Aid Absorption and Spending in Africa: A Panel Cointegration Approach

This article focuses on the macroeconomic management of large inflows of foreign aid. It investigates the extent to which African countries have coordinated fiscal and macroeconomic responses to aid surges. In practice, we construct a panel dataset to assess the level of aid ‘absorption’ and ‘spending’. This article departs from the recent empirical literature by utilising better measures for aid inflows and by employing cointegration analysis. The empirical short-run results indicate that, on average, Africa's low-income countries have absorbed two-thirds of (grant) aid receipts. This suggests that most of the foreign exchange provided by the aid inflows has been used to finance imports. The other third has been used to build up international reserves, perhaps to protect economies from future external shocks. In the long run, absorption increases but remains below its maximum. Moreover, we also show that aid resources have been fully spent, especially in support of public investment. There is only weak evidence that a share of aid flows have been ‘saved’. Overall, these findings suggest that the macroeconomic management of aid inflows in Africa has been significantly better than often portrayed in comparable exercises. The implication is that African countries will be able to efficiently manage a gradual scaling up in aid resources.     

The Real Exchange Rate,Foreign Aid and Macroeconomic Transmission Mechanisms in Tanzania and Ghana

Abstract

A recent study of 36 sub-Saharan African countries found a positive impact of aid in the majority of these countries. However, for Tanzania and Ghana, two major aid recipients, aid did not seem to have been equally beneficial. This study singles out these two countries for a more detailed empirical investigation. The focus is on the effect of aid when allowing external and nominal factors to play a role in the macroeconomic transmission mechanism. We conclude that when monetary and external factors are properly accounted for, then aid has been pivotal to growth in both real GDP and investment.     

Are There Negative Returns to Aid?

The World Bank report Assessing Aid assumes that an inflow of aid, above a certain level, starts to have negative effects. In this analysis we empirically test this assumption. We find evidence for negative returns to aid at high levels of aid inflows. However, the results are sensitive to both the countries included in the sample and model specification. Moreover, the turning-point above which aid starts to have a negative effect on growth seems to be much higher than assumed in the background calculations for Assessing Aid.     

Democracy’s effect on economic growth: A pooled time-series analysis, 1951–1980

The relationship between democracy and economic growth has concerned social scientists since the 17th century, but recent democracy movements make this question especially important today. Do poor countries face a cruel trade-off between democracy and growth? Do democracy and growth go together as a “win-win” proposition? Or is democracy irrelevant to growth? Using pooled annual time-series data from 1951–1980 for 106 countries, including 88 non-core countries, we explore long-term and short-term direct and indirect effects of democracy on growth. Little or no direct effect emerges, but positive indirect effects appear via two mechanisms: a marginally significant effect via investment and a robust effect via government expenditure. Democracy also has a robust non-linear effect on economic growth via social unrest, inhibiting growth under non-democratic regimes and furthering it in highly democratic ones. Combining these findings, we conclude that democracy does not significantly hamper economic growth, and under many circumstances slightly boosts it.     

Aid and Sectoral Growth: Evidence from Panel Data

This article examines empirically the proposition that aid to poor countries is detrimental for external competitiveness, giving rise to Dutch disease type effects. At the aggregate level, aid is found to have a positive effect on growth. A sectoral decomposition shows that the effect is (i) significant and positive in the tradable and the nontradable sectors, and (ii) equally strong in both sectors. The article thus provides no empirical support for the hypothesis that aid reduces external competitiveness in developing countries. A possible reason for this finding is the existence of large idle labour capacity that prevents the real exchange rate from appreciating.     

Aid and Performance: A Reassessment

Two visions of aid effectiveness and allocation are compared. The first, corresponding to the new aid paradigm, argues that aid is only effective if domestic policies are appropriate. The second, in contrast, argues that aid effectiveness depends on the external and climatic environment: the worse this environment, or the more vulnerable the recipient countries, the greater the effectiveness of aid. Cross-sectional econometric tests related to GDP growth on two 12-year pooled periods clearly favour the second view. The two views can be reconciled through the principle of performance-based aid allocation, where performance is defined as outcomes adjusted for the impact of environmental factors. Performance can then be measured in several manners which are subject to comparison. One approach would lead one to allocate more aid the worse the (external) environment is (for a given policy) and the better the policy is (for a given environment).     

