Chapter 15: Foreign aid, economic growth, FDI, and trade openness in lower middle-income countries: a dynamic panel data analysis
A primary objective of foreign aid is to foster economic development. Although economic development does not always mean economic growth, there has been much theoretical debate, especially since the 1960s, about whether aid has a positive impact on the economic growth of the developing countries. Most of the earlier empirical studies supply inconclusive results. Mosley (1980) discusses the econometric flaws in these studies. More recent studies include Mosley (1997), who demonstrates that the net impact of aid is neutral overall, positive in most of the Asian countries, and negative in most of the African nations. This is consistent with Hansen and Tarp’s (2000) finding that aid impacts on economic growth, as long as the aid to gross domestic product ratio is not excessively high. According to two other studies (Collier and Dollar, 2002; Lensink and White, 2001), above a certain level, aid has a pernicious impact on the growth rate of a recipient country. The two studies, however, find different critical levels. On the other hand, Guillaumont and Chauvet (2001) maintain that the effectiveness of aid depends much more upon external factors (for example, export instability and terms-of-trade fluctuations) and climatic factors (for example, droughts, flood, and earthquakes) than on the economic environment. Specifically, they argue that aid is more effective in raising a recipient country’s income when external and climatic factors are worse. An influential book by World Bank (1998) provoked particular interest in the question of aid effectiveness.
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