Foreign Aid – Economic Growth Nexus: A Systematic Review ... · Theory & Evidence from Developing...

DYNAMIC RESEARCH JOURNALS (DRJs) Journal of Economics and Finance (DRJ-JEF)

Volume 2 ~ Issue 7 (July, 2017) pp: 01-16

ISSN (Online); 2520-7490 www.dynamicresearchjournals.org

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Foreign Aid – Economic Growth Nexus: A Systematic Review of Theory & Evidence from Developing Countries

1Thabani Nyoni and 2Wellington G. Bonga

[email protected] ; [email protected]

Abstract: What is the relationship between foreign aid and economic growth? This is probably one of the most

famous questions in the foreign aid – economic growth debate. Whether this question has been sufficiently

answered remains to be known. Developing nations have been and continue to be known to receive help from

developed countries. Now, the reason for which the developed countries give aid is another aspect on its own. In

this study, we look at the foreign aid - economic growth nexus by systematically reviewing both theory and

evidence from 33 studies carried out in over 100 developing countries around the world. Theory and evidence

reveals that the foreign aid - economic growth nexus is ambiguous. However, our analysis indicates that foreign

aid is positively related to economic growth in most developing countries and therefore developing countries

cannot afford to turn a blind eye at the donor community. We also note with kin interest that in developing

countries where there is excessively bad governance and rampant corruption, recipient governments

paradoxically lament over aid ineffectiveness. What a scenario! The study, amongst other policy prescriptions,

advises recipient governments to use aid for its intended purposes and stop playing the blame-game at the

expense of their poor and the ailing economies.

Keywords – Aid Policy, Developing Countries, Economic Growth, Foreign Aid.

JEL Codes: E21, E22, F21, F34, F35, F42, F43, G28, H54, H81, H84, I22, O24, O43, P33, P35, P45, R53.

I. INTRODUCTION

“Foreign Assistance is not an end1 in itself. The purpose of aid must be to create the conditions where it is

no longer needed” – Former United States President, Mr. Barrack Obama, 2009

Foreign aid can be defined as the international transfer of public funds in the form of loans and grants

directly from a government or international financial institution to another government for welfare purposes.

Briefly, they take two forms such as loans at concessional terms (constitutes 25% of grant amount) and grants

such as non-refundable in nature (World Bank, 2015; OECD, 2015). Foreign aid consists of all resources –

physical goods, skills and technical know-how, financial grants (gifts), or loans (concessional rates) transferred

by donors to recipients (Riddell, 2007). Foreign aid forms one of the largest components of foreign capital flows

to low-income countries (Radalet, 2006). It is no secret that developing countries are characterised by resource

starved economies, with crucial constituents of these resources being capital related. This much needed capital

to boost economic growth and welfare is largely inadequate domestically, which consequently warrants the need

for external capital. And most of low income countries lack the necessary impetus to attract substantial FDI, the

ONLY external capital readily available to support development undertakings has to come from foreign aid

(Kargbo, 2012).

The existence of foreign aid has been on the global scene as it has been in existence since the creation of

national states and republics. Developed countries have always helped developing countries to the reduce

suffering of mankind. Foreign aid, as highlighted by Pallage & Robe (2001), is a significant source of income to

developing countries, especially in Africa, where it averages 12.5% of gross domestic product (GDP) and

establishes by far the important source of foreign capital. Therefore, foreign aid has the potential to play a key

role in promoting and sustaining both economic growth and development in developing countries all over the

world.

It is imperative to highlight the ambiguity on the nature of the relationship between foreign aid and

1 Perhaps, the main mistake, should we say, with most developing countries governments; is that they want to engage foreign aid in order to

“clear” their problems. This should not be the case. Aid should be there to close those gaps that exist as a result of lack of domestic resources, not as a result of poor governance, greed and so forth. When aid is continuously needed, in most cases; that is a sign that, the

recipient government is not using aid for the intended purpose. Why, for example, would Zimbabwe, Nigeria, Pakistan, India, Ethiopia etc

“continuously” need foreign aid? Food for thought. Unfortunately, politicians and other “politically connected” citizens in recipient

countries, after misusing and or facilitating the misuse of aid; have a tendency of blaming the donor community. It is imperative to note that

when aid is properly used, there should be a point when the recipient country would be self-sufficient and would need no more aid.

Foreign aid – Economic growth Nexus: A Systematic Review of Theory & Evidence from Developing Countries


economic growth. In fact, mainstream foreign aid literature is generally torn between two rival schools of

thought, the aid-skeptics and the aid-optimists. Foreign aid-skeptics2; in support of the “Dutch Disease” (the

idea that high levels of aid inflow may generate undesirable effects on the economy), argue against the

proponents of the aid-effectiveness hypothesis, the aid-optimists; and apparently assert that, foreign aid; rather

than helping poor countries to grow richer, crowds out both private sector investment and innovation and leads

to increased government corruption and rent-seeking, undermining both economic and political development,

enabling governments to remain unaccountable to their citizens, encouraging dependency on donors and

therefore effectively reducing incentives for recipient countries to adopt good policies.

