Aid and Growth: What Does the Cross-Country Evidence Really Show?

One of the most enduring and important questions in economics is whether foreign aid helps countries grow. There is a moral imperative to this question: it is a travesty for so many countries to remain poor if a relatively small transfer of resources from rich countries could set them on the path to growth. In fact, in the Millennium Declaration adopted in 2000, world leaders state, “We will spare no effort to free our fellow men, women and children from the abject and dehumanizing conditions of extreme poverty, to which more than a billion of them are currently subjected” and they resolve “to grant more generous development assistance, especially to countries that are genuinely making an effort to apply their resources to poverty reduction.” As a result, the effort is on to mobilize billions of dollars of aid to help poor countries, especially those with good policies and institutions. 

Yet, the question of whether aid helps poor countries grow in a sustained way is still mired in controversy. In this paper, we will re-examine (yet again!) whether aid leads to growth. What does this paper add to the voluminous literature on aid effectiveness? Essentially two things. First, most papers in the literature examine aid-effectiveness in a typically narrowly defined setting. We attempt to examine the aid-growth relationship under a variety of settings, using one common framework. Second, we examine carefully the issue of endogeneity—the possibility that aid flows could go to countries that are doing particularly badly, or to countries that are doing well, creating a spurious correlation between aid and growth. 

More specifically, the cross-country aid-growth literature has typically examined particular aspects of the possible relationship. Burnside and Dollar (2000), for example looked at the impact of aid on growth conditional on the quality of economic policy. Hansen and Tarp (2001) examine the relationship in a panel framework, and more recently, Dalgaard, Hansen, and Tarp (2004) focus on aid’s impact conditional on the country’s location (geography). Recently, Clemens et. al. (2004) disaggregate aid into what they term short- and long-impact aid. We examine under one framework, the robustness of the relationship across time horizons (medium and long run) and periods (1960s through 1990s), sources of aid (multilateral and bilateral), types of aid (economic, social, food, etc.), timing of impact of aid (contemporaneous and varying lags (from 10-30 years)), specifications (cross-section and panel), and samples (including and excluding outliers).