Foreign aid and the economic growth of developing countries (LDCs): Further evidence

The objectives of this article are to revisit the critical role that foreign aid presently plays in the economic growth of the LDCs and to examine the nature of its utilization in those countries which heavily rely on foreign aid. Other sources of economic growth such as capital (physical and human capital), raw labor, technological changes, and the degree of political and civil liberties will also be considered. Using average cross-sectional data for eighty countries over the 1971–1990 period, the study shows that foreign aid has a statistically positive effect on economic growth in developing countries. Lack of political and civil liberties is found to have a negative, but statistically marginal impact on economic growth. A policy implication which may be drawn from the study is that foreign capital inflow can have a beneficial effect by supplementing domestic savings rather than replacing them. Bichaka Fayissa, Ph.D., is Professor of Economics at Middle Tennessee State University, Murfreesboro, TN. He has published in theInternational Journal of Social Economics, World Development, Keil World Economics, Quarterly Review of Economics and Finance, Applied Economics, Economia Internazionale, Journal of Economics and Finance, Journal of Legal Economics, and several other journals.     

Persuasion and Predation: The Effects of U.S. Military Aid and International Development Aid on Civilian Killings

ABSTRACT

Powerful states frequently employ foreign aid to pursue international security objectives. Yet aid's effectiveness will be undermined if it exacerbates the effects of conflict on civilians within recipient states. This article investigates how international development aid and U.S. military aid influence recipient governments' incentives and ability to target civilians. U.S. military aid has a persuasion effect on state actors, which decreases a recipient state's incentives and necessity to target civilians. Development aid flows, however, trigger a predation effect in some environments, exacerbating civilian targeting. An analysis of aid flows in 135 countries on civilian killings between 1989–2011 provides support for both the persuasion and predation effects associated with aid.     

Aggregate consumption,interest rates and inflation in LDCS: An error correction model

This article explores the relationship between the real interest rate and the consumption‐saving decisions in LDCs following the Error Correction Methodology. The model also includes an income term, the inflation rate and a term for inflation uncertainty. The main conclusion drawn from this exercise is that, for low‐inflation countries there is a positive and stronger interest rate effect on saving while this effect is less clear (and not significant) for most high‐inflation countries. Also, the results show that for at least half of the countries in the sample, an EC model with a unit elasticity restriction seems to be an adequate representation of the data.     

Robbing the Riches: Capital Flight,Institutions and Debt

Capital flight undermines economic growth and the effectiveness of debt relief and foreign aid, and sometimes drains more resources from poor countries than does debt service. In an analysis of a large panel of developing and emerging market countries using annual data for 1970–2001, we show that both institutions and macro policies robustly affect capital flight. Our study also supports the existence of a revolving door relationship between debt and capital flight. More notably we find countries with weak institutions have a greater propensity to accumulate debt because weak institutions spur capital flight, which, in turn, creates a financing need.     

Economic Fluctuations and Growth in Sub-Saharan Africa: The Importance of Import Instability

The traditional thesis that export instability (XI) is deleterious to economic growth in developing economies has received mixed empirical results. For African countries, recent research suggests that the effect of XI is weak, but that capital (investment) instability (KI) adversely influences economic growth. The current study argues that in many of these nations, imports are likely to be critical to the growth process, while exports represent only one of the various sources of investment resources. Hence, import instability (MI) may pose a more serious problem than XI in hindering economic growth. Employing 1968-1986 World Bank data for 33 sub-Saharan African countries, XI, KI and MI variables are calculated for each country as the standard errors around the respective 'best-fitted' trends over the sample period. These instability measures and additional World Bank data are then used to estimate an augmented production function that controls for the effects of labour, capital, and exports. The study finds that although KI is still a relevant argument of the production function, MI appears to be even more important, while XI is extraneous.     

Higher education and economic growth in Africa

This paper uses panel data over the 1960–2000 period, a modified neoclassical growth equation, and a dynamic panel estimator to investigate the effect of higher education human capital on economic growth in African countries. We find that all levels of education human capital, including higher education human capital, have positive and statistically significant effect on the growth rate of per capita income in African counties. Our result differs from those of earlier research that find no significant relationship between higher education human capital and income growth. We estimate the growth elasticity of higher education human capital to be about 0.09, an estimate that is twice as large as the growth impact of physical capital investment. While this is likely to be an overestimate of the growth impact of higher education, it is robust to different specifications and points to the need for African countries to effectively use higher education human capital in growth policies.     

The Long-run Relationship between Outward Foreign Direct Investment and Total Factor Productivity: Evidence for Developing Countries

Outward foreign direct investment (FDI) from developing countries has been growing significantly in both absolute and relative importance in recent years. Nevertheless, there is surprisingly little research on the home-country effects of outward FDI for these countries. This paper examines the long-run relationship between outward FDI and total factor productivity for a sample of 33 developing countries over the period from 1980 to 2005. Using panel co-integration techniques, we find that outward FDI has, on average, a robust positive long-run effect on total factor productivity in developing countries and that increased factor productivity is both a consequence and a cause of increased outward FDI.     

