Effect of Aid on Indicators of Economic Growth

Za Eng Mawi

ECON 4120 - Econometrics

July 19, 2016

Abstract

In this paper, economic growth is observed not only from GDP but also from other indicators

such as self-employment, proportion of students in secondary education, foreign direct

investment, GINI index, labor force participation rate, number of new businesses, and poverty

headcount. Also, aid is observed as net aid received, net development assistance and net flows

from UN agencies. It is found that net development assistance and net flows from UN agencies

both have significant negative-effects on secondary education, net aid received has significant

positive-effect on GINI index and poverty headcount.

Introduction

“Fighting poverty is a big business. But who benefits the most?” asks the documentary Poverty

Inc. After watching this documentary, I was inspired to search for my own answers about aid

effectiveness on recipient countries’ economic growth. In the documentary, it is said that aid

does not help economic growth. Thus, such is the hypothesis that I started this paper with.

Literature Review

Does aid help the economic growth of the recipient countries? This questions has so many

answers that any two people can hardly agree on one.

Doucouliagos and Paldam tried to find the common answer by looking at results from 68

different papers on aid effectiveness on growth and found that aid does not have significant

effect on growth “on average”( 2008). They updated their findings in 2010 with only to confirm

the first findings. In another study, Burhop looked at income per capita and investment of 45

countries for 40 years (1960-1999) but could not find evidence that aid causes economic growth.

In my study, I looked at 125 countries for 25 years (1990-2014).

On the other hand, Hansen and Tarp found that aid has positive-effect on growth through

investment (2001). They also pointed out that aid has “decreasing returns” and that” estimated

effectiveness of aid is highly sensitive to the choice of estimator”. Unlike their study that only

focused on GDP and investment, my study looked at eight different indicators of economic

growth. Similarly, Minoiu and Reddy separated aid into two types, developmental aid and non-

developmental aid. They found that developmental aid has a positive-effect on growth in the

long run (2010). In my study, I separated aid into three types: net aid received, net

developmental assistance and net flows from UN agencies.

Model

I want to find out how does aid affect different factors of economic growth. Therefore, I chose

eight variables that I believe are important indicators of economic growth. My chosen indicator-

variables are as followed.

Indicator Variable Definition totalEmployers Workers who, working on their own account or with one or a few

partners, hold the type of jobs defined as a "self-employment jobs" i.e. jobs where the remuneration is directly dependent upon the profits derived from the goods and services produced), and, in this capacity, have engaged, on a continuous basis, one or more persons to work for them as employee(s) (% of employment)

SecondaryEduPupils The total number of pupils enrolled at secondary level in public and private schools

fdi Direct investment equity flows in the reporting economy. It is the sum of equity capital, reinvestment of earnings, and other capital (BoP, current US$)

gdp GDP at purchaser's prices is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products (constant 2005 US$)

GINI The extent to which the distribution of income (or, in some cases, consumption expenditure) among individuals or households within an economy deviates from a perfectly equal distribution (World Bank estimate)

LFPR the proportion of the population ages 15 and older that is economically active: all people who supply labor for the production of goods and services during a specified period (modeled ILO estimate)

newBusinesses the number of new limited liability corporations registered in the calendar year

povertyHeadcount the percentage of the population living on less than $3.10 a day at 2011 international prices (2011 PPP) (% of population)

I also have three different variables for aid as followed. The reason for choosing these

three is based on my data availability. I thought of combining them but I think that the

development assistance can also be from the UN agencies. Also, the net aid received could be

calculated based on development assistance and/or net flows from UN agencies.

Aid Variable DefinitionaidRecieved Aid flows (net of repayments) from official donors to countries and

territories in part II of the DAC list of recipients: more advanced countries of Central and Eastern Europe, the countries of the former Soviet Union, and certain advanced developing countries and territories (constant 2013 US$)

devAssistance Disbursements of loans made on concessional terms (net of repayments of principal) and grants by official agencies of the members of the Development Assistance Committee (DAC), by multilateral institutions, and by non-DAC countries to promote economic development and welfare in countries and territories in the DAC list of ODA recipients (constant 2013 US$)

totalUN The net disbursements of total official flows from the UN agencies. Total official flows are the sum of Official Development Assistance (ODA) or official aid and Other Official Flows (OOF) and represent the total disbursements by the official sector at large to the recipient country (current US$)

Each indicator-variable is observed as the dependent variable with each of the aid-

variable as the independent variable and a unique set of other independent variables. I also

observed the indicator-variables and aid-variables with and without controlling the differences in

countries and years. As a result, I have 8 main models with 6 sub-models for each, resulting in a

total of 48 models.

