Foreign aid allocation, governance, and economic growth

Foreign aid to developing countries is a subject of heated debate among politicians, economists, and development specialists. Does aid promote economic growth and reduce poverty? Some argue that foreign aid has no effect on growth and may sometimes even undermine growth in aid recipient countries. Others suggest that foreign aid positively influences economic growth. Still others suggest that foreign aid has a positive impact on growth but this impact is conditional on a good institutional and policy environment. This debate has high stakes, given that foreign aid in the form of official development assistance (ODA) by leading donor nations reached over US$120 billion in 2010, the highest level ever recorded.

This study contributes to the debate by taking a different approach from conventional analyses of the aid–growth relationship. Analysis of the aid–growth relationship shows no significant connection between aggregate aid and per capita GDP growth. Rather than treating ODA as a single category, the study disaggregates it into several different categories, based on which sector of a recipient’s economy the ODA is meant to help or promote. The study investigates whether changes in sectoral allocation of ODA influence the effectiveness of foreign aid in promoting economic growth. Although this is not an entirely new direction for research in this area, little is known about the possible causal impacts of aid to different sectors on economic growth. The results of the study are presented in Foreign Aid Allocation, Governance, & Economic Growth, recently published by the University of Pennsylvania Press for IFPRI.