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Foreign aid and domestic output in the long run

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  • Dierk Herzer
  • Oliver Morrissey

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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    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. Dong, Yan & Fan, Cijun, 2020. "The role of China's aid and ODI in the economic growth of African countries," Emerging Markets Review, Elsevier, vol. 44(C).
    3. Md Ismail Hossain & Md Istiak Hossain & Mollah Aminul Islam & Md Reza Sultanuzzaman, 2022. "Does Foreign Aid Have an Expected Role in the Economic Growth of Bangladesh? An Analysis in ARDL Approach," International Journal of Economics and Financial Issues, Econjournals, vol. 12(6), pages 113-126, November.
    4. Francois, John Nana & Keinsley, Andrew, 2019. "The long-run relationship between public consumption and output in developing countries: Evidence from panel data," Economics Letters, Elsevier, vol. 174(C), pages 96-99.
    5. Channing Arndt & Sam Jones & Finn Tarp, 2016. "What Is the Aggregate Economic Rate of Return to Foreign Aid?," The World Bank Economic Review, World Bank, vol. 30(3), pages 446-474.
    6. Katsushi S. Imai & Raghav Gaiha, 2014. "Dynamic and Long-term Linkages among Growth, Inequality and Poverty in Developing Countries," Economics Discussion Paper Series 1410, Economics, The University of Manchester.
    7. Ranjan Kumar Dash & Deepa Jitendra Gupta & Tarun Khandelwal, 2024. "Revisited the role of foreign aid in capital formation: experience of South Asian countries," Palgrave Communications, Palgrave Macmillan, vol. 11(1), pages 1-12, December.
    8. Abrams M E Tagem, 2017. "Aid, Taxes and Government Spending: A Heterogeneous Cointegrated Panel Analysis," Discussion Papers 2017-02, University of Nottingham, CREDIT.
    9. Belay Asfaw Gebresilassie & Tibebu Legesse & Girma Gezimu Gebre, 2024. "Impact of Foreign Aid on Economic Growth in Ethiopia," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 15(2), pages 5288-5306, June.
    10. 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.
    11. Abrams M. E. Tagem, 2023. "The dynamic effects of aid and taxes on government spending," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 30(6), pages 1656-1687, December.
    12. Francois, John Nana & Ahmad, Nazneen & Keinsley, Andrew & Nti-Addae, Akwasi, 2022. "Heterogeneity in the long-run remittance-output relationship: Theory and new evidence," Economic Modelling, Elsevier, vol. 110(C).
    13. Dierk Herzer, 2019. "The long-run effect of aid on health: evidence from panel cointegration analysis," Applied Economics, Taylor & Francis Journals, vol. 51(12), pages 1319-1338, March.
    14. Ismahene Yahyaoui & Najeh Bouchoucha, 2021. "The long‐run relationship between ODA, growth and governance: An application of FMOLS and DOLS approaches," African Development Review, African Development Bank, vol. 33(1), pages 38-54, March.
    15. Boateng, Elliot & Agbola, Frank W. & Mahmood, Amir, 2021. "Foreign aid volatility and economic growth in Sub-Saharan Africa: Does institutional quality matter?," Economic Modelling, Elsevier, vol. 96(C), pages 111-127.
    16. Tefera, Mamo G & Odhiambo, Nicholas M, 2022. "The impact of foreign aid on economic growth in Africa: Empirical evidence from low-income countries," Working Papers 29830, University of South Africa, Department of Economics.
    17. Yahyaoui, Ismahen & Bouchoucha, Najeh, 2019. "The Long-run relationship between ODA, growth and governance: An application of FMOLS and DOLS Approachs," MPRA Paper 95938, University Library of Munich, Germany.
    18. Lionel Roger, 2015. "Foreign Aid, Poor Data, and the Fragility of Macroeconomic Inference," Discussion Papers 2015-06, University of Nottingham, CREDIT.
    19. Abrams M.E. Tagem, 2017. "The economics and politics of foreign aid and domestic revenue," WIDER Working Paper Series wp-2017-180, World Institute for Development Economic Research (UNU-WIDER).
    20. Elena Groß & Felicitas Nowak‐Lehmann Danzinger, 2022. "What effect does development aid have on productivity in recipient countries?," Review of Development Economics, Wiley Blackwell, vol. 26(3), pages 1438-1465, August.

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    More about this item

    Keywords

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

    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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