Model 1: Effect of Aid on Self Employment

1 .1¿ totalEmploers=β0+β1aidRecieved+β2 fdi+β3 gdp+β4gdpDeflator+μ

1. 2¿ totalEmploers=β0+β1devAssistance+ β2 fdi+ β3 gdp+β4 gdpDeflator+μ

1.3¿totalEmploers=β0+β1 totalUN+ β2 fdi+ β3 gdp+β4 gdpDeflator+μ

1. 4¿ totalEmploers=β0+β1aidRecieved+ β2 fdi+ β3 gdp+β4 gdpDeflator+country∗+ year∗+μ

1.5¿ totalEmploers=β0+β1devAssistance+β2 fdi+β3gdp+β4 gdpDeflator+country∗+ year∗+μ

1. 6¿ totalEmploers=β0+ β1 totalUN+β2 fdi+β3gdp+β4 gdpDeflator+country∗+ year∗+μ

Similarly to Model 1, Model 2 - 8 are repeated by exchanging aidRecieved for

devAssistance and totalUN, and then are repeated again by controlling for differences in

countries and years.

Model 2: Effect of Aid on Secondary Education

SecondaryEduPupils=β0+β1aidRecieved+β2gdp+ β3GINI+β4householdConsumption+β5LFPR+β6PrimaryEduPupils+β7SecondaryEduVocPupils+μ

Model 3: Effect of Aid on foreign direct investment

fdi=β0+β1aidRecieved+β2gdp+ β3householdConsumption+β4 gdpDeflator+β5 firms+μ

Model 4: Effect of Aid on GDP

gdp=β0+β1aidRecieved+ β2 Exports+β3 Imports+β4 govConsumption+β5householdConsumption+β6 fdi+β7gdpDeflator+μ

Model 5: Effect of Aid on GINI

GINI=β0+β1aidRecieved+β2totalEmployers+β3SecondaryEduPupils+β4SecondaryEduVocPupils+β5 fdi+ β6 gdp+β7govConsumption+ β8householdConsumption+β9gdpDeflator+β10LFPR+μ

Model 6: Effect of Aid on Labor Force Participation Rate

LFPR=β0+β1aidRecieved+β2totalEmployers+β3SecondaryEduPupils+β4 SecondaryEduVocPupils+ β5 fdi+ β6 gdp+β7gdpDeflator+β8householdConsumption++ β9govConsumption+μ

Model 7: Effect of Aid on New Businesses

newBusinesses=β0+ β1aidRecieved+β2SecondaryEduPupils+β3SecondaryEduVocPupils+β4 fdi+ β5 gdp+β6GINI+ β7 govConsumption+β8householdConsumption+β9 gdpDeflator+μ

Model 8: Effect of Aid on Poverty Headcount

povertyHeadcount=β0+β1aidRecieved+β2 primaryEduPupils+β3SecondaryEduPupils+β4 SecondaryEduVocPupils+β5 fdi+β6gdp+ β7 govConsumption+β8householdConsumption+β9 gdpDeflator+ β10 LFPR+μ

Since every country is unique and has its own problems and advantages, I created a

dummy variables for each country to account for the differences in countries. Similarly, I created

a dummy variable for each year to control for the variations from one year to the next. A list of

independent variables (aside from the eight indicator-variables and three aid-variables) are as

followed.