However, on the other side of the same coin; several aid-optimists3, vehemently argue against the “Dutch

Disease” popularized by aid-skeptics; and rather maintain that there is a positive relationship between foreign

aid and economic growth. This is primarily attributed to the debatable fact that foreign aid complements

domestic resources, supplements domestic savings, helps to close the foreign exchange gap, provides access to

modern technology and managerial expertise and allows easier access to foreign markets.

Foreign aid, as averred by the World Bank (2013), has been relatively considered as a stable source of

foreign exchange earnings in comparison to the other sources of foreign capital such as Foreign Direct

Investment (FDI) and Foreign Portfolio Investment (FPI). The Monetary Declaration of 2002 notes that foreign

aid, in the form of Official Development Assistance (ODA) plays an important role by complementing other

sources of financing required for development, especially for those developing countries where private direct

investors are reluctant to invest with the fear of low profit.

Furthermore, foreign aid also stimulates economic development by providing the necessary infrastructure,

strengthening basic social services such as health and education, providing humanitarian assistance during crisis

periods as well as rejuvenating distressed economies such as the Samalian, Angolan, Malian, DRC, Niger,

Burundi, Nigerian, Indian, Mozambican, Pakistan and Kenyan economies. For bed-ridden economies like

Zimbabwe, aid cannot be avoided! In this consciousness, this study seeks to systematically review both theory

and evidence on the relationship of foreign aid and economic growth in the context of several developing

countries around the world.

Relevance of the Study

Although foreign aid plays a pivotal role in developing countries, it is alarming to note that developing

countries continue to lament over uncountable socio-economic problems such as unemployment, high degree of

indebtedness and absolute poverty. GDP growth in most developing countries is very low despite relatively

significant aid inflows as portrayed in figures 1 & 2 below. This debatable scenario has prompted the researchers

to systematically scrutinize the nexus of foreign aid and economic growth in developing countries. Furthermore,

sustaining economic growth is a top priority for most developing countries and yet domestic resources in most

low-income countries are far from adequate. This could be attributed to that fact that in most developing

countries savings rates are usually very low. Such disproportionate gaps between the countries exports and

imports frequently result in trade deficits; and these scenarios of two gaps, savings gap and trade gap; can be

closed using foreign aid if developing countries are to sustain economic growth. Therefore, the present study

seeks to investigate the relationship of foreign aid and economic growth in developing countries.

Statement of Objectives

� The main objective of this study is to systematically examine the nexus between foreign aid and

economic growth in developing countries.

Other objectives are:

� To investigate other factors that also exist to affect economic growth in developing countries.

2 such as Chandrasekhar (1965), Rhaman (1968), Jalee (1968), Frank (1969), Griffin (1970), Griffin & Enos (1970), Hayter (1971), Bauer

(1972), Bauer (1976), Wood (1980), Hayter (1981), Bauer (1982; 1984), Krauss (1983), Hayter & Watson (1985), Mbaku (1993), Pack &

Pack (1993), Boone (1994), Pedersen (1996), Svensson (1998), Dollar & Easterly (1999), Knack (2000), Lensik & Morrisey (2000), Hudson

& Mosley (2001), Gong & Heng-fu (2001), Knack (2001), Easterly et al (2003), Brautigan & Knack (2004), Mallick & Moore (2006),

Roodman (2007), Mallick (2008), Rajan & Subramanian (2008), Ngang (2008), Moyo (2009), Christensen et al (2010) and Safdari & Mehrizi (2011) amongst others 3 such as Rostow (1960), Rosenstein-Rodan (1961), Chenery & Bruno (1962), Chenery & Strout (1966), Papanek (1973), Gulati (1975),

Over (1975), Gupta (1975), Mosley (1980), Singh (1985), Hudson & Horrel (1987), Mosley et al (1987), Levy (1988), Islam (1992), Islam

(1995), Snyder (1993), Fayissa & El-Kaissy (1999), Burnside & Dollar (2000), Henrik & Tarp (2000), Hansen & Tarp (2001), Morrisey

(2001), Lu & Ram (2001), Collier & Dollar (2002), Chauvet & Guillamount (2003), Lloy et al (2003), Gomanee et al (2003), Kosack

(2003), Easterly et al (2004), Dalgaard et al (2004), Burnside & Dollar (2004), Clemens et al (2004), Ghulam (2005), McGillivray (2005),

Hatemi & Irandoust (2005), Addison et al (2005), Karras (2006), Pattillo et al (2007), Bearce & Tirone (2008), Minoiu & Sanjay (2009),

Salish & Ogwumike (2010), Arndt et al (2010), Sakyi (2011), Herzer & Morrissey (2011), Clement et al (2012), Juselius et al (2014) and

Arndt & Jones (2015) amongst others



II. FOREIGN AID INFLOWS TO DEVELOPING COUNTRIES: FACTS & FIGURES

Top 17 recipient countries of gross ODA inflows are Myanmar, Afghanistan, India, Vietnam, Indonesia,

Kenya, Egypt, Nigeria, DRC, Morocco, Mozambique, South Sudan, Uganda, Ethiopia, Pakistan, Tanzania and

