Aid, Policies, and Growth

Abstract

Aid has a positive impact on growth in developing countries with good fiscal, monetary, and trade policies. Aid appears not to affect policies systematically either for good or for ill. Any tendency for aid to reward good policies has been overwhelmed by donorsë pursuit of their own strategic interests.

Burnside and Dollar use a new database on foreign aid to examine the relationships among foreign aid, economic policies, and growth of per capita GDP.

In panel growth regressions for 56 developing countries and six four-year periods (1970-93), they find that the policies that have a great effect on growth are those related to fiscal surplus, inflation, and trade openness.

They construct an index for those three policies and have that index interact with foreign aid. They have instruments for both aid and aid interacting with policies.

They find that aid has a positive impact on growth in developing countries with good fiscal, monetary, and trade policies. In the presence of poor policies, aid has no positive effect on growth.

This result is robust in a variety of specifications, which include or exclude middle-income countries, include or exclude outliers, and treat policies as exogenous or endogenous.

They examine the determinants of policy and find no evidence that aid has systematically affected policies, either for good or for ill. They estimate an aid allocation equation and show that any tendency for aid to reward good policies has been overwhelmed by donors' pursuit of their own strategic interests.

In a counterfactual, they reallocate aid, reducing the role of donor interests and increasing the importance of policy. Such a reallocation would have a large positive effect on developing countries' growth rates.

This paper - a product of the Macroeconomics and Growth Division, Policy Research Department - is part of a larger effort in the department to study the effectiveness of foreign aid. The study was funded by the Bank's Research Support Budget under research project Economic Policies and the Effectiveness of Foreign Aid (RPO 681-70).