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Foreign aid and domestic output in the long run

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  • Dierk Herzer
  • Oliver Morrissey

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Abstract

The principal argument of this paper is that the effect of aid on GDP depends on a trade-off that is country specific: aid has a direct positive effect through financing investment but an indirect effect through aggregate productivity that can be negative if aid exacerbates growth-retarding factors such as poor governance. Data for 59 developing countries over 1971–2003 are analysed to explore the trade-off and highlight the heterogeneous nature of the relationship between aid and output. We show that output, aid and investment comprise a cointegrated relation, and derive country specific estimates of the long run association between aid and output. These aid-output coefficients are, on average, negative but smaller than the positive investment-output coefficients. Insofar as aid is used to finance investment, the overall effect on output may therefore be positive. We also show that cross-country differences in the estimated long run aid-output coefficients can be explained mainly by cross-country differences in law and order, religious tensions and government size. Copyright Kiel Institute 2013

Suggested Citation

  • Dierk Herzer & Oliver Morrissey, 2013. "Foreign aid and domestic output in the long run," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 149(4), pages 723-748, December.
  • Handle: RePEc:spr:weltar:v:149:y:2013:i:4:p:723-748
    DOI: 10.1007/s10290-013-0169-y
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Abrams M.E. Tagem, 2017. "The economics and politics of foreign aid and domestic revenue," WIDER Working Paper Series 180, World Institute for Development Economic Research (UNU-WIDER).
    2. Lionel Roger, 2015. "Foreign Aid, Poor Data, and the Fragility of Macroeconomic Inference," Discussion Papers 2015-06, University of Nottingham, CREDIT.
    3. Channing Arndt & Sam Jones & Finn Tarp, 2016. "What Is the Aggregate Economic Rate of Return to Foreign Aid?," World Bank Economic Review, World Bank Group, vol. 30(3), pages 446-474.
    4. Katsushi S. Imai & Raghav Gaiha, 2014. "Dynamic and Long-term Linkages among Growth, Inequality and Poverty in Developing Countries," The School of Economics Discussion Paper Series 1410, Economics, The University of Manchester.
    5. Abrams M E Tagem, 2017. "Aid, Taxes and Government Spending: A Heterogeneous Cointegrated Panel Analysis," Discussion Papers 2017-02, University of Nottingham, CREDIT.

    More about this item

    Keywords

    Foreign aid; Output (GDP); Investment; Heterogeneous panel cointegration techniques; General-to-specific approach; F35; O11; C23; C52;

    JEL classification:

    • F35 - International Economics - - International Finance - - - Foreign Aid
    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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