Syria. Amongst the top 10 countries, according to the OECD (2015), the first top 5 countries constitutes 15% of

the total gross ODA whereas the top 10 countries constitutes 23% of gross ODA inflows. Below is a pie chart

showing the share of both bilateral and multilateral aid in total ODA inflows provided by the DAC countries

where multilateral ODA constitutes 31% and the rest 69% ODA inflows provided by the bilateral institutions:

Figure 1

Source of Data: OECD, 2015

Top 10 ODA donors in 2014 Table 1 Donor ODA (USD million) % United States 9338 17

EU Institutions 6737 12

IDA 6386 12

United Kingdom 4346 8

United Arab Emirates 3787 7

Germany 3016 6

France 2929 5

African Development Bank 2042 4

Global Fund 1957 4

Japan 1558 3

Other donors 12098 22

Total 54193 100


Table 1 above shows that in 2014 the United States provided 17% ODA in developing countries while

the UK, Germany and France provided 8%, 6% and 5% ODA respectively. Other donors accounted for 22% of

ODA.

Top 10 ODA recipients by recipient USD million, net disbursements in 2014 Table 2 Country ODA (USD million) % Ethiopia 3585 7

Egypt 3532 7

Kenya 2665 5

Tanzania 2648 5

Nigeria 2476 5

DRC 2398 4

Morocco 2247 4

Mozambique 2103 4

South Sudan 1964 4

Uganda 1633 3

Other recipients 28 941 53

Total 54 193 100


Table 2 above shows that in 2014, top 10 ODA recipients consisted of Ethiopia, Egypt, Kenya,

Tanzania, Nigeria, DRC, Morocco, Mozambique, South Sudan and Uganda. It is clear that all of these countries

69%

31%

%

Bilateral ODA

Multilateral ODA



in the top 10 category are African countries. This could be attributed to the various socio-economic problems in

Africa.

ODA by income group in 2014 (net disbursements in USD millions) Figure 2


The figure above confirms the fact that most aid-recipient countries are developing countries (least

developed countries, low incomes countries etc). Such countries are in need of aid in various forms, e.g

humanitarian, developmental etc., to help them rejuvenate their struggling economies.

ODA trends (Constant, 2007 US $ millions) in developing countries since 1960s Figure 3

Source of Data: OECD 2015

Figure 3 above shows the trends of ODA in developing countries over a period of 5 decades. The thin

dark trend line confirms the fact that foreign aid has been and continues to increase in developing countries.

However, it is surprising to notice that with such incremental aid inflows, most developing continue to lament

over various socio-economic ills. What could be the problem? Is there a relationship between foreign aid and

economic growth? What is the nature of such a relationship (if it exists)? Does foreign aid really help? The

present study seeks to answer these questions through an extensive systematic review of theory and evidence in

developing countries around the world. To provide more relevant information, the study will be biased towards

recent studies.

III. METHODOLOGY In order to gather up all the necessary information on the foreign aid – economic growth nexus in

developing countries, the study employed a systematic review of literature. Purposive sampling was used to

55%

6%

21%

6% 12%

ODA

Least Developed

Countries

Other Low Income

Lower Middle Income

Upper Middle Income

Unspecified

414711481688

676552744565

1063670

1960s 1970s 1980s 1990s 2000-2012

All Developing Countries Total

All Developing Countries Total

Linear (All Developing Countries Total)



select the representatives of the sample. It is quite imperative to note that the criterion of selection was based on

relevance of study topic as well as the geographical area of the studies. It is also important at this stage, to

highlight the fact that most developing countries are from Africa as compared to other continents around the

world and therefore special preference has been directed towards African studies. The variables of the study are

collected from 33 studies conducted in more than 100 different developing countries around the world.

Studies Selected for Review Table 3. Studies Selected for Review Author (s) Year Country/Countries Title of Study

Boone 1995 96 countries Politics of the effectiveness of foreign aid

Ramesh 1998 Several developing countries The impact of foreign aid on growth and savings in

developing countries

Economides et al 2003 75 aid recipient countries Do foreign aid transfers distort incentives and hurt

economic growth? Theory and evidence from 75 aid-

recipient countries

Cuberes & Tsui 2004 136 countries Does foreign aid induce population growth?

Amanja & Morrisey 2006 Kenya Foreign aid, investment and economic growth in Kenya:

A Time Series Approach

Ekanaye & Chatma 2007 Asia, Africa, Latin America,

Caribbean

The effect of foreign aid on economic growth in

developing countries

Veiderpass & Anderson 2007 60 countries Foreign aid, economic growth and efficiency development

Obaydullah 2007 Bangladesh Impact of foreign aid on development in Bangladesh

Kabete 2008 Tanzania Foreign aid and economic growth: the case of Tanzania

Andrews 2009 Africa Foreign aid and development in Africa: What the

literature says and what the reality is

Chheang 2009 67 developing countries The effect of foreign aid on economic growth and

corruption in 67 developing countries

Minoiu & Reddy 2009 Developing countries Development aid and economic growth: a positive long

run relation

Dimanche 2010 79 developing countries Foreign aid and economic growth

Asirvatham 2010 Several developing countries Foreign aid and development

Tadesse 2011 Ethiopia Foreign aid and economic growth in Ethiopia

Kiumbe 2012 Kenya The impact of foreign aid on economic growth in Kenya

Daud 2012 African Muslim Countries The effectiveness of IDB’s foreign aid on economic

growth: an empirical study of African Muslim Countries

Sohail 2012 Several developing countries Assessing foreign aid: the case of foreign aid to the education sector

