This paper considers the impact of foreign aid on the risk of civil conflict. Previous studies on this topic have not properly addressed the problem of endogeneity between aid and conflict as well as the distorting influences of country specific time invariant effects. We propose GDP levels of donor countries as new and powerful instruments for foreign aid flows in the conflict regression. Aid flows are often defined as a fixed percentage of Donor’s GDP hence they are strongly correlated. Changes in donor GDP constitute an exogenous shock to aid received by developing countries, as Donor GDP is not expected to have a direct effect on the risk of civil conflict in sub-Saharan Africa (SSA). We find a statistically significant and economically important negative effect of foreign aid on the risk of civil conflict. A ten percent increase in foreign aid decreases the risk of civil conflict by about six percent.
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Paper provided by Utrecht School of Economics in its series Working Papers with number
06-09.
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