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The Long-Run Impact of Foreign Aid in 36 African Countries: Insights from Multivariate Time Series Analysis

Author

Listed:
  • Katarina Juselius
  • Niels Framroze
  • Finn Tarp

Abstract

Studies of aid effectiveness abound in the literature, often with opposing conclusions. Since most time-series studies use data from the exact same publicly available data bases, our claim here is that such differences in results must be due to the use of different econometric models and methods. To investigate this we perform a comprehensive study of the long-run effect of foreign aid (ODA) on a set of key macroeconomic variables in 36 sub-Saharan African countries from mid-1960s to 2007. We use a well-specified (Cointegrated) VAR (CVAR) model as our statistical benchmark. It represents a much-needed general-to-specific approach which can provide broad confidence intervals within which empirically relevant claims should fall. Based on stringent statistical testing, our results provide broad support for a positive long-run impact of ODA flows on the macroeconomy. For example, we find a positive effect of ODA on investment in 33 of the 36 included countries, but hardly any evidence supporting the view that aid has been harmful. From a methodological point of view our study documents the importance of transparency in results reporting in particular when the statistical null does not correspond to a natural economic null hypothesis. Our study identifies three reasons for econometrically unsatisfactory results in the literature: failure to adequately account for unit roots and breaks; imposing seemingly innocuous but invalid data transformations; and imposing aid endogeneity/exogeneity without testing.

Suggested Citation

  • Katarina Juselius & Niels Framroze & Finn Tarp, 2011. "The Long-Run Impact of Foreign Aid in 36 African Countries: Insights from Multivariate Time Series Analysis," WIDER Working Paper Series 051, World Institute for Development Economic Research (UNU-WIDER).
  • Handle: RePEc:unu:wpaper:wp2011-51
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    References listed on IDEAS

    as
    1. Hristos Doucouliagos & Martin Paldam, 2005. "Aid Effectiveness on Growth. A Meta Study," Economics Working Papers 2005-13, Department of Economics and Business Economics, Aarhus University.
    2. Finn Tarp, 2006. "Aid and Development," Discussion Papers 06-12, University of Copenhagen. Department of Economics.
    3. Spanos, Aris, 2009. "The Pre-Eminence of Theory versus the European CVAR Perspective in Macroeconometric Modeling," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 3, pages 1-14.
    4. Tseday Jemaneh Mekasha & Finn Tarp, 2013. "Aid and Growth: What Meta-Analysis Reveals," Journal of Development Studies, Taylor & Francis Journals, vol. 49(4), pages 564-583, April.
    5. Easterly, William, 1999. "The ghost of financing gap: testing the growth model used in the international financial institutions," Journal of Development Economics, Elsevier, vol. 60(2), pages 423-438, December.
    6. Henrik Hansen & Finn Tarp, 2000. "Aid effectiveness disputed," Journal of International Development, John Wiley & Sons, Ltd., vol. 12(3), pages 375-398, April.
    7. Heller, Peter S, 1975. "A Model of Public Fiscal Behavior in Developing Countries: Aid, Investment, and Taxation," American Economic Review, American Economic Association, vol. 65(3), pages 429-445, June.
    8. Hansen, Henrik & Tarp, Finn, 2001. "Aid and growth regressions," Journal of Development Economics, Elsevier, vol. 64(2), pages 547-570, April.
    9. Bacha, Edmar L., 1990. "A three-gap model of foreign transfers and the GDP growth rate in developing countries," Journal of Development Economics, Elsevier, vol. 32(2), pages 279-296, April.
    10. Kongsted, Hans Christian, 2005. "Testing the nominal-to-real transformation," Journal of Econometrics, Elsevier, vol. 124(2), pages 205-225, February.
    11. Arndt Channing & Jones Sam & Tarp Finn, 2010. "Aid, Growth, and Development: Have We Come Full Circle?," Journal of Globalization and Development, De Gruyter, vol. 1(2), pages 1-29, December.
    12. Karuna Gomanee & Sourafel Girma & Oliver Morrissey, 2005. "Aid and growth in Sub-Saharan Africa: accounting for transmission mechanisms," Journal of International Development, John Wiley & Sons, Ltd., vol. 17(8), pages 1055-1075.
    13. Devarajan, Shantayanan & Swaroop, vinaya, 1998. "The implications of foreign aid fungibility for development assistance," Policy Research Working Paper Series 2022, The World Bank.
    14. Jusélius, Katarina, 2009. "Special Issue on Using Econometrics for Assessing Economic Models: An Introduction," Economics - The Open-Access, Open-Assessment E-Journal, Kiel Institute for the World Economy (IfW), vol. 3, pages 1-20.
    15. Juselius, Katarina, 2006. "The Cointegrated VAR Model: Methodology and Applications," OUP Catalogue, Oxford University Press, number 9780199285679.
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    Keywords

    foreign aid; Africa; transmission channels; unit roots; Cointegrated VAR;

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