Fasanya & Onakaya 2012 Nigeria Does foreign aid accelerate economic growth? An

empirical analysis for Nigeria

Kargbo 2012 Sierra Leone Impact of foreign aid on economic growth in Sierra

Leone

Kolawole 2013 Nigeria Foreign assistance and economic growth in Nigeria: The Two-Gap Model Framework

Deerfield 2013 Several developing countries A study of corruption, foreign aid and economic growth

Ojiambo 2013 Kenya Effects of foreign aid predictability on investment and

economic growth in Kenya

Dayanath & Chihashi 2013 Sri Lanka Fiscal policy and economic growth in the presence of

foreign aid (the Sri Lankan experience)

Hossain 2014 Bangladesh The effect of foreign aid on economic growth in Bangladesh

Ahmed 2014 Sub-Sahara African countries The effect of foreign aid on economic growth

Trinh 2014 Vietnam Foreign aid and economic growth: the impact of aid on

determinants of growth – the case of Vietnam

Abdu 2015 India Impact of saving, foreign aid on economic growth in

India (1981-2011): A perspective of the dual gap model

Girma 2015 Ethiopia The impact of foreign aid on economic growth: empirical

evidence from Ethiopia (1974-2011) using ARDL

approach

Hotouom 2015 Tanzania The effect of foreign aid on economic growth in

Tanzania

Mwanamanga 2015 Malawi Does foreign aid promote growth?

Simplice & Jellal 2016 53 African countries Foreign aid and fiscal policy: theory and evidence

Sahoo 2016 South Asian Economies Foreign aid and economic development: empirical

evidence from selected South Asian Economies

Source: Reviewed Literature (2017)



IV. RESULTS & DISCUSSION Description of Reviewed Literature

The table below shows a brief description of reviewed previous studies

Table 4. Author (s) Year Country/Countries Nature of Data Period Model (s)

Boone 1995 96 countries Panel 1960-1990 Panel Least

Squares Estimation Method (PLSEM)

Ramesh 1998 Several developing

countries

Cross-sectional 1970-1993 OLS

Economides et al 2003 75 aid recipient countries Panel 1975-1995 PLSEM

Cuberes & Tsui 2004 136 countries Panel 1973-2004 PLSEM

Amanja & Morrisey 2006 Kenya Time Series 1964-2002 Vector

Autoregression

(VAR) & Vector

Error Correction

Model (VECM)

Ekanaye & Chatma 2007 Asia, Africa, Latin

America, Caribbean

Panel 1980-2007 PLSEM

Veiderpass & Anderson 2007 60 countries Panel 1995-2000 PLSEM

Obaydullah 2007 Bangladesh - - Correlation &

Critical Analysis

Kabete 2008 Tanzania Time Series 1990-2004 OLS

Andrews 2009 Africa - - Systematic Review

Chheang 2009 67 developing countries Panel 1986-2005 PLSEM

Minoiu & Reddy 2009 Developing countries Cross-sectional 1960-2000 OLS & 2SLS

Dimanche 2010 79 developing countries Cross-sectional For the year 2000 OLS

Asirvatham 2010 Several developing

countries

Time Series 1980-2007 OLS

Tadesse 2011 Ethiopia Time Series 1970-2009 VECM

Kiumbe 2012 Kenya Time Series 1970-2010 OLS

Daud 2012 Africa Muslim Countries Panel 1987-2010 Simultaneous

Equation Model

(SEM), ARDL,

OLS & 3SLS

Sohail 2012 Several developing countries

Cross-sectional 1973-2007 Pooled OLS, Logistic approach

& Generalized

Methods of Moments (GMM)

Fasanya & Onakaya 2012 Nigeria Time Series 1970-2010 OLS

Kargbo 2012 Sierra Leone Time Series 1970-2007 ARDL approach

Kolawole 2013 Nigeria Time Series 1980-2011 Error Correction Model (ECM)

Deerfield 2013 Several developing

countries

Cross-sectional 1969-1997 OLS

Ojiambo 2013 Kenya Time Series 1966-2011 OLS

Dayanath & Chihashi 2013 Sri Lanka Time Series 1962-2011 3SLS & 2SLS

Hossain 2014 Bangladesh Time Series 1980-2012 OLS

Ahmed 2014 Sub-Sahara Africa Cross-sectional 2000-2012 OLS

Trinh 2014 Vietnam Time Series 1993-2012 ARDL

Abdu 2015 India Time Series 1981-2011 VAR

Girma 2015 Ethiopia Time Series 1974-2011 Autoregressive

Distributed Lag

(ARDL) approach

Hotouom 2015 Tanzania Time Series 1987-2013 VAR

Mwanamanga 2015 Malawi Time Series 1960-2012 OLS

Simplice & Jellal 2016 53 African countries Panel 1996-2010 Two Stage Least

Squares (2SLS)

Sahoo 2016 South Asian Economies Cross-sectional 1970-2013 VECM


Foreign-Aid Economic Growth Nexus

There is no consensus as to the relationship between foreign aid and economic growth. The table below

is a summary of the major findings of various previous studies considered in this investigation.