Variable Definition PrimaryEduPupils The total number of pupils enrolled at primary level in public and

private schoolsSecondEduVocPupils The number of secondary students enrolled in technical and

vocational education programs, including teacher trainingExports The value of all goods and other market services provided to the rest

of the world (constant 2005 US$)firms The percentage of firms formally registered when they started

operations in the countrygovConsumption All government current expenditures for purchases of goods and

services (constant 2005 US$)householdConsumption

The market value of all goods and services, including durable products (such as cars, washing machines, and home computers), purchased by households (constant 2005 US$)

gdpDeflator Inflation as measured by the annual growth rate of the GDP implicit deflator shows the rate of price change in the economy as a whole(annual %)

Imports The value of all goods and other market services received from the rest of the world (constant 2005 US$)

country_* Represents all the dummy variables for each country (from country_1 to country_125)

year_* Represents all the dummy variables for each year (from year_1 to year_25)

Data

All data was collected from the database of the World Bank, World Development Indicators. I

chose 125 countries that receive aid and collected data for the span of 25 years from 1990-2014.

The list of countries can be found in Appendix A.

Results

Without Control for differences in countries and years

Controlled for differences in countries and years

aidRecieved devAssistance totalUN aidReceived devAssitance totalUNtotalEmployers -0.06845*

(0.01058)-1.12e-09*(1.76e-10)

-1.06e-09*(1.69e-10)

-8.91e-11(2.58e-10)

-0.01375(0.03764)

-8.67e-11(2.53e-10)

SecondEduPupils -9260.463^(3635.593)

-2.517e-4*(6.91e-5)

-2.017e-4*(6.72e-5)

2988.757^(6551.603)

-2.267e-4*(5.84e-5)

-2.305e-4*(5.63e-5)

fdi 1.30e+07^(2.02e+07)

-0.2292(0.2924)

-0.166(0.2995)

3.34e+08^(1.87e+08)

-1.7655(1.6857)

-0.8149(1.64)

gdp -4.92e+07^(5.76e+07)

-2.7577*^(0.7902)

-2.7137*^(0.7739)

-1.47e+08^(4.65e+08)

-0.1802(0.3641)

-0.1792(0.3604)

GINI 0.4627*^(0.0582)

-3.81e-09*(1.28e-09)

-2.33e-09(1.39e-09)

0.20017**^(0.07034)

1.24e-09(7.32e-10)

1.24e-09(7.19e-10)

LFPR 0.07995(1.633)

-3.24e-09(3.82e-08)

-1.81e-09(3.6e-08)

-19.051**^(7.236)

-4.83e-09(6.07e-08)

-7.84e-09(5.86e-08)

newBusinesses -139.066^(103.525)

-3.16e-06(1.74e-06)

-3.6e-06***(1.62e-06)

1056.54**^(395.4024)

-3.88e-06(2.12e-06)

-3.97e-06***(1.95e-06)

povertyHeadcount 0.5432*^(0.06409)

5.45e-09*(1.37e-09)

5.94e-09*(1.32e-09)

0.3712*^(0.08585)

-1.14e-09(8.6e-10)

-1.11e-09(8.38e-10)

Legend

* Statistically significant at 1% level

** Statistically significant at 5% level

*** Statistically significant at 10% level

^ Economically significant

Findings

Net aid received (aidRecieved), net development assistance (devAssistance) and net

flows from all UN agencies (totalUN) have significant negative-effects on self-employment.

However, when controlled for the differences in countries and time, none of them has a

significant effect on self-employment. Even though the first finding confirms my hypothesis, the

latter varies.

Net development assistance and net flows from all UN agencies have statistically

significant negative-effects on secondary education with and without the control on the

differences. This, again, confirms my hypothesis, but the effects are too small to matter

economically.

Thought net aid received has an economically significant positive-effect on foreign direct

investment, there is no statistically significant effect by any of the aid variables.

All three aid variables have negative-effects on GDP. While net aid received only has

economically significant effect, net development assistance and net flows from all UN agencies

show both statistically and economically significant effects. When I control for the differences,

both of their significances disappear.

Net aid received shows economically and statistically positive-effect on GINI index even

with the control. It may means that my hypothesis is correct but it may also shows the reverse

effect. At the same time, net development assistance shows statistically significant negative-

effect on GINI index (without the control) contrary to net aid received.

The only aid variable that has statistically significant effect (at 5% level) on labor force

participation rate is net aid received only when controlling for differences.

Net flows from all UN agencies shows statistically significant negative-effect (at 10%

level) on new Businesses. Though net aid received shows economically significant negative

effect without the control, it shows even economically and statistically significant (at 10%)

positive-effect with the control.

