Foreign Aid, Government Policies, and Economic Growth: Further Evidence from Cross-Country Panel Data for 1970-1993

Abstract

Six four-year panels for 56 aid-receiving countries, covering the period 1970-1993, are used to judge the effect of foreign aid on economic growth, with a particular focus on the role of aid-receiving countries’ government policies in the effect of aid on growth. The main point made is that the parameter indicating the role of policy in the effectiveness of aid seems highly fragile. If a reasonable augmentation of the models is done by including country-specific intercept dummy variables, policy is observed to have no significant influence on the effect of aid on growth. In some cases, the aid-policy interaction parameter does not show a positive sign even without the country-dummies. Much caution is, therefore, urged in drawing strong conclusions from such estimates about the role of aid-receiving countries’ policies in the effectiveness of aid. Three additional points are noted. First, the aid-parameter has a positive sign in every augmented model (that includes country-specific intercept dummies), but its statistical significance is somewhat mixed. Second, contrary to what one might think, the parameter estimates for several variables become more precise when country-dummies are included. Last, contrast between the estimates from models that do and do not include fixed-effects country-dummies appears methodologically instructive.