Table 5. Author (s) Year There is a

relationship between Foreign Aid & Economic Growth

Foreign Aid affects Economic Growth positively

Foreign Aid affects Economic Growth negatively

Other findings

Boone 1995 * - * � The study also found out that the

impact of aid does not vary

according to whether recipient

governments are liberal democratic

or highly repressive

Ramesh 1998 * * - -

Economides et

al

2003 * * * � Foreign aid is negatively affected

by adverse effects of associated

rent-seeking activities

Cuberes & Tsui 2004 * - * � Foreign aid induces population growth

� Foreign aid reduces mortality rate

and increases life expectancy

Amanja &

Morrisey

2006 * - * � Private investment, public

investment and imports positively

affect economic growth

Ekanaye &

Chatma

2007 * * * -

Veiderpass &

Anderson

2007 * * - -

Obaydullah 2007 * * - -

Kabete 2008 * - * � Total debt service has a negative

impact on GDP growth in Tanzania � Export growth and net national

savings have positive impact on

growth

Andrews 2009 * * * -

Chheang 2009 * - * � Foreign aid is positively related to

corruption in the sense that the

more aid a country gets the better

the corruption ranking of the

country is

Minoiu &

Reddy

2009 * * - -

Dimanche 2010 * - * -

Asirvatham 2010 * - * � There is an insignificant

relationship between the interaction

term (Aid) and growth

Tadesse 2011 * * - � However, volatility of aid by

creating uncertainty in the flow of

aid has a negative influence on

domestic capital formation activity

� The aid-policy interaction term has produced a significant negative

effect on growth implying that bad

policies can constrain aid effectiveness

� Rainfall variability has a significant

impact on economic growth � The study also revealed that

Ethiopia has no problem of capacity

constraint as to the flow of foreign

aid

Kiumbe 2012 * - * � There is a positive relationship

between investment and growth

Daud 2012 * * - � There is long run and short run

causality between corruption and

aid

� The study also establishes that countries like Morocco and Nigeria

are victims of the corruption trap

Sohail 2012 * * - -

Fasanya & 2012 * * � Domestic investment increased in



Onakaya response to aid flows and

population growth has no significant effect on aid flows

Kargbo 2012 * * - � The effect of foreign aid during the

war is found to be weak or non-existent

Kolawole 2013 - - - � No causality between aid and

growth

� Negative relationship between FDI

and growth

� ODA has no impact on real growth

in Nigeria

Deerfield 2013 * - * -

Ojiambo 2013 * * - � Foreign also has a positive effect on

public investment

� Private investment positively

affects economic growth

� Macroeconomic policy

environment positively affects

economic growth

Dayanath &

Chihashi

2013 * - * -

Hossain 2014 * * - � However, the study also revealed

that foreign aid generates decreasing returns in Bangladesh

because of capacity constraints of

Bangladeshi institutions to utilize the foreign aid effectively

Ahmed 2014 * - * � Education and FDI positively and

significantly affect growth

Trinh 2014 * * - -

Abdu 2015 * * - � There is a unidirectional causality running from savings to economic

growth

Girma 2015 * * � However, the coefficient of aid policy index interaction shows that

aid has positively contributed to

economic growth in Ethiopia if

supplemented with stable

macroeconomic policy environment

Hotouom 2015 * * - � Population growth, investment and

aid policy contributed positively to

economic growth

Mwanamanga 2015 * - * � The study indicates that aid

effectiveness is circumstantial,

conditional on countries having

supportive governance structures,

sound policies, and strong political will

Simplice &

Jellal

2016 * * - -

Sahoo 2016 * * - � Aid volatility has shown a

significant negative impact on economic growth of Pakistan and

Sri Lanka

SUMMARY STATISTICS

- (32/33)=97% (19/33)=58% (16/33)=48% -


As shown in the table above, the nexus between foreign aid and economic growth is indeed ambiguous.

However, most studies reviewed (58%) generally confirm the aid effectiveness hypothesis while 48% of the

studies reviewed; generally reject the aid effectiveness hypothesis. It is imperative to note that almost all the

studies reviewed (as shown by 97%) confirm that there indeed exists a relationship between foreign aid and

economic growth. Only Kolawole (2013) found that there is no causality between aid and growth and that in the

case of Nigeria, Official Development Assistance (ODA) has no impact on real growth. It is also worth to

highlight that the nexus between foreign aid and economic growth has also been found to be mixed (in the sense

that in as much as it can be positive, it can also be negative) in Asia, Africa, Latin America & Caribbean

(Ekanaye & Chatma, 2007), Africa (Andrews, 2009) as well as in 75 Aid recipient countries studied by



Economides et al (2003). However, reviewed literature also indicates that there are other factors which also

exist to affect economic growth in developing countries and these include but are not limited to private

investment, public investment, imports, exports, savings, FDI and so on; these factors are shown in the table

below:

Table 6 Other factors that affect economic growth in developing countries

Source

Private investment Amanja & Morrisey (2006), Ojiambo (2013)

