On the Link between Foreign Aid and Growth in Developing Countries

Objectives: This study aims to highlight some of the main debates on the aid-growth nexus from theoretical and empirical perspectives. Prior Work: Despite the intense debate on whether aid works for growth, the increasing trends of aid flows to developing countries motivates this study to revisit these debates. Approach: This study uses a detailed survey of theoretical and empirical literature on the aid-growth nexus. Results: This review finds that the aid-growth nexus is the most empirically researched area, and yet evidence remains inconsistent and controversial. Two lines of debate are identified, namely aid effectiveness (aid proponents) and aid ineffectiveness (aid opponents). While aid proponents argue that aid positively affects growth, aid opponents find that aid either has a negative or null impact on growth. Implications: Contrary to scholarly debates, the common belief among donors is that the effect of aid on growth is positive and aid flows to the productive/economic sectors are more growth-enhancing. Thus, aid-financing decisions by donors and policymakers should take this aspect into account. Value: Besides exploring the debates, this review discusses the reasons behind the inconsistent evidence on the aid-growth nexus and further highlights the relevant methodological approaches to address this problem, which is mostly aid endogeneity.