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Re-examining the relationship between domestic investment and foreign aid: does political stability matter?

Author

Listed:
  • Nabamita Dutta
  • Deepraj Mukherjee
  • Sanjukta Roy

Abstract

While past studies had conflicting conclusions regarding the impact of foreign aid on growth and development of a nation, recent studies have tried to delve deeper into the question, 'what makes aid work?' (see, Dutta, Leeson, and Williamson, 2013; Burnside and Dollar, 2000, 2004; Svensson, 1999). This paper tests how political stability (vis-�-vis political instability) affects the relationship between domestic investment and foreign aid. Applying dynamic panel estimators, our results show that political stability affects aid's effectiveness on domestic capital formation. The paper considers alternative measures of political stability (vis-�-vis instability), focusing on the political characteristics of a system that have the potential to make a nation stable. Political stability affects policy selection by the government positively and, thus, public resources such as foreign aid are put to the desired use. The estimated marginal impacts show that foreign aid enhances domestic investment in the presence of a stable political climate, but there is a diminishing return to aid.

Suggested Citation

  • Nabamita Dutta & Deepraj Mukherjee & Sanjukta Roy, 2015. "Re-examining the relationship between domestic investment and foreign aid: does political stability matter?," International Review of Applied Economics, Taylor & Francis Journals, vol. 29(3), pages 259-286, May.
    • Handle: RePEc:taf:irapec:v:29:y:2015:i:3:p:259-286
    DOI: 10.1080/02692171.2014.945991
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    References listed on IDEAS

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    1. Bourguignon, François & Platteau, Jean-Philippe, 2012. "Does Aid Availability Affect Effectiveness in Reducing Poverty?," WIDER Working Paper Series 054, World Institute for Development Economic Research (UNU-WIDER).
    2. repec:unu:wpaper:wp2012-54 is not listed on IDEAS
    3. François Bourguignon & Jean-Philippe Platteau, 2012. "Does Aid Availability Affect Effectiveness in Reducing Poverty?," WIDER Working Paper Series wp-2012-054, World Institute for Development Economic Research (UNU-WIDER).
    4. World Bank, 2011. "World Development Indicators 2011," World Bank Publications - Books, The World Bank Group, number 2315, April.
    5. Alesina, Alberto & Perotti, Roberto, 1996. "Income distribution, political instability, and investment," European Economic Review, Elsevier, vol. 40(6), pages 1203-1228, June.
    6. World Bank, 2011. "Regional Highlights World Development Indicators 2011," World Bank Publications - Books, The World Bank Group, number 27344, April.
    7. World Bank, 2010. "World Development Indicators 2010," World Bank Publications - Books, The World Bank Group, number 4373, April.
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    Cited by:

    1. 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.
    2. Amponsah, Mary & Agbola, Frank W. & Mahmood, Amir, 2023. "The relationship between poverty, income inequality and inclusive growth in Sub-Saharan Africa," Economic Modelling, Elsevier, vol. 126(C).

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