Does foreign aid cause economic growth in recipient countries?
A recent article in The Economist summarizes the ongoing debate about whether or not foreign aid is actually successful in spurring economic growth in recipient countries, and if so, how that growth can be measured. Economists and policymakers have struggled to find a fair and accurate way to measure the long-term economic effects of foreign aid programs. The article cites a new study co-authored by MPRC faculty associate Sebastian Galiani, Ben Zou (University of Maryland), and Stephen Knack and Colin Xu (The World Bank).
Galiani and his colleagues looked at a sample of 35 countries that crossed the World Bank’s International Development Association income threshold between 1987 and 2010. They found that although the IDA threshold is an arbitrary income level that does not necessary represent real structural change in economic growth, major donors appeared to view crossing the IDA threshold as a signal that a country was no longer in such dire need of aid. Total aid declined significantly once a recipient country crossed the IDA income threshold. Study results showed that a one percent increase in the aid to GNI ratio raised annual per capita GDP growth by approximately 0.35 percentage points.
These findings have implications for foreign aid policy. If aid reductions are followed by declines in economic growth in the recipient countries, it might be beneficial to step down the amount of foreign aid more gradually once a country has passed the IDA income threshold.