Foreign aid and economic growth in the developing countries - a  (Page 5/21)

On the contrary, project aid and food aid are found to reduce public investment whereas program aid and technicalassistance positively affect public investment in Uganda (Mavrotas, 2003).

Giles (1994), applying a Granger causality test between foreign aid and economic growth and other diagnostictests, finds a causal relationship between foreign aid loans, but not foreign aid grants, with economic growth in Cameroon, whichcontradicts the previous work of John Mbaku in 1993.

Domestic resources have positive and significant impact on economic growth while foreign resources donot show any significant contribution in Bangladesh from 1972 to 1988. However, after foreign resources are decomposed intodifferent categories, we can observe that the loans are more effective than grants and food aid is more effective than projectaid (Islam, 1992).

Aid might have different effects in different developing countries. Chenery and Carter (1973), following theprevious two-gap derived model of Chenery and Strout (1966) and using data from 50 countries over the period 1960-1970, show thatthe effects of official development assistance (ODA) on the development performance of countries under study are differentamong certain groups of countries. In five countries, namely Taiwan, Korea, Iran, Thailand and Kenya, foreign assistanceaccelerated economic growth whereas in six cases it retarded growth, i.e. India, Colombia, Ghana, Tunisia, Ceylon andChile.

In comparison to a no-aid pattern of growth, post-aid growth rates can be higher or lower depending upon threefactors (i) initial poverty of country (ii) additional rise of government consumption as percentage of aid received and (iii) theterm of aid. Ceteris paribus, a given amount of aid tends to increase post-aid growth if domestic savings ratio is higher, thepercentage of aid fungible into government consumption is lower and the term of aid is longer. The critical assumptions are thatgovernment replaces portions of its savings with aid then allocates this freed money to other programs, which can not be cut back oncestarted (Dacy, 1975).

Incorporating export price shocks into Burnside and Dollar’s (1997) analysis, Collier and Delh (2001) showa significant and negative relation between negative shocks and economic growth. They argue that “the adverse effects of negativeshocks on growth can be mitigated by offsetting increases in aid”. Therefore, they suggest that targeting aid towards negative shockexperiencing countries could be more effective than towards good-policy countries. Using a 2.5% cut off in their sample size of113 countries, they find 179 positive shocks and 99 negative shocks episodes. They indicate that the change in aid interacted withpositive shocks is insignificant, while the interaction of negative shock with the change of aid is significant at the 1% level.Additionally, incorporating shocks into Alesina-Dollar’s (1998) regression, they show that so far donors have not taken shocks intoaccount in aid allocation. Finally, they claim that the aid effectiveness might be increased significantly if both policy andadverse export price shocks are considered upon determining aid allocation.