As for the poverty headcount, net aid received consistently has a statistically and

economically significant positive-effect on it with and without the control. Net development

assistance and net flows from UN agencies both show statistically significant positive-effect

without the control, they show negative-effect with the control and they are no longer

statistically significant.

Conclusion

Out of the eight indicators, the only statistically significant effects that is big enough to

matter economically even when controlled for differences for countries and times are the effect

of net aid received on GINI index and that on poverty headcount. Since both show a positive

effect, may mean that aid increases GINI index and poverty headcount; however, it can also be

the case that more aid is sent to countries with higher GINI index and poverty headcount.

Development assistance and net flows from UN agencies both have significant negative-effects

on secondary education but the effect is too small to matter economically. Aid received also has

a significant but weaker negative-effect on labor force participation and positive-effect on

number of new businesses. It may mean that aid increases new businesses but reduces labor force

participation. It can be the case that people quit their jobs and start their own businesses with the

aid, but it can also be the case that the aid makes working class people lazy and boosts somewhat

well-off people to start their own businesses. All in all, there are mixed signals from the results

so it is hard to draw a clear conclusion. Further research should be done by revising the models.

Perhaps developing a new way to measure economic growth based on the interactions of all

available growth indicators.

Appendix A

List of Aid Recipient Countries

Afghanistan

Albania

Algeria

Angola

Antigua and Barbuda

Armenia

Azerbaijan

B

Bangladesh

Belize

Benin

Bhutan

Bolivia

Bosnia and

Herzegovina

Botswana

Burkina Faso

Burundi

C

Cambodia

Cameroon

Central African

Republic

Chad

Chile

Colombia

Comoros

Congo, Republic of the

Congo, Democratic

Republic of the

Costa Rica

Cote d'Ivoire

Cuba

D

Djibouti

Dominica

Dominican Republic

E

Ecuador

El Salvador

Equatorial Guinea

Eritrea

Ethiopia

F

Fiji

G

Gabon

Gambia

Georgia

Ghana

Grenada

Guatemala

Guinea

Guinea-Bissau

Guyana

H

Haiti

Honduras

I

Indonesia

Iran

Iraq

J

Jamaica

Jordan

K

Kazakhstan

Kenya

Kiribati

Kosovo

Kyrgyzstan

L

Laos

Lebanon

Lesotho

Liberia

Libya

M

Macedonia

Madagascar

Malawi

Malaysia

Maldives

Mali

Marshall Islands

Mauritania

Mauritius

Micronesia

Moldova

Mongolia

Montenegro

Mozambique

Myanmar (Burma)

N

Namibia

Nepal

Nicaragua

Niger

Nigeria

North Korea

P

Pakistan

Palau

Panama

Papua New Guinea

Paraguay

Peru

R

Rwanda

S

St. Kitts and Nevis

St. Lucia

St. Vincent and The

Grenadines

Samoa

Sao Tome and Principe

Serbia

Seychelles

Sierra Leone

Slovakia

Slovenia

Solomon Islands

Somalia

South Sudan

Sri Lanka

Sudan

Suriname

Swaziland

Syria

T

Tajikistan

Tanzania

Thailand

Timor-Leste

Togo

Tonga

Tunisia

Turkey

Turkmenistan

Tuvalu

U

Uganda

Uruguay

Uzbekistan

V

Vanuatu

Venezuela

Vietnam

Y

Yemen

Z

Zambia

Zimbabwe

References

Burhop, Carsten. 2005. “Foreign Assistance and Economic Development: A Re-evaluation.”

Science Direct.

Doucouliagos, Hristos. Paldam, Martin. 2008. “Aid Effectiveness on Growth: A Meta Study.”

Science Direct.

2010. “The Ineffectiveness of Development Aid on Growth: An Update.” Science Direct.

Hansen, Henrik. Tarp, Finn. 2001. “Aid and Growth Regressions.” Journal of Development

Economics. Vol. 64. 547–570

Minoiu, Camelia. Reddy, Sanjay G. 2010. “Development Aid and Economic Growth: A positive

Long-run Relation.” The Quarterly Review of Economics and Finance. Vol. 50. 27–39

“Poverty Inc.” Directed by Michael Matheson Miller. 2014; Acton Institute, DVD.