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Foreign Aid, Recipient Growth, and the Strategic Goals of Donor Governments

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Yes, but only in recipient countries with good policies Burnside and Dollar 2000 ... Aid Pessimist: Recipient governments misspend their foreign aid. ... – PowerPoint PPT presentation

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Title: Foreign Aid, Recipient Growth, and the Strategic Goals of Donor Governments


1
Foreign Aid, Recipient Growth, and the Strategic
Goals of Donor Governments David H. Bearce
Associate Professor of Political Science
University of Pittsburgh dhb12_at_pitt.edu Daniel
C. Tirone Ph.D. Candidate in Political
Science University of Pittsburgh dct8_at_pitt.edu
2
Research Question Is foreign aid effective at
promoting economic growth in recipient national
economies? No Boone 1996 Yes, but only in
recipient countries with good policies Burnside
and Dollar 2000 No, not even in countries with
good policies Easterly, Levine and Roodman
2004 Thus, one might conclude that to the
extent that foreign aid can be effective, it
has not been so for much of the recent past and
it does not depend on conditions within
recipient countries.
3
Proposed Answer Foreign aid can be effective at
promoting economic growth, but only when the
strategic benefits of aid provision are small for
donor govts. Incorporates key insight from
political science research Foreign aid levels
have been determined by the strategic, military
and political interests of donor governments,
especially during the Cold War. Explores new
causal channel Foreign aid serves as a
financial incentive for recipient governments to
engage in politically-costly, but
growth-enhancing, economic reform.
4
An Argument for Conditional Foreign Aid
Effectiveness Aid Pessimist Recipient
governments misspend their foreign aid. Aid
Optimist Even if this is true, aid could still
promote economic growth by acting as a financial
incentive for recipient governments to engage in
politically-costly, but growth-enhancing,
economic reform. Aid Pessimist When Western
donors provide aid primarily to achieve various
strategic, military, and political objectives,
they cannot enforce their conditions for economic
reform. Aid Optimist If this is true, then
aid could be effective at promoting economic
growth when it is not provided primarily to
achieve these strategic, military, and political
objectives.
5
Testable Hypothesis More foreign aid should be
associated with more economic growth, but only
when the strategic benefits associated with
providing aid are small. Political science
research on the determinants of foreign aid show
that aid was driven primarily by strategic
considerations during the Cold War.
(Schraeder, Hook and Taylor 1998 Alesina and
Dollar 2000) But strategic considerations
became less important in the post-Cold War.
(Meernik, Krueger and Poe 1998 Neumayer
2003) H1 More foreign aid should be associated
with more economic growth, but only after 1990.
Before 1991, foreign aid should be
uncorrelated with recipient economic growth.
6
Statistical Model Unit of Analysis
aid-eligible developing country/years 1964-2003
(N3882). Economic Growthit ß0 ß1Foreign
Aidit-4 ßXControls Economic Growth measures
the growth rate of real GDP per capita in
constant terms. Foreign Aid measures the net
amount of Western aid in millions of constant US
dollars, lagged 4 years. (Excludes aid from
non-OECD governments.) Controls include Lagged
Growth, Population, Gross National Income,
Economic Development, Investment, Private
Consumption, Government Consumption, Trade
Openness, Exchange Rate, Democratization,
Internal Military Conflict, 7 Regional Dummies,
and t-1 Year Dummies.
7
Estimates of Economic Growth
Cell entries are OLS coefficients with robust
standard errors clustered on country in
parentheses. For space considerations, the
coefficients and standard errors not reported for
all control variables. Statistical significance
is indicated as following using two-tailed tests
p .01, p .05, p .10.
8
Alternative Explanation? Aid composition
shifted in the 1980s from capital projects to
technical assistance. To distinguish our
argument from this alternative explanation, we
offer an additional testable hypothesis. H2
Foreign aid has been less temporally sticky
post-1990 than pre-1991. Foreign Aidit ß0
ß1Foreign Aidit-1 ßXControls Expectation
ß1 will be larger (closer to 1.0) in the pre-1991
period than in post-1990 period.
9
Estimates of Foreign Aid
10
Does Aid Cause Economic Reform?
H3 More foreign aid should lead to more economic
reform, but only after 1990. Before
1991, foreign aid should be uncorrelated with
economic reform. ?Economic Reformit ß0
ß1Foreign Aidit-5 ßXControls ?Economic
Reform measures change in Fraser economic reform
index over five year interval 1975-2000 (N425)
11
Estimates of ?Economic Reform
12
Conclusion Sachs vs. Easterly Sachs (2005)
proposes large increase in Western aid, but shows
little evidence of past aid effectiveness. Easte
rly (2006) counters that aid has been largely
ineffectiveness in the past. So who is
right? Easterly is correct that Western aid has
not been effective for much of the Cold War
era. But this does not mean that aid could not
be effective now, provided that Western
governments do not use aid to recruit/maintain
allies in the war against terror.
13
Country/Year Unit of Analysis Economists often
use more aggregated unit of analysis (e.g.
country/5-year period). This may produce
temporal aggregation bias (Geweke
1982), resulting in a regression with high R2,
yet few stat. sig. independent variables. Prefer
able to use natural time unit of the theory
(Freeman 1989). Donor governments make foreign
aid decisions on annual basis. Recipient
governments make economic plans on similar
basis. All governments concerned about
short-term economic growth (related to
election outcomes and coup risk). The natural
time unit of our theory is the country/year.
14
How to Instrument Foreign Aid? Valid
instruments must be excludable in 2nd-stage
(Economic Growth) equation. Hard to find
instruments that satisfy exclusion restriction.
Rodrik (2005) it is genuinely hard to find
credible instruments which satisfy both the
exogeneity and exclusion requirement because it
is always possible to find a story about why an
exogenous variable belongs as a regressor in the
second-stage of the estimation (therefore making
it invalid as an instrument). Foreign Aid with
a long lag may be the most valid
instrument. Foreign Aidit-4 plausibly exogenous
to Economic Growthit-0 Foreign Aidit-4 unlikely
to affect Economic Growthit-0 through any channel
other than those associated with foreign aid.
15
Two Additional Points re Instrumenting Foreign
Aid 1. Traditional instruments are strategic,
military, and political variables Allied
with donor government, former colony of donor
government, Israel/Egypt dummies. Problem if
our theory is correct, then these instruments
strongly correlated with ineffective aid and
only weakly correlated (if at all) with effective
aid. 2. Foreign Aid endogeneity makes it
harder, not easier, to find positive relationship
with Economic Growth.
Economic Foreign Growth
Aid
() (-)
16
  • Why Not Deflate Foreign Aid by National Income?
  • Theoretically inappropriate
  • We are not arguing that aid affects growth
    through some government spending channel.
  • Through reform channel, government keeps aid to
    compensate for engaging in politically-costly
    economic reform.
  • While there may a larger of reform losers in a
    larger economy, there should also be a larger
    of reform winners.
  • Statistically problematic
  • Foreign Aid coefficient would be driven by
    either increases in numerator (aid)
  • or by decreases in denominator (national
    income).
  • If national income positively related to
    economic growth, then its inverse (1/GDP) should
    be negatively related to growth.

17
Deflating Foreign Aid by Democracy To enact
politically-costly economic reform, recipient
government may need to use aid money to pay off
its winning coalition. Democracies have a larger
winning coalition, meaning that aid money buys
less political support for economic reform in
democracies. Thus, deflate Foreign Aid by some
measure of democracy (e.g. Polity rescaled 1-21).
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