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Aid, Governance, and Private Foreign Investment: Some Puzzling Findings and a Possible Explanation

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Author Info
Harms, Philipp
Lutz, Matthias

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Abstract

Does official aid pave the road for private foreign investment or does it suffocate private initiative by diverting resources towards unproductive activities? In this paper we explore this question using data for a large number of developing and emerging economies. Controlling for countries' institutional environment, we find that, evaluated at the mean, the marginal effect of aid on private foreign investment is close to zero. Surprisingly, however, the effect is strictly positive for countries in which private agents face a substantial regulatory burden. After testing the robustness of this result, we offer a theoretical model that is able to rationalize our puzzling observation.

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Paper provided by Hamburg Institute of International Economics in its series Discussion Paper Series with number 26128.

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Date of creation: 2003
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Handle: RePEc:ags:hiiedp:26128

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Keywords: Aid; Foreign Direct Investment; Institutions; International Relations/Trade; F35; F21; O16; O19;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Reinikka, Ritva & Svensson, Jakob, 2002. "Coping with poor public capital," Journal of Development Economics, Elsevier, vol. 69(1), pages 51-69, October. [Downloadable!] (restricted)
  2. Philipp Harms & Heinrich W. Ursprung, 2002. "Do Civil and Political Repression Really Boost Foreign Direct Investments?," Economic Inquiry, Oxford University Press, vol. 40(4), pages 651-663, October.
    Other versions:
  3. Christopher F Baum & Mark E. Schaffer & Steven Stillman, 2002. "Instrumental variables and GMM: Estimation and testing," Boston College Working Papers in Economics 545, Boston College Department of Economics, revised 14 Feb 2003. [Downloadable!]
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  4. Harms, Philipp, 2002. "Political Risk and Equity Investment in Developing Countries," Applied Economics Letters, Taylor and Francis Journals, vol. 9(6), pages 377-80, May. [Downloadable!] (restricted)
  5. Wheeler, David & Mody, Ashoka, 1992. "International investment location decisions : The case of U.S. firms," Journal of International Economics, Elsevier, vol. 33(1-2), pages 57-76, August. [Downloadable!] (restricted)
  6. Svensson, Jakob, 2000. "Foreign aid and rent-seeking," Journal of International Economics, Elsevier, vol. 51(2), pages 437-461, August. [Downloadable!] (restricted)
  7. Chakrabarti, Avik, 2001. "The Determinants of Foreign Direct Investment: Sensitivity Analyses of Cross-Country Regressions," Kyklos, Blackwell Publishing, vol. 54(1), pages 89-113.
  8. Kaufmann, Daniel & Kraay, Aart & Zoido-Lobaton, Pablo, 1999. "Governance matters," Policy Research Working Paper Series 2196, The World Bank. [Downloadable!]
  9. Craig Burnside & David Dollar, 2000. "Aid, Policies, and Growth," American Economic Review, American Economic Association, vol. 90(4), pages 847-868, September. [Downloadable!] (restricted)
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  10. Ratha, Dilip, 2001. "Complementarity between multilateral lending and private flows to developing countries : some empirical results," Policy Research Working Paper Series 2746, The World Bank. [Downloadable!]
  11. William Easterly & Ross Levine & David Roodman, 2003. "New Data, New doubts: A Comment on Burnside and Dollar's "Aid, Policies, and Growth" (2000)," NBER Working Papers 9846, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Feyzioglu, Tarhan & Swaroop, Vinaya & Zhu, Min, 1998. "A Panel Data Analysis of the Fungibility of Foreign Aid," World Bank Economic Review, Oxford University Press, vol. 12(1), pages 29-58, January.
  13. Henrik Hansen & Finn Tarp, 2000. "Aid effectiveness disputed," Journal of International Development, John Wiley & Sons, Ltd., vol. 12(3), pages 375-398.
  14. A. R. Pagan & A. D. Hall, 1983. "Diagnostic tests as residual analysis," Econometric Reviews, Taylor and Francis Journals, vol. 2(2), pages 159-218. [Downloadable!] (restricted)
  15. Lensink, Robert & White, Howard, 1999. "Are there negative returns to aid?," Research Report 99E60, University of Groningen, Research Institute SOM (Systems, Organisations and Management). [Downloadable!]
  16. Dollar, David & Easterly, William, 1999. "The search for the key : aid, investment, and policies in Africa," Policy Research Working Paper Series 2070, The World Bank. [Downloadable!]
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  17. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages S103-26, October. [Downloadable!] (restricted)
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  18. Schneider, Friedrich & Frey, Bruno S., 1985. "Economic and political determinants of foreign direct investment," World Development, Elsevier, vol. 13(2), pages 161-175, February. [Downloadable!] (restricted)
  19. Stephen Knack, 2001. "Aid Dependence and the Quality of Governance: Cross-Country Empirical Tests," Southern Economic Journal, Southern Economic Association, vol. 68(2), pages 310-329, October.
  20. J. Svensson, 1999. "Aid, Growth and Democracy," Economics and Politics, Blackwell Publishing, vol. 11(3), pages 275-297, November. [Downloadable!] (restricted)
  21. Boone, Peter, 1996. "Politics and the effectiveness of foreign aid," European Economic Review, Elsevier, vol. 40(2), pages 289-329, February. [Downloadable!] (restricted)
  22. Hansen, Henrik & Tarp, Finn, 2001. "Aid and growth regressions," Journal of Development Economics, Elsevier, vol. 64(2), pages 547-570, April. [Downloadable!] (restricted)
  23. Chang, Charles C. & Fernandez-Arias, Eduardo & Serven, Luis, 1999. "Measuring aid flows : a new approach," Policy Research Working Paper Series 2050, The World Bank. [Downloadable!]
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  24. Graham Bird & Dane Rowlands, 1997. "The Catalytic Effect of Lending by the International Financial Institutions," The World Economy, Blackwell Publishing, vol. 20(7), pages 967-991, November. [Downloadable!] (restricted)
  25. Alesina, Alberto & Dollar, David, 2000. " Who Gives Foreign Aid to Whom and Why?," Journal of Economic Growth, Springer, vol. 5(1), pages 33-63, March. [Downloadable!] (restricted)
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  26. Richard H. Clarida, 1993. "International Capital Mobility, Public Investment and Economic Growth," NBER Working Papers 4506, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  27. Rodrik, Dani, 1995. "Why is there Multilateral Lending?," CEPR Discussion Papers 1207, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  28. Alberto Alesina & Beatrice Weder, 2002. "Do Corrupt Governments Receive Less Foreign Aid?," American Economic Review, American Economic Association, vol. 92(4), pages 1126-1137, September. [Downloadable!]
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Philipp Harms & Michael Rauber, 2004. "Foreign aid and developing countries' creditworthiness," Working Papers 04.05, Swiss National Bank, Study Center Gerzensee. [Downloadable!]
  2. KIMURA Hidemi & TODO Yasuyuki, 2007. "Is Foreign Aid a Vanguard of FDI? A Gravity-Equation Approach," Discussion papers 07007, Research Institute of Economy, Trade and Industry (RIETI). [Downloadable!]
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