970 and 1970-1980 when state intervention is not taken into account. When the state intervention variable is included in theregression, the effect of foreign aid gets statistically weak over time. Moreover, foreign aid negatively affects the domestic savingsrate whereas per capita income, country’s size and exports positively affect it (Singh, 1985).

Different types of aid have different impacts on growth. In a country analysis of Cote d’Ivoire from 1975 to1999,Ouattara (2003) categorizes foreign aid into project aid, program aid, technical assistance and food aid. Using a disaggregationapproach with auto regressive techniques, he finds that (i) project aid displaces public savings, impact of program aid is almostneutral while technical assistance and food aid increase public savings, and (ii) project aid and to a lesser extent, program aid,worsen the foreign dependence of Cote d’Ivoire while technical assistance and food aid reduce the gap.