The impact of Foreign Aid on the Economic Growth and Development of Sub-Saharan African Countries.
- juweejr2017
- Jun 10, 2019
- 10 min read
By Aloysius Juwee Morris
Abstract
This study analyses the impact of Foreign Aid on the economic growth and development of Sub-Saharan African countries. The study has collected data from a list of 46 out of the 50 plus African countries from 1980 to 2017. The study tested the hypothesis that Foreign Aid promotes growth in developing countries using Panel data series of foreign Aid.
Foreign Aid’s effect on economic growth measured in terms of real GDP growth rate has had many mix results and reactions from different scholars who have written extensively on the subject.
The results of this study show that the behavior of authorities in Sub Saharan African Countries has made Foreign Aid to have no significant impact on Economic growth as represented by the dependent variable Annual GDP Growth Rate.
Key Words: Corruption, Developing countries, Economic growth, Foreign aid, Human capital, Public debt Official Development Assistance, OECD GDP Per-Capita, Absorptive capacity, Private Capital Flow.
INTRODUCTION
Foreign Aid has played a very fundamental role in the socio development of developing countries especially in Sub Saharan Africa. Sub Saharan Africa is the countries that lie south of the massive Sahara Desert It has been established by credible sources that since the 1960s, Africa has benefited from an estimated 600 Billion in Foreign Aid. But Africa sadly still lags behind in terms of growth and development.
The paper seeks to establish a relationship between Foreign Aid on the one hand and GDP growth and by extension development on the other hand. How Foreign Aid has impacted developing countries in Sub Saharan Africa.
There are several previous empirical studies on the subject matter and these studies have proven to have mixed results. Prominent amongst those are, Hansen and Tarp (2000), Gominee et al (2003) Dalggaard et al (2004), and Karras (2006), found out that there is positive effect of Foreign Aid on growth; Burnside and Dollar (2000) also find evidence that foreign aid has a positive effect on growth only in economies where there are effective monetary, fiscal and trade policies; Brautigam and Knack (2004) find evidence that foreign aid has had a negative effect on growth; while Jansen and Paldam (2003) found evidence to suggest that foreign aid has had no effect on growth.
As we may be aware the main role of foreign aid in stimulating economic growth is to provide support domestic financial sources; such as savings, which leads to increased investment and capital stock.
The primary focus of the paper is Liberia my home country. Liberia is a country located on the West Coast of Africa with an estimated population of about 4.9 Million persons (2017 est.). The country has been plagued by political instability and corruption. Due to these, the country remains underdeveloped amidst the huge amount of aid provided by the International and donor communities. This paper seeks to further establish that Foreign Aid has so far had no direct positive effect on the growth and development of Liberia as was supported by the findings of Brautigam and Knack (2004). It has been empirically established that since the 1960s to 2018, Liberia has received in foreign aid in the amount of 16.9 billion United States Dollars from various international Partners including United States Agency for International Development (USAID), The Paris Club, the EU, China, The UK, and other Bretton Woods Institutions Like the World Bank, etc.; and as proven by Burnside and Dollar (2000), there has not been any real positive effect because of the lack of effective fiscal, monetary and trade policies in Liberia.
Instead of positively impacting growth and development in Liberia, these aid packages have only ended in the domain of corrupt officials of government and made the rich richer and the poor poorer. In spite of this massive foreign aid, over 50% of the Population lives in extreme poverty, Life expectancy is just 57 years on the average for males and females; the population is one of the least skilled with illiteracy of over 60%. Liberia remains way down the HDI.
Liberia remains settled at the bottom of Transparency International’s corruption barometer.
There has recently been a marked increase in the amounts of Foreign Aid to Sub sahara Africa while other inflows have had a rapid decline( Foreign Direct Investements and Remittances) and these other sources of flows are expected to further spiral down to a record low in the coming years. Another point of Interest is that the budget of developing countries in Sub Saharan are hit hard by rises in food prices, oil prices and a sharp decline in the prtice of extractive minerals such as iron ore which has had an advesre on the export values of Liberia and has affected the flow of Foreign Exchange flow into the region.
Africa being the highest recipient of Foreign Aid; i.e net bilateral aid to Africa totaled an amount of USD 26 Billion and of that amount, 22.5 Billion came to Sub Saharan Africa in the year 2008 alone those are the aid amounts as captured by the Official Development Assistance from a cluster of countries (donors) known as the Development Assistance Committee (DAC). These amounts do not include debt reliefs for those countries that have been classified as Heavily Indebted Poor Countries (HIPC). According to the Organization for Economic Cooperation and Development (OECD), bilateral aid to sub Saharan Africa rose to 10% in real terms.
