Does foreign aid reduce poverty? A dynamic panel data analysis for sub-Saharan African countries

This study examines the effect of foreign aid on extreme poverty in sub-Saharan Africa (SSA) over the period 1981–2013. The study uses recent dynamic panel estimation techniques, including those methods which deal with endogeneity by controlling for simultaneity and unobserved heterogeneity. The main findings of the study are summarized as follows: firstly, foreign aid does have a statistically significant poverty reduction effect in SSA. Secondly, the disaggregation of aid by source and type shows that total ODA, grants and multilateral aid have poverty reduction effects. Thirdly, democracy enhances the effectiveness of foreign aid in reducing poverty. Lastly, GDP per capita and globalization reduce extreme poverty, while inequality has a detrimental effect on the fight against poverty. This study confirms that the volume of aid matters as well as how it is allocated. The policy implications of these findings are that development partners should continue to focus on poverty reduction as the main objective for ODA. Further, aid allocation should be focused on channels which have more poverty-reduction effects, such as GDP per capita and democracy. Finally, aid recipient countries should come-up with income distributional policies that allow the benefits of growth to accrue to many people, thereby lifting the majority out of extreme poverty.