The Puzzling Effects of Foreign Aid (ODA) on FDI: Examining Africa’s Experience

Abstract

The foreign aid -FDI relationship hypothesis is quite recent in the development literature but sparks interesting controversy. Existing results are inconclusive on whether the two capital flows are complementary or substitutes. The argument of this paper is that previous studies’ implicit treatment of developing countries as a uniform entity could partly be blamed for the inconclusive results. It therefore attempts a unique study for Africa and further disaggregates the continent into two groups based on natural resource endowment to see if some level of clarity can emerge for better aid allocation and policy targeting.  Employing fixed effects estimation model for a balanced panel of 93 countries including 42 African countries on annual data covering 1996-2008, the study finds that total foreign aid to Africa has positive effect on FDI. It also emerged that Production sector aid has no negative effect on FDI in Africa. This type of aid rather has a significant positive effect on resource-seeking FDI in Africa proxy for by FDI in “oil and mineral exporting African countries”. There is no evidence of rent seeking and/or MPK reducing effect of aid to Africa as found for developing countries in some earlier studies.

Keywords: Foreign aid, FDI, Effects, Africa, Developing countries