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Aid, governance, and private foreign investment: some puzzling findings and a possible explanation

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  • Matthias Lutz
  • Philipp Harms

Abstract

Does offcial 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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Bibliographic Info

Paper provided by Money Macro and Finance Research Group in its series Money Macro and Finance (MMF) Research Group Conference 2003 with number 57.

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Date of creation: 27 Sep 2004
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Handle: RePEc:mmf:mmfc03:57

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Web page: http://www.essex.ac.uk/afm/mmf/index.html

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  1. Chakrabarti, Avik, 2001. "The Determinants of Foreign Direct Investment: Sensitivity Analyses of Cross-Country Regressions," Kyklos, Wiley Blackwell, vol. 54(1), pages 89-113.
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  9. Christopher F Baum & Mark E. Schaffer & Steven Stillman, 2003. "Instrumental variables and GMM: Estimation and testing," Stata Journal, StataCorp LP, vol. 3(1), pages 1-31, March.
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Cited by:
  1. Kilby, Christopher, 2005. "World Bank Lending and Regulation," Vassar College Department of Economics Working Paper Series 66, Vassar College Department of Economics.
  2. Carl-Johan Dalgaard & Henrik Hansen & Finn Tarp, 2004. "On The Empirics of Foreign Aid and Growth," Economic Journal, Royal Economic Society, vol. 114(496), pages F191-F216, 06.
  3. Philipp Harms & Michael Rauber, 2004. "Foreign aid and developing countries' creditworthiness," Working Papers 04.05, Swiss National Bank, Study Center Gerzensee.
  4. Kilby, Christopher, 2005. "Aid and regulation," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(2-3), pages 325-345, May.
  5. Philipp Harms & Matthias Lutz, 2004. "The Macroeconomic Effects of Foreign Aid: A Survey," University of St. Gallen Department of Economics working paper series 2004 2004-11, Department of Economics, University of St. Gallen.
  6. 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).

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