How Does Foreign Aid Affect Economic Growth

Foreign Aid and Economic Growth

The economic objectives of foreign aid are to induce high growth rates in Less Developing Countries which in turn will generate additional domestic savings and investment. However, there is much dispute as to whether development assistance to poor countries has been successful in achieving these objectives. There have been numerous attempts to investigate the effects of foreign capital in terms of direct foreign investment, and foreign aid and other foreign inflows on developing countries, their results have been conflicting.

Aid antagonists like Bauer claim there is a negative causal relationship between aid and growth in less developing countries. This is because aid retards growth by substituting

They argue that most studies show that where aid has dominated, pride and ambition have given way to dependence and deference, and where it has been targeted, public management and services have either decayed or collapsed, poverty and inequality have worsened, and insecurity has prevailed. He cites Rwanda as an example where many developed countries helped to position the country at the edge of the abyss of genocide – only to disclaim any responsibility in the aftermath. With a few exceptions, (Korea, Botswana and Honduras) where aid has had a significant impact on poverty reduction, improved social services and competent public institutions, in a much larger number of countries (Cuba, Zambia, Democratic Republic of Congo, Haiti, Sierra Leone, Somalia) western aid has played minor role in building efficient public sector and in lifting millions out of poverty. In some cases, major recipients of aid are today collapsed states (e.g. Congo Democratic Republic, Sierra Leone, Somalia). One of the best-known attempts to assess the impact of aid on growth is by Burnside and Dollar (2000). The study shows that aid has positive effects on growth in the good policy environment, while it does not work in a distorted environment. Good policy environments, according to Burnside and Dollar, are those that are open to trade, have low inflation rates, good share of the budget surplus in relation to GDP (lower budget deficit) and balanced government consumption in GDP. They further argue that there appears to be no systematic impact from aid on policy. For example, in Ghana, good policies were rewarded, while in the case of Zambia, aid increased between 1970 and 1993, while policies deteriorated throughout the period. Burnside and Dollar thus found that aid significantly increased growth in good policy environments as measured by a composite measure of macroeconomic