A new instrument suggests that foreign aid boosts growth

by on February 25, 2014 at 12:42 am in Economics | Permalink

There is a new paper by Sebastian Galiani, Stephen Knack, Lixin Colin Xu, and Ben Zou, and the results are intriguing:

The literature on aid and growth has not found a convincing instrumental variable to identify the causal effects of aid. In this paper we exploit an instrumental variable based on the fact that since 1987, a major criterion for IDA (International Development Association) eligibility has been whether or not a country is below a certain threshold of per capita income. This threshold is predetermined and arbitrary, so it is plausibly exogenous to recipient countries in a model that conditions on initial income levels, country and period fixed effects. We find evidence that other donors tend to reinforce rather than compensate for reductions in IDA aid following threshold crossings. Overall, the aid to GNI ratio drops by about 60% on average after countries cross the threshold. Focusing on the 35 countries that have crossed the IDA income threshold from below between 1987 and 2010, we find a positive, statistically significant, and economically sizable effect of aid on growth. A one percentage point increase in the aid to GNI ratio from the sample mean raises annual real per capita GDP growth by approximately 0.6 percentage points. We also demonstrate that an important reason for underestimating aid effects is the attenuation bias associated with measurement errors in aid that the literature has ignored so far. Finally, there is some evidence that our results may apply to the other low-income countries that are still below the threshold.

1 Doug February 25, 2014 at 1:45 am

It’s important to note that the paper uses the logarithm of the aid to GDP ratio. So the effect is mostly dominated by the effect of aid at the very low and basic level, e.g. things like basic vaccinations or parasite treatments. In fact the average impact of aid could still be negative and the regression coefficient on a logarithmic term could still be positive.

2 leftistconservative February 25, 2014 at 1:50 am

foreign aid is theft.

How come this site never acknowledges the widespread fraud in academia?

How come this site never acknowledges that academic papers are basically for sale to corporations and think tanks?

Growth Uber Alles!

3 prior_approval February 25, 2014 at 2:09 am

The Chairman and General Director of the Mercatus Center would undoubtedly point you to this refutation, at least in his case –

‘Does the Mercatus Center do directed research or research for hire?

Mercatus scholars do not do directed research or research for hire. Researchers select their own projects and are committed to the highest standards of academic quality and credibility for their research procedures and products.

We ensure our standards through rigorous internal review, peer review, and a transparent process for selecting and undertaking research projects.

While the credibility of the research any organization produces should stand on the quality and reliability of that research alone, more is often necessary. The Mercatus Center strictly adheres to a stated policy regarding independence of research.’ http://mercatus.org/content/about

4 leftistconservative February 25, 2014 at 3:54 am

oh, well, then, OK. That puts that idea to rest.

LOL…

How many academics have been put in jail for their bogus studies?

None.

Where there is money and no negative feedback, there will be people creating fake studies and taking that money.

This is axiomatic.

Academia is fraud and is the handmaiden of the rich and the corporations.

5 Academic February 25, 2014 at 7:02 am

“no negative feedback”

HAHAHA- you haven’t spent much time in academia, have you? All we get is negative feedback. Every second of every day.

6 msgkings February 25, 2014 at 12:08 pm

@leftistconservative: internet anarchism is so bloody boring. It’s not 1998 anymore, and the Occupy folks have all gone home.

The world is so much less of a mess than most of the posters here can ever fathom

http://www.rationaloptimist.com

7 prior_approval February 25, 2014 at 2:04 am

But thankfully, none of those countries have a minimum wage braking their growth, right?

8 Dirk February 25, 2014 at 2:45 am

because the FX rate goes up not onlyharming exporters but “inflating” the GDP number in this case.

“A one percentage point increase in the aid to GNI ratio from the sample mean raises annual real per capita GDP growth by approximately 0.6 percentage points”

With other words: The net effect is minus(!) 0.4 percentage points?

9 Errorr February 25, 2014 at 5:13 am

Um, I think you have made an error in the denominators. It doesn’t say a 1% increase in GDP from aid.

I’m still largely skeptical on how effective foreign aid is but I can’t imagine that there is NO positive effect even if it isn’t always very effective.

Although I think the question is how does aid effect long term growth.

10 dirk February 25, 2014 at 8:03 am

“It doesn’t say a 1% increase in GDP from aid.”

It says a “annual real per capita GDP growth by approximately 0.6 percentage points” in the same or following period (doesnt really matter as there is a lot of persistence in aid and the regression gets its effects from the cross-section not really the time series), which is pretty much the same as a 1% increase in GDP (ignoring population growth)

So even if the 0.6 % is not artificial (e.g. due to increased FX rates lowering prices of imported goods, unproductive work in the development sector counted…) or offset by other negative effects, which can be doubted, the net effect is negative. That’s quite amazing.

11 HM February 25, 2014 at 11:58 am

Aid is a transfer payment from abroad which is not counted in GDP. If the results are true it means consumption opportunities expand by 1.6%.

12 dirk February 25, 2014 at 1:57 pm

I thought of the exclusion of transfers in GDP as well, but I dont believe that makes a difference when it comes to practical matters. It only holds true if the government that receives US Dollars as aid directly uses them to buy e.g. weapons. But is more likely that they use it to employ e.g. development aid workers and pay them some salaries. This is then counted as productive work and included in GDP.

Effectively it is as if they were exporting some good consciousness and receiving USD in exchange. And production is included in GDP.

13 Intelektualac February 25, 2014 at 4:03 am

This is puzzling to say the least.
If state-sponsored kleptocratic non-market-driven aid helps growth, how does it not really stifle it when it undercuts the free enterprise and wastes significant part of funds on political projects, corruption and nepotism?

14 Errorr February 25, 2014 at 5:15 am

While I appreciate the sentiment to a certain degree the argument would be that overall growth is hurt through the redistribution and world income suffers.

15 Maciste February 25, 2014 at 9:11 am

I look forward to Bill Easterly’s comments on these new results!

16 BpF February 25, 2014 at 8:06 pm

Anybody know the language this was written in? I would like to apply Google translate and find out if there is any sense to it.
But seriously, the obfuscatory language trivializes the very concept of academic research. So sad.

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