Public investment Amanja & Morrisey (2006)

Imports Amanja & Morrisey (2006)

Savings Kabete (2008), Abdu (2015)

Rainfall variability Tadesse (2011)

Aid policy Girma (2015), Hotouom (2015)

Population growth Hotouom (2015)

Domestic investment Kiumbe (2012), Hotouom (2015)

FDI Kolawole (2013), Ahmed (2014)

Education Ahmed (2014)

Aid volatility Sahoo (2016)

Total debt service Kabete (2008)

Export growth Kabete (2008)

Macroeconomic policy environment Ojiambo (2013)


Discussion of the Impacts of Change in Foreign Aid and “other factors” (shown in table 6 above) on economic growth in developing countries

Foreign aid: There is no straight forward consensus on the nature of the aid-growth nexus. Literature is

basically divided between aid optimists and aid skeptics. Each side is supporting its ideas strongly. However, in

this study, it has been shown that most studies e.g Economides et al (2003), Ekanaye & Chatma (2007), Tadesse

(2011), Kargbo (2012), Abdu (2015) and Shoo (2016) amongst others; support the idea that foreign aid is

positively related to growth. This proposition has been upheld by most theories. For example, the McKinnon

Foreign Exchange Constraint Model (MFECM), which basically argues that foreign aid, is a catalyst for higher

economic growth for all developing countries that experience trade bottlenecks. The MFECM further asserts

that foreign aid helps to remove trade bottle necks available in developing countries by providing strategic

commodities in which they are unable to produce. The MFECM is hinged on the principles of the Chenery-

Bruno (1962) model, that was followed by the famous dual gap model (the Two-Gap Model [TGM])

propounded by Chenery & Strout (1966); which basically argues that a developing country may need foreign aid

inflows in order to help close the savings gap and or the foreign exchange gap (the trade gap), if its own

investment is below the desired level. In this case foreign aid positively affects economic growth. The Public

Interest Theory (PIT), also supports our analysis in the sense that it asserts that foreign aid is necessary for

growth because it helps in closing the investment gap in the recipient country. In the same line of thinking, the Harrod-Domar, Solow, and Endogenous growth models also confirm

that foreign aid is only there to supplement inadequate domestic resources in developing countries. In particular,

the Harrod-Domar model argues that developing countries need foreign aid to help attain a steady rate of

economic growth in the long-run. The Solow growth is just a revised version of the Harrod-Domar growth

model and basically acknowledges that foreign aid helps complement inadequate savings in developing

economies. The Endogenous growth model, which is a well-known reaction to the Solow-Swan neoclassical

growth model; argues that endogenous factors are inadequate to spur the development process and therefore

foreign aid is there to assist developing countries on the grounds that most developing do not have enough

resources for spurring real growth. Moreso, the Big Push Theory (BPT) is another important theory that

supports our analysis. The BPT basically proposes that a big investment package (a big push), is required to

overcome the obstacles of economic development in developing countries. But the problem is that developing

countries are usually not able to arrange such huge amounts of capital to invest. In this regard, according the

PBT, foreign aid facilitates the capital deficit problems of theses developing countries via the provision of

adequate amount of foreign exchange reserves at a concessional rate. In consensus with BPT, the Poverty Trap

Model (PTM), states that a developing country requires a one-time infusion of aid to spur economic growth and

development.

The fact that developing countries do not have adequate resources is indisputable. Therefore, foreign

aid cannot be ignored in such economies. In Zimbabwe, for example, there are a plethora of natural resources

and yet there is no enough financial resources and capital (plant & machinery) to help make meaningful use of



these abundant natural resources. Today Zimbabwe is lamenting over many problems, most of which can be

easily solved by provision of foreign capital inflows. Nigeria, just like any other developing country, continues

to receive its share of aid. However, the main problem of Nigeria is corruption and bad governance (as is the

case in Zimbabwe and many other developing countries). This tendency of misusing aid is number one factor

that militates against aid-effectiveness and developing countries should see to it that it comes to a halt or else

they remain poor!

However, our investigation is not without scholarly objections. There are many authors, e.g Boone

(1995), Svenson (2000), Amanja & Morrissey (2006), Williamson (2008), Djankov et al (2008), Chheang

(2009), Kiumbe (2012) and Girma (2015) amongst others; who have already shown that foreign aid is useless to

the recipient countries in the sense that it affects economic growth negatively. These aid-skeptics are

theoretically backed by the Public Choice Theory (PCT), which argues that foreign aid ineffective and virtually

malicious to the recipient countries. According to the PCT, foreign aid has no effect whatsoever on development

or any poverty indicator, therefore, developing countries do not need foreign aid to improve their economies.

Savings: The relationship between savings and economic is obvious in these sense that there is

overwhelming consensus that savings and economic growth are positively related. Many theories e.g the Solow

growth model, the Harrod-Domar model, the Keynesian theory of saving, as well as the Neoclassical theory of

saving and investment amongst others; support the view that savings are positively related to growth.

