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Do Foreign Aid Transfers Distort Incentives and Hurt Growth? Theory and Evidence from 75 Aid-recipient Countries

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Author Info
George Economides
Sarantis Kalyvitis ()
Apostolis Philippopoulos ()

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Abstract

In this paper, foreign aid transfers can distort individual incentives, and hence hurt growth, by encouraging rent-seeking as opposed to productive activities. We construct a model of a small growing open economy that distinguishes two effects from foreign transfers: (i) a direct positive effect, as higher transfers allow the financing of infrastructure; (ii) an indirect negative effect, as higher transfers induce rent-seeking competition on the part of self-interested individuals. In this framework, the growth impact of aid is examined jointly with the determination of rent-seeking behavior. We test the main predictions of the model for a cross-section of 75 aid-recipient countries between 1975 and 1995. There is evidence that aid has a direct positive effect on growth, which is however significantly mitigated by the adverse indirect effects of associated rent-seeking activities. This is especially the case in recipient countries with relatively large public sectors.

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Paper provided by CESifo GmbH in its series CESifo Working Paper Series with number CESifo Working Paper No. 1156.

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Date of creation: 2004
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Handle: RePEc:ces:ceswps:_1156

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Keywords: foreign aid incentives growth

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Find related papers by JEL classification:
D70 - Microeconomics - - Analysis of Collective Decision-Making - - - General
D90 - Microeconomics - - Intertemporal Choice and Growth - - - General
F35 - International Economics - - International Finance - - - Foreign Aid
H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General

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References listed on IDEAS
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    Other versions:
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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. Konstantinos Angelopoulos & Apostolis Philippopoulos, 2005. "The Role of Government in Anti-Social Redistributive Activities," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  2. Henk C. Kranendonk & Jan Bonenkamp & Johan P. Verbruggen, 2004. "A Leading Indicator for the Dutch Economy – Methodological and Empirical Revision of the CPB System," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  3. Luis Angeles & Kyriakos C. Neanidis, 2006. "Aid Effectiveness: The Role of the Local Elite," The School of Economics Discussion Paper Series 0633, Economics, The University of Manchester. [Downloadable!]
    Other versions:
  4. Michael A. Clemens & Steven Radelet & Rikhil Bhavnani, 2004. "Counting chickens when they hatch: The short-term effect of aid on growth," International Finance 0407010, EconWPA. [Downloadable!]
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