The Effectiveness of Aid under Post-Conflict Conditions: A Sector-Specific Analysis

It is widely believed that foreign aid may help conflict-affected countries to recover after the termination of conflicts. However, the available empirical evidence supporting this view largely neglects the heterogeneous nature of aid. Drawing on the conflict database of the Uppsala Conflict Data Program, we address the hypothesis that the effectiveness of post-conflict aid differs between specific sectors. Our focus is on social and economic infrastructure which is most likely to suffer during conflict episodes so that the need for aid is particularly pressing in this area. We find fairly robust evidence that post-conflict aid is effective in improving social infrastructure. In contrast, aid appears to be ineffective in improving economic infrastructure.     

The Robust Result in Meta-analysis of Aid Effectiveness: A Response to Mekasha and Tarp

In this response to Mekasha and Tarp (2013) we show that contrary to what they state, their study validates our basic analysis. They confirm that the literature finds that aid is of little economic importance in generating growth. The results also show that the literature systematically selects control variables for their effect on aid effectiveness. We argue that their choice of the random effects model is not appropriate for the problem at hand, and that the way they use multiple meta-regression analysis contradicts the robust results reached at the basic analysis.     

International tourism and export instability

Export diversification has been suggested as a strategy for decreasing the level of export earnings instability which is experienced by many developing countries. In recent years the international tourism sector has made an increasingly important contribution to the economies of many low income countries. This article examines whether diversification into the non‐traditional tourism sector has succeeded in decreasing the instability of export earnings. It was found that although tourism has the advantage of high growth rates and is a major source of foreign currency receipts, earnings from international tourism did not bring about a significant decrease in the instability of export earnings of most of the developing and industrialised countries considered. Furthermore, a net increase in the instability of earnings from tourism and merchandise exports occurred in a number of countries, and may be a particular problem in small, open developing economies.     

Modelling the demand for foreign savings in developing countries: Testing a hypothesis with Latin American data

The demand for foreign savings is an important feature of the economy in many LDCs, and it would be helpful to have a better understanding of its determinants. This paper considers one approach to modelling the demand for foreign savings in LDCs. If the demand for investment shifts out more buoyantly than does the supply of domestic saving in response to current macro‐economic conditions, persistent demand for foreign savings will be generated as a normal feature of the development process. We test this hypothesis with elasticities computed from the parameters of investment and domestic saving equations estimated for a sample of 21 Latin American countries. The empirical results show that in approximately half of the countries in the sample (and most notably in Brazil and in Mexico), the demand for foreign savings is rooted in the parameters of the investment and domestic saving functions.     

Aid and Resource Mobilisation in Sub-Saharan Africa: the Role of Reverse Flows

This article seeks to ascertain the role of ‘reverse flows’ in explaining the observed limited impact of aid on resource mobilisation in Sub-Saharan Africa. It departs from the previous empirical literature on aid and resource mobilisation by abandoning the pervasive, but untenable, assumption that aid either displaces domestic saving (increases consumption) or increases investment. Some aid is, in fact, used to finance reverse flows (debt servicing, capital flight, and reserve accumulation). The evidence suggests that, for the period covering 1980 to 2006, nearly 50 per cent of aid to Sub-Saharan African countries was used to finance reverse flows.     

The Return to Foreign Aid

Abstract

We estimate the average rate of return on investments financed by aid and by domestic resource mobilisation, using aggregate data. Both returns are expected to vary across countries and time. Consequently we develop a correlated random coefficients model to estimate the average returns. Across different estimators and two different data sources for GDP and investment our findings are remarkably robust; the average gross return on ‘aid investments’ is about 20 per cent. This is in accord with micro estimates of the economic rate of return on aid projects and with aggregate estimates of the rate of return on public capital.     

Who Benefits from Aid for Trade? Comparing the Effects on Recipient versus Donor Exports

Abstract

Recent studies offer an ambiguous picture on the effectiveness of foreign aid in strengthening the export capacity of recipient countries. Moreover, the literature on aid for trade (AfT) has often neglected the fact that exporters in the donor countries may be among the main beneficiaries. We simultaneously estimate and compare the effects of AfT on trade in both directions. We find that AfT increases recipient exports to donors as well as recipient imports from donors. The first effect tends to dominate the latter, which contradicts the sceptical view that donors grant AfT primarily to promote their own export interests.