Furthermore, many studies e.g Mphuka (2010), Festus (2011), Mandishekwa (2014), Mohamed (2014), Turan &

Olesia (2014), Jagadeesh (2015) confirm this relationship. Therefore, developing countries should promote a

savings culture in their economies. Unfortunately, most developing countries are either “instant gratifiers” or

they cannot save simple because they do not have anything to save. In latter scenario, foreign aid is critically

needed as a matter of emergency; otherwise the electorate (the civilians) will continue to live in abject poverty

until they die!

Population growth: The relationship between population growth and economic growth is ambiguous in

the sense that it can be positive one country and be negative in another. Having said this, it follows that

available literature is also torn between those who argue for and those who argue against population growth.

Main theorists in the population growth dynamics, Malthus (1798) and Solow (1956) argue that population

growth is a real problem and has a negative effect on economic growth. On the other side of the same coin,

orthodox theorists such as Ahlburg (1998) and Becker et al (1999) argue that population growth is not a real

problem, but rather an opportunity for growth. In our investigation, we find that in Tanzania, as shown by

Hotouom (2015); population growth is positively related to economic growth. Similarly Nyoni & Bonga

(2017h) found that population growth is positively related to economic development in the Zimbabwean

scenario. This is true for some Africa countries eg Tanzania, Nigeria, DRC, Zimbabwe amongst others where

there are abundant natural resource endowments, most of which are either not being used or are currently being

misused. In such cases, an increase in population growth is an opportunity for increased markets (increase

aggregate demand for commodities) and apparently means more supply of labour which is one of the major

factors of production. However, our analysis is already being opposed by many authors who support the

mainstream population growth ideas postulated by Malthus (1978) and these include but are not limited to

Adetiloye & Adeyemo (2012), Wako (2012), Zhang (2015) as well as Ali et al (2015). Investment: There is consensus among economists and policy makers that investment (private or

public) plays a pivotal role in economic growth of any nation. In fact, there is an undeniably strong relationship

between investment and the rate of economic growth (Nyoni & Bonga, 2017f). In our analysis Amanja &

Morrissey (2006) and Ojiambo (2013) found that private investment is positively related to economic growth in

Kenya. This is very reasonable because investment is a source of multiplier effects in the economy, especially

given the fact that most developing countries have abundant resources but lack the capacity to exhaust those

resources in an economically meaningful manner. Sustainable economic growth, according to Nyoni & Bonga

(2017f), mainly depends on a nation’s ability to invest and make efficient and productive use of the resources at

its disposal. Without investment of sufficient amount and quality, as warned by Nyoni & Bonga (2017f), there

cannot be growth. Economic theory (e.g Accelerator theory; Neoclassical theory) supports our finding that

investment is indeed the backbone of growth and development. Various other authors e.g Ellis et al (2010), Sial

et al (2010), Riley (2012) and Uthman (2015) also support our analysis. FDI: The nature of the link between FDI and economic growth is ambiguous in the sense that there is

no universally accepted position on this issue. Some authors say the relationship between FDI and economic

growth is positive while others argue that it is negative; and yet extremists actually assert that there is no

relationship whatsoever, between FDI and economic growth. In this study, we find that FDI is positively related

to economic growth. This is probably the most accepted idea in the FDI literature as shown by many authors e.g

Nair-Reichert & Weinhold (2001), Yao & Wei (2007), Vu et al (2008), Tang et al (2008), Brooks et al (2008),

Nunnenkamp et al (2009), Zhao & Zhang (2010), Wang (2010), Lean & Tan (2011), Wu et al (2012), Lipsey et

al (2013), Pegkas (2015), Tan & Tang (2016), Vogiatzoglou & Thi (2016). This is especially true in developing



countries where domestic resources are always not enough to stimulate real growth. In such situations, FDI

becomes a good source of foreign capital inflows that can help host countries make meaningful use of their

domestic resources. FDI, in excess of financial resources and capital (plant & equipment); is well known for

bringing in expert technical know-how and creating employment opportunities in the host country. In this regard

FDI positively impacts on economic growth. However, on the other side of the same coin, some researchers e.g

Kholdy (1995), Duasa (2007), Tomohara & Takii (2011), Mohamed et al (2013) as well as Sothan (2017) have

found that FDI has a negative impact on economic growth. This may be true in the sense that foreign companies

may compete against local companies and result in their failure and closure, and that foreign companies usually

remit most of their profits back to their home countries and have a tendency of bringing “try & error” (obsolete

and or sub-standard or dumped) technology in the host country. In such circumstances FDI is a burden on

growth and development. Furthermore, others e.g Kakar & Khilji (2011), Ludosean (2012) as well as Mutafoglu

(2012), think that there is no relationship between FDI and economic growth and thus FDI has virtually no

impact on growth, whatsoever!

