By Axel Drehe

Rich countries gave more than $130 billion to official development assistance in 2014. Over the last five decades, western donors spent $4.14 trillion – the equivalent of more than seven times the 2014 GDP of Nigeria. These flows are topped up by support from non-governmental organisations and other private charities, and so-called new donor countries. Yet, in many of the developing countries receiving the aid, poverty still looms large, and underdevelopment persists.

The apparent lack of any correlation between the amount of foreign aid a country receives and its per capita rate of economic growth, in particular, has fostered vigorous debate among economists about whether or not aid is effective. Despite a large number of academic articles, this literature has not reached a consensus. Researchers seem divided into ideological camps, each fighting for their model, with one group claiming to show that aid works, and the other group pointing to a lack of robustness of these results. The earlier literature is far from providing causal estimates on how aid affects growth but rather shows (the lack of) correlations between the two. However, studying correlations alone can hardly provide insights – after all, aid could go to where growth is low or, as well, where good policies make future growth more likely.

Estimating the causal effect of foreign aid on growth: Current evidence

Attempts to estimate the causal effect of foreign aid on growth can be divided into four groups, all aiming to identify variables that affect growth only through aid (and use them as instruments for aid). One group relies on variables that are based on the size of the recipient country’s population to predict how much aid a country receives (e.g. Rajan and Subramanian 2008), a second uses past values of aid to predict current ones (and estimates difference or system GMM regressions, e.g. Minoiu and Reddy 2010), and a third predicts aid with the recipient’s political connections to their donors (e.g. Bjørnskov 2013). None of these strategies meets their goals. Population size affects growth through other variables than aid, like foreign direct investments or trade (Bazzi and Clemens 2013). Lagged aid can affect growth directly, even holding contemporaneous aid constant. And while political connections can be helpful to estimate the causal effect of politically motivated aid (the local average treatment effect, or LATE), there is little reason to be confident this effect could be generalised to represent those of aid in general.

Political motives of donors and aid

As we explain in Dreher et al. (2014), there are reasons to assume that the motive for giving aid affects the outcome. Among them, favoured countries get approval for aid projects of low quality that would not have been approved otherwise. What is more, political interests can reduce the motivation of the donor and recipient to invest in projects to make them most successful and to enforce the conditions that had been attached to the aid.

Figure 1 gives a hint of the political motives donors might have. The figure shows that countries of particular geo-strategic importance – measured by their presence as temporary members of the United Nations Security Council (UNSC) – receive substantially more aid than other countries, and get almost twice the aid the same countries receive before they enter the UNSC. This relationship holds in more rigorous settings, highlighting the importance of vote-buying in international organisations as one important motive for giving ‘aid’.

Read more: Does foreign aid boost growth?

Source:World Economic Forum