Foreign Aid-Growth Nexus in Africa: Do Institutions Matter?

The aim of this work is to investigate the institution’s role on amelioration of the effectiveness of foreign aid in two subregions: 25 low-income and 23 middle-income African economies. To do this, we estimate an OLS (ordinary least squares), FMOLS (fully modified ordinary least squares), and SGMM (system generalized method of moments) models. Yearly data from 48 African provinces in a panel framework for the period 1996–2014 has been used. The evidence reveals that both in short- and long-run results confirm that foreign aid is not effective in terms of economic growth and with increasing returns. In addition, aid ineffectiveness is more important in the low-income African countries than in the middle-income African countries. But, the aid effectiveness is promoted with the presence of good institutions. In this case, the analysis evidence finds that foreign aid is more effective in two subregions. About the six institutional dimensions, the pertinent governance indicators that ameliorate aid effectiveness are Rule and Laws, Government Effectiveness, and Voice and Accountability, in low-income countries. However, all institutional indicators, except Rule and Laws, ameliorate aid effectiveness in middle-income countries. The long-run aid effectiveness is promoted by Government Effectiveness and Voice and Accountability, in low-income countries. But, in middle-income countries, aid effectiveness can be ameliorated, especially, by Political Stability and Regulatory Quality.