Education: The Human Capital Theory proposes that there is a positive relationship between education

and economic growth, via the labour productivity transmission mechanism. This is, of course, attributed to the

fact, education improves human capital efficiency in production, which; in the long run increases the level of

growth in the economy. As indicated by Bonga (2016), education increases labor productivity, increases

innovative capacity and also helps in facilitating diffusion and transmission of knowledge and to successfully

implement new technologies. In this study, Ahmed (2014); also found out that education is another factor that

positively affects economic growth. These results are acceptable in the sense that more educated workers are

likely to be more productive than their uneducated counter-parts. It is indeed imperative to mention that most

developing countries now have a relatively reasonable level of literacy. For example, Zimbabwe literacy rate is

currently over 90%. Other developing countries such as Cuba, Nigeria, Kenya, India, Pakistan, have literacy that

are well above 50%. This shows that developing countries are now realizing the importance of education in the

economy. Many previous studies e.g Mankiw et al (1992), Schultz (2009), Kim & Terada-Hagiwara (2010),

Adiqa (2011), Hawkes & Ugur (2012) as well as Afzalet et al (2012) support our analysis.

Aid volatility: Aid volatility is a cause for concern. Various authors such as Bulir & Hamann (2001;

2003; 2005), Eifert & Gelb (2005) and Fielding & Mavrotas (2005), amongst others; have already

acknowledged this fact. Aid volatility is one of the factors that give birth to macroeconomic instability and it is a

factor of vulnerability on its own. Aid volatility has its most devastating effects in developing countries which

are usually vulnerable and where the prospects of aid increase mainly apply. In our investigation, aid volatility

has been shown [by Sahoo (2016)] to have a negative impact on growth. Many authors that include but not

limited to Chauvet & Guillaumont (2008), Neanidis & Varvarigos (2009), Arellano et al (2009) and Lane &

Lipschitz (2009) support these findings.

Total debt service: Total debt service negatively impacts on growth, many researchers e.g Muhta

(2004), Kabete (2008), Hameed et al (2008), Safia & Shabbir (2009), Reinhart & Rogoff (2010), Gohar et al

(2012), Ajayi & Oke (2012), Uma et al (2013). Developing countries should be financially disciplined in order

to minimise debts.

Export & Import growth: Exports are very important in any economy because they are a source of

foreign exchange reserves which can then be used to import those commodities which are relatively scarce in

the home country. Kabete (2008), in line with Ullah & Asif (2009), Uman et al (2011), Khan et al (2012),

Zaheer et al (2014), Bonga et al (2015) and Nyoni & Bonga (2017h) found that export growth is positively

related to economic growth. On the other side, imports are equally important as found by Wong (2008), Kogid

et al (2011) and Khan et al (2012); since they also affect economic growth positively. Developing countries

should import only those resources and or products that they do not have in the home country. The tendency of

importing already existing commodities is economically suicidal to the local industry and should be avoided at

all costs.

Macroeconomic policy environment: Sound macroeconomic policy is compulsory for all economies,

whether developing or developed. Without sound macroeconomic policy, there cannot be growth. According to

various authors such as Fischer (1991; 1993), Easterly & Rebelo (1993), Durbarry et al (1998) as well as

Ojiambo (2013) sound macroeconomic policy is associated with higher growth. Most developing countries,

especially in Africa, are regrettably well-known for poor macroeconomic policy environment that continues to

militate against aid effectiveness and growth.

V. RECOMMENDATIONS The study recommends the following:

1. If developing countries still require foreign aid to support their developmental processes, then they

need to make proper plans on the productive use of aid. Many donors are increasingly selective, they

no longer want their resources on countries that continuously misuse aid, especially developmental aid.



In the case of economically distressed economies such as Zimbabwe, Nigeria, Kenya, Somalia and

Gambia, we recommend that the respective governments should devote foreign aid on developmental

activities such as health, education an infrastructure, where private investors are reluctant to invest.

2. Developing countries should maintain good working relations with the donor community and sign long

term agreements relating to foreign aid inflows, primarily to reduce the problem of fluctuations in aid

flows.

3. There is need to increase export growth in developing countries as the study has also shown that export

growth has a positive effect on economic growth.

4. Since foreign aid has been shown to have its own weaknesses such as the Dutch disease, corruption and

policy conditionality; governments of developing countries should work in partnership with the donor

community in order to properly address the weaknesses of foreign aid. In this regard, developing

countries are advised to institute effective sterilization measures by channeling aid funds into

investments rather than increasing government expenditure.

5. In recognition of the fact that good governance and policies matter in the aid-growth nexus, policy

makers in developing countries ought to promote measures of good governance including strong fiscal

discipline and sound social policies. This may facilitate prudent management of public resources

including aid.

6. Developing countries are encouraged to maintain stable macroeconomic policy environments in order

to reap the full benefits of aid inflows.

VI. CONCLUSION Foreign aid is one of the most important sources of capital for most developing countries. In fact

developing countries, especially in Africa, can refuse aid at their own peril. However, it has been noticed with

kin interest that in most cases recipient governments, if not closely monitored, end up misusing aid and at the

end of the day claim that aid is not effective! Despite the overwhelming fact that the aid-growth nexus is

ambiguous, most studies confirm a positive relationship and most foreign aid theories such as the McKinnon’s

Foreign Exchange Constraint Model, Harrod-Domar Model, Solow Model and many others, re-affirm the

proposition that aid is positively related to economic growth. However, our analysis also indicates that foreign

aid is not without its woes. Foreign aid, especially, if misused; can produce unintended results such as

corruption and the Dutch disease. It is thus imperative to note that developing countries must use aid for its

intended purpose, if aid-effectiveness is anything to go by.

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