The Relationship Between Foreign Aid and Growth: A Comparative Analysis of Low Income, Lower-Middle Income and Upper-Middle-Income African Countries

Abstract

The research is financed from Humanities and Social Science Youth Foundation of Ministry of Education of China（13YJCZH133）

Abstract

Our paper studies 53 African economies by segregating them into 27 Africa low-income economies (ALICs), 18 Africa lower-middle-income economies (ALMICs) and 8 Africa upper-middle-income (AUMICs) economies according to United Nations (UN) income threshold categorization. The paper uses panel data of aid and GDP (economic growth) with control variables from 1990 to 2015 to investigate the direction and causal linkage between aid and economic growth in a quest to fill the void created by previous empirical literature in generating inconclusive results on the effects of foreign aid on economic growth through aggregate countries studies. Our study addresses this gap by employing Pedroni (1999) panel cointegration method to test the cointegration relationship between the series and the granger causality is investigated by the pooled mean group estimator (PMGE). Then, we investigate whether or not a strong relationship between aid and economic growth holds by using Pedroni (2001) method of Panel FMOLS and DOLS estimates. The results established the existence of cointegration relationship between aid and growth in all the three income sub-groups. There is also evidence of bidirectional granger causality between aid and economic growth in low- income and lower-middle income sub-groups. The results however record unidirectional causality in the case of African upper-income sub-group. There are mixed panel FMOLS and DOLS findings for the groups. The panel results indicate a strong relationship between aid and growth for the lower and upper-middle-income economies and no strong relationship for the low-income countries. The issues of strong aid-growth relationship in the individual country case analysis present a new perspective to policy makers to understand by taking into consideration the specific degree of GDP growth in each country in order to formulate effective aid-based policies to propel growth.

Keywords: foreign aid, economic growth, Africa, disaggregated aid, Causality Analysis