The issue of the economic effect of aid, especially public aid is characterized by many scholarly disagreements on one side of the paradigm, the traditionalist argued that foreign aid has spurred growth while other side are critics who have argued that foreign aid has had no significant effect on the growth and development of recipient countries. Michael P. Todaro (p 707)
Total official and private flows are defined as the sum of official development assistance, other official flows and private flows. This represents the total (gross or net) disbursements by the official and private sector of the creditor country to the recipient country. Total official flows incorporate the sum of concessional and non-concessional flows to developing countries, including export credits, which have a primarily commercial motive. Private flows are defined as flows at market terms and financed out of private sector resources and private grants. This indicator is measured in million USD constant prices, using 2014 as the base year.
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LITERATURE REVIEW
Foreign Aid is defined as the voluntary transfer of resources from one country to another country. This transfer includes any flow of capital to developing countries. A developing country usually does not have a robust industrial base and is characterized by a low Human Development Index (HDI).
Foreign aid may be given as a signal of diplomatic approval, or to strengthen a military ally. Other reasons to give foreign aid include to reward a government for behaviour desired by the donor, to extend the donor’s cultural influence, to provide the infrastructure needed by the donor for resource extraction from the recipient country, or to gain other kinds of commercial access.
Given the above definition for Foreign Aid, and the desire to see a world where there is an improvement in human capital, a reduction in poverty and improvement in infrastructural development, the concept of giving out foreign Aid to less privileged countries by donor countries has been a moral imperative. Liberia, in particular, has benefitted from the massive provision of foreign Aid since its founding but this paper will limit its scope to the last five decades and a half. From this period until 2017, Liberia has benefited an estimated 16.9 billion United States Dollars in aid with the United States being its biggest donor. Has these massive aid packages impacted Liberia’s growth and/or development? Is the answer this paper seeks
In his findings Karras (2006), concluded that the effect of foreign aid on growth in Sub Saharan Africa is positive, permanent and significant statistically; what this finding did not consider was how effective policies such as fiscal, monetary and trade are in the region.
However, Ekanayake and Charrna (2010) find evidence that foreign aid has had a mixed effect on the economic growth of developing economies. Ouattara (2006) concludes in his findings that more focus should be placed on debt servicing than on acquiring additional loans because according to his paper which focuses on Senegal, 41% of aid to the country is used to finance Senegal’s debts and that the debt servicing has been proven to have a significant negative effect on domestic spending.
Aid to Sub-Saharan Africa has been crucial for many years because the majority of the countries in the region have high corruption-levels, which create deep-rooted problems for the recipient country and how the aid amounts are managed for the direct positive effect on economic growth in sub Saharan Africa Zahra Sheikh Ahmed (2014)
However, it has been proven theoretically unclear whether foreign aid has had any positive effect on economic growth. ... several empirical studies using cross-country data, panel data and time series data have also reported a negative relationship between capital inflows and domestic savings in developing countries, raising doubts that foreign aid can positively impact economic growth.
In his work Svensson (1999) examines whether civil and political liberties play any role in aid effectiveness. In that work he finds that an aid and democracy interaction term is highly significant and that an aid and policy term as postulated by à la Burnside and Dollar is insignificant. Democracy has been established to be only a proxy for good policies which is important for aid effectiveness.
Roodman examines seven leading papers in the aid-growth literature, (including Burnside and Dollar (2000), Collier and Dollar (2002) and Dalgaard et al. (2004)) and finds that each of them is susceptible to changes in the sample and in specification. Similarly, Clemens et al. (2012), a paper that makes many very important contributions, shows that changes to the identification strategy of three influential papers in the literature, including Burnside and Dollar (2000) and Rajan and Subramanian (2008), changes the results dramatically and brings their findings into broad agreement that aid has an unconditional effect on growth. Kosack (2003) finds that aid has a positive effect on HDI growth but onlyin democratic countries. His estimates also suggest that aid will have a negative effect on HDI growth in countries where rule of law is a major challenge. Interestingly, he finds that democracy alone has a negative effect on HDI growth; but in poor countries where democracy is practiced, the impact of aid could reverse the negative effect; in short, he implies that democracy without aid would only affect Human Development Index negatively in poor countries
(p. 6). McGillivray and Noorbakhsh (2007) examine the effect of aid on the level of the HDI and allow conflict to enter the analysis. They find that aid alone has a negative effect on HDI scores but disagree with Kosack (2003) in that they do not find either a negative effect of democracy on the HDI or a positive aid*democracy interaction term. These two studies gives us a second reason to divide the sample along lines of democracy.
