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

31 Pages Posted: 13 Apr 2004

See all articles by George Economides

George Economides

Athens University of Economics and Business - Department of International and European Economic Studies

Sarantis C. Kalyvitis

Athens University of Economics and Business - Department of International and European Economic Studies

Apostolis Philippopoulos

Athens University of Economics and Business - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); University of Essex

Date Written: March 2004

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 selfinterested 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.

Keywords: foreign aid, incentives, growth

JEL Classification: F35, D7, D9, H2

Suggested Citation

Economides, George and Kalyvitis, Sarantis C. and Philippopoulos, Apostolis, Do Foreign Aid Transfers Distort Incentives and Hurt Growth? Theory and Evidence from 75 Aid-Recipient Countries (March 2004). Available at SSRN: https://ssrn.com/abstract=528163 or http://dx.doi.org/10.2139/ssrn.528163

George Economides

Athens University of Economics and Business - Department of International and European Economic Studies ( email )

GR-10434 Athens
Greece
+30-210-8214122 (Phone)
+30-210-8203729 (Fax)

Sarantis C. Kalyvitis (Contact Author)

Athens University of Economics and Business - Department of International and European Economic Studies ( email )

Patission Str 76
GR-10434 Athens
Greece

Apostolis Philippopoulos

Athens University of Economics and Business - Department of Economics ( email )

76 Patission Street
GR-10434 Athens
Greece
+301 322 3187 (Phone)

CESifo (Center for Economic Studies and Ifo Institute for Economic Research) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

University of Essex ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

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