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

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  • Harms, Philipp
  • Lutz, Matthias

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 (HWWA) in its series HWWA Discussion Papers with number 246.

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Date of creation: 2003
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Handle: RePEc:zbw:hwwadp:26128

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Keywords: Aid; Foreign Direct Investment; Institutions;

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  1. 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.
  2. Barro, R.J., 1988. "Government Spending In A Simple Model Of Endogenous Growth," RCER Working Papers 130, University of Rochester - Center for Economic Research (RCER).
  3. Hansen, Henrik & Tarp, Finn, 2001. "Aid and growth regressions," Journal of Development Economics, Elsevier, vol. 64(2), pages 547-570, April.
  4. Dollar, David & Alesina, Alberto, 2000. "Who Gives Foreign Aid to Whom and Why?," Scholarly Articles 4553020, Harvard University Department of Economics.
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  7. 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.
  8. Shang-Jin Wei, 2000. "How Taxing is Corruption on International Investors?," The Review of Economics and Statistics, MIT Press, vol. 82(1), pages 1-11, February.
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  11. Richard H. Clarida, 1993. "International Capital Mobility, Public Investment and Economic Growth," NBER Working Papers 4506, National Bureau of Economic Research, Inc.
  12. 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.
  13. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-38, May.
  14. Svensson, Jakob, 2000. "Foreign aid and rent-seeking," Journal of International Economics, Elsevier, vol. 51(2), pages 437-461, August.
  15. Philipp Harms & Heinrich W. Ursprung, 2002. "Do Civil and Political Repression Really Boost Foreign Direct Investments?," Economic Inquiry, Western Economic Association International, vol. 40(4), pages 651-663, October.
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  18. Reinikka, Ritva & Svensson, Jakob, 2002. "Coping with poor public capital," Journal of Development Economics, Elsevier, vol. 69(1), pages 51-69, October.
  19. Philipp Harms, 2002. "Political risk and equity investment in developing countries," Applied Economics Letters, Taylor & Francis Journals, vol. 9(6), pages 377-380.
  20. Lensink, Robert & White, Howard, 1999. "Are there negative returns to aid?," Research Report 99E60, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
  21. Boone, Peter, 1996. "Politics and the effectiveness of foreign aid," European Economic Review, Elsevier, vol. 40(2), pages 289-329, February.
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  24. Feyzioglu, Tarhan & Swaroop, Vinaya & Zhu, Min, 1998. "A Panel Data Analysis of the Fungibility of Foreign Aid," World Bank Economic Review, World Bank Group, vol. 12(1), pages 29-58, January.
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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. Kilby, Christopher, 2005. "Aid and regulation," The Quarterly Review of Economics and Finance, Elsevier, vol. 45(2-3), pages 325-345, May.
  3. 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.
  4. Philipp Harms & Michael Rauber, 2004. "Foreign aid and developing countries' creditworthiness," Working Papers 04.05, Swiss National Bank, Study Center Gerzensee.
  5. 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).
  6. 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.

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