Using quantile regression, Gomanee et al. (2005b) examine aid’s effects on human development as measured by both the HDI and the infant mortality rate. They argue that while aid might not have a direct effect on welfare, it may have an indirect one via pro-public expenditures (PPE). By constructing a PPE index they find that aid has a positive effect on welfare through public expenditure and that the effect is greater in countries with lower welfare. They also argue that good economic policy is not required for aid to be effective in promoting human development. A related paper, Gomanee et al. (2005a), finds to the contrary that there is a direct effect of aid on human development and little evidence of an indirect effect via PPE. It is clear that there is nearly as much disagreement and tendency for conflicting results in the aid-human development literature as there is in the aid-growth literature.
There are also works that concern with the effects of aid on economic and human development. However, the papers above provide a sufficient overview of the evidence and suggest that it may be informative to examine whether aid has different effects in groups of countries defined by economic policy and democracy.
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Methodology, Concept and Statistical Models
The method of research used to analyze the data is Panel pooled Data across randomly selected countries throughout sub Saharan Africa to establish the true effect of Foreign Aid on economic growth as represented by GDP growth rate which is used in the model as the dependent variable. Most of the emphasis is on Liberia my home country.
The section also discusses the model specification to examine the relationships between Foreign Aid and per capita GDP growth over a period of time from 1980 to 2017.
The model is derived using the conventional production function which introduces Foreign Aid as a new variable as seen below:
Y=f(L,K,A);
where Y is the GDP in real terms L represents labor stock, K is the Capital stock of the domestic economies and A is the Foreign Aid stock
Given the above, I derive the growth rate determinants of real GDP as follows:
y=α+βl+δk+ϕa
The lower case letters in the model above denote the rate of growth of the individual variables as precedent in many other studies on the matter abay, the rate of growth of capital is approximately determined by the share of investment in gross domestic product.
Since there are rather insurmountable problems associated with the attempts to to measure capital stock, the above assumptions are necessary. The paper shows that there is a diminishing returns to Foreign Aid due to the absorptive capacity constraints of the the recipient countries especially those in sub-Saharan Countries, particularly Liberia. To take the above relationship into account, I add a square term to the model below:
GDPPC Git=β0+ β1ODACAPITAit+β2(GRLE/GDP)it+β3ln(ODA percent of GNI i0)+ β4+eit
Where the subscript it stands for i in years t and io represents the original level of the GDP of the dummy countries. The fundamental objective of this is to show the effect of foreign aid on GDP growth rate. The coefficients of β1 and β2 are positive while β3 is positive or negative and β4 is negative
Results
In order to ascertain the authenticity of these models a panel data was collected from 48 countries from sub Saharan including Liberia; in this model, the growth rate is measured by the growth rate of gdp per capita in 2015 dollars.
The data on GDP per capita is taken from the World Bank database, the data on ODA per capita, the ODA as a percent of GNI and other variables in the model were taken from the OECD and World Bank databases.
Below is the summary of the statistical findings using a random selection countries from the region under consideration.
Tables and figures missing
Recommendation
In order to enhance the true effect of Foreign Aid on economic growth, Donors should set criteria aimed at reducing corruption levels in recipient countries such as Liberia;
Foreign Aid has been misapplied on many instances by the government and so inorder to avert a future recurrence, aid recipient countries such as Liberia and other countries in the Sub Saharan countries should put into place monitoring and evaluations to ensure the key purpose for which the aid was given is met.
There should put place in place strong institutions and strong laws to fight corruption across nations of the region in so doing the foreign aid will have the desired effect on the development and growth of the countries concerned.
As in the case of Senegal, foreign aid should not be misapplied in ways such as servicing public debt and providing support for unplanned projects and/or providing means to enrich politicians.
References
Lauren Tait & Abu Siddique & Ishita Chatterjee, 2015.
Foreign Aid And Economic Growth In Sub-Saharan Africa
Economics Discussion / Working Papers 15-35, The University of Western Australia, Department of Economics.
Foreign Aid, Institutions, and Governance in Sub‐Saharan Africa
Deborah A. Bräutigam and Stephen Knack
Kieth Griffin and John L. Enos; Foreign Assistance: “Objectives and Consequences”, Economic Development and Cultural Change 18(1970): 313-327, Paul Collier, The Bottom Billion: why the poorest countries are failing and what can be done about it(New York:Oxford University Press, 2007), p 28
The Economic and Social Review, Vol. 47, No. 3, Autumn, 2016, pp. 339-360
The Effects of Foreign Aid in Sub-Sahara Africa
ROBERT GILLANDERS*
Hanken School of Economics, Helsinki, Finland
World Bank Annual Reports (2009,2010,…..2016)
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