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Do Foreign Aid Transfers Distort Incentives and Hurt Growth? Theory and Evidence from 75 Aid-recipient Countries

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  • George Economides
  • Sarantis Kalyvitis
  • Apostolis Philippopoulos

Abstract

In this paper, foreign aid transfers can distort individual incentives, and hence hurt growth, by encouraging rent-seeking as opposed to productive activities. We construct a model of a small growing open economy that distinguishes two effects from foreign transfers: (i) a direct positive effect, as higher transfers allow the financing of infrastructure; (ii) an indirect negative effect, as higher transfers induce rent-seeking competition on the part of self-interested individuals. In this framework, the growth impact of aid is examined jointly with the determination of rent-seeking behavior. We test the main predictions of the model for a cross-section of 75 aid-recipient countries between 1975 and 1995. There is evidence that aid has a direct positive effect on growth, which is however significantly mitigated by the adverse indirect effects of associated rent-seeking activities. This is especially the case in recipient countries with relatively large public sectors.

Suggested Citation

  • George Economides & Sarantis Kalyvitis & Apostolis Philippopoulos, 2004. "Do Foreign Aid Transfers Distort Incentives and Hurt Growth? Theory and Evidence from 75 Aid-recipient Countries," CESifo Working Paper Series 1156, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_1156
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    Citations

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    Cited by:

    1. Addison, Tony & Mavrotas, George & McGillivray, Mark, 2005. "Aid, Debt Relief and New Sources of Finance for Meeting the Millennium Development Goals," WIDER Working Paper Series 009, World Institute for Development Economic Research (UNU-WIDER).
    2. Tony Addison & George Mavrotas & Mark McGillivray, 2005. "Development assistance and development finance: evidence and global policy agendas," Journal of International Development, John Wiley & Sons, Ltd., vol. 17(6), pages 819-836.
    3. Raghbendra Jha, 2004. "Macroeconomic stabilization and pro-poor budgetary policy in the globalized economy," CAMA Working Papers 2004-08, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    4. Angeles, Luis & Neanidis, Kyriakos C., 2009. "Aid effectiveness: the role of the local elite," Journal of Development Economics, Elsevier, pages 120-134.
    5. Larrú, José María, 2013. "The developmental contribution of the Offset Agreements: the case of Colombia," MPRA Paper 51456, University Library of Munich, Germany.
    6. Cui, Xiaoyong & Gong, Liutang, 2008. "Foreign aid, domestic capital accumulation, and foreign borrowing," Journal of Macroeconomics, Elsevier, vol. 30(3), pages 1269-1284, September.
    7. Marcelo Bianconi, 2011. "Transfer programs under alternative insurance schemes and liquidity constraints," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 20(2), pages 175-197.
    8. Michael A. Clemens & Steven Radelet & Rikhil Bhavnani, 2004. "Counting chickens when they hatch: The short-term effect of aid on growth," International Finance 0407010, EconWPA.
    9. Mark McGillivray, 2005. "Réformer la formule : commentaires.Efficacité de l'aide et régimes de politiques économiques dans les pays receveurs," Revue d’économie du développement, De Boeck Université, vol. 13(2), pages 119-127.
    10. Maria Rosaria Carillo & Valentina Chiariello & Rita De Siano, 2016. "Women in Parliaments and Aid effectiveness in Sub-Saharan African countries," Discussion Papers 5_2016, CRISEI, University of Naples "Parthenope", Italy.
    11. Konstantinos Angelopoulos & Apostolis Philippopoulos, 2005. "The Role of Government in Anti-Social Redistributive Activities," CESifo Working Paper Series 1427, CESifo Group Munich.

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    Keywords

    foreign aid; incentives; growth;

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