Does Development Aid Speed Development?

New research suggests that development aid does foster growth—but at what cost?

An article in The Economist summarizes some of the recent research on the impact of development aid on development. As anyone who has worked in the field must suspect, the relationship is complex, and thus it has been hard for economists to understand. They are pretty good at measuring the amount of development aid (shown in the graph above left) and the GDP per capita in countries (in the graph above right). Separating out the impact of the one variable from the booming, buzzing confusion of the real world is much harder.

I quote from the article:

What the UN sees as a potent weapon against poverty, others consider money down a rat hole. Critics reckon aid hurts its recipients by fostering dependency, propping up oppressive or incompetent regimes and pushing up the value of poor countries’ currencies, thereby undermining the competitiveness of their exports. If aid helped, they say, the poorest countries would have been getting steadily richer for decades, which they have not (see right-hand chart). Those who favour giving aid argue that it could indeed lift people out of poverty, but rich countries simply do not give enough. It is like sending fire engines to combat a wildfire: it only works if you send a lot of them...... 

A study by the World Institute for Development Economics Research has reviewed all peer-reviewed papers on aid and growth published since 2008. It concludes that the evidence that aid boosts growth is itself growing rapidly. 

Whether that extra growth constitutes good value for money is another question. Unfortunately, there have been few studies of the cost-effectiveness of aid. A forthcoming analysis by Chris Doucouliagos of Deakin University and Martin Paldam of Aarhus University of 141 studies published between 1970 and 2011 finds that the average estimated effect of aid on growth is positive and statistically significant, but so small that it may not be terribly meaningful. Advocates of freer trade or more liberal immigration regimes contend that the economic benefits of such measures for poor countries far outweigh those of aid. Supporters of the 0.7% target can take comfort in the growing evidence that aid boosts growth; but they have more work to do to demonstrate that it boosts it by more, and at lower cost, than the alternatives.

Here are the original studies referenced by The Economist:

• “The Effect of Aid on Growth: Evidence from a Quasi-Experiment”, by Sebastian Galiani, Stephen Knack, Colin Xu and Ben Zou, SSRN working paper, June 2014
• “On the Simultaneity Problem in the Aid and Growth Debate”, by Markus Brückner, Journal of Applied Econometrics, January/February 2013
• “Natural Disasters, Foreign Aid and Economic Growth”, by Osborne Jackson, SSRN working paper, February 2014
• “Aid, Growth and Employment”, UNU-WIDER position paper, May 2014
• “Finally a breakthrough? The recent rise in the size of the estimates of aid effectiveness”, by Hristos Doucouliagos and Martin Paldam. From the forthcoming “Handbook on the Economics of Foreign Aid”, edited by Mak Arvin, Edward Elgar, 2015