Foreign Aid and Economic Growth in Developing Countries: Evidence from Sub-Saharan Africa

This study aims at understandingthe impact of foreign aid on the economic growth of the Sub Saharan African region.Despite being the largest foreign aid recipient in the world, the region is thepoorest with the lowest Human Development Index (HDI) and Gross National Income(GNI) per capita. This raises serious questions about the effectiveness of foreignaid to the economic growth and development of the region. As such, we examine therelationship between foreign aid, determined by the official development assistance(ODA), and the economic growth rate of the Sub Saharan Africa’s ten largest recipientsof foreign aid, for a 23-year period from 1990 to 2012. These ten countries includeEthiopia, the Democratic Republic of Congo, Tanzania, Kenya, Cote d’Ivoire, Mozambique,Nigeria, Ghana, Uganda and Malawi. We find that aid by itself does not have significantimpact on economic growth. However, the variable aid interacted with the policyindex was found to be statistically significant and positive, which means that aidtends to increase growth rate in a good policy environment. Subsequently, when weinclude the institutional quality index and its interaction term in the model, wefind that institutional quality has a positive and significant impact on growth;however, none of the aid variables was significant. We also test the two-gap growthmodel which states that foreign aid enhances economic growth through investmentand imports. The results show that foreign aid is a good ingredient for supplementinginvestment and imports requirements in these ten countries. We believe that givenforeign aid is conditional on the economic, political and institutional environmentof the recipient country, this can explain why aid effectiveness is insignificantin the Sub Saharan Africa region where bad governance is a core issue on the region.Therefore, respective governments, donor agencies, and policy makers should takeinto consideration these multiple aspects when undertaking aid-financing activities.