Global Financial Crisis and Foreign Development Assistance Shocks in Least Developing Countries

Article excerpt

This paper evaluates whether the exogenous component of the global financial crisis affects OECD-DAC EU donor countries ODA disbursements to the LDCs and how it impacts on LDCs economic prosperity. Using both static and dynamic panel techniques, we find that global financial crisis in OECD-EU donor countries are causes for the significant downside of ODA flows to the LDCs. Consequently it adversely affects through the various transmission channels (e.g., ODA disbursements, remittances, bilateral financial flows, export growth) to the LDCs economic growth. Our results also explore that due to countercyclical role of ODA flows from the donors' largely affect to the LDCs economic development process negatively. The robustness checks using alternative estimation technique supports our original estimation results in every context.

Keywords: Financial Crisis, ODA, Economic Growth, OECD-EU Donors, LDCs

JEL classification: F35, F39, O5, O11

(ProQuest: ... denotes formulae omitted.)

1. INTRODUCTION

Foreign development assistance, widely known as Official Development Assistance (ODA), is the most prominent development tool employed by the developed countries in its attempts to promote prosperity in the developing countries. Since the Second World War, ODA has become an institutionalized part of foreign policy of donors which accounts for an important source of many developing countries' fiscal income (Grant and Nijman, 1998). Several studies (Ang, 2010; Burnside and Dollar, 2000; Easterly, 2003; Easterly, Levine, and Roodman, 2004; Hansen and Tarp, 2001; Karras, 2006; Rajan and Subramanian, 2005) have already widely witnessed the impact of ODA on the Least Developed Countries' (LDCs) economic growth. Some researchers have asserted that ODA flows also affect the foreign direct investment (FDI) inflows into developing countries, as donors always encourage the improvement of the recipient countries' FDI (Kimura and Todo, 2010; OECD, 2004). But the ODA's impact on developing countries' growth remains a subject for further investigation, because developing countries in particular LDCs directly demand foreign aid for their economic development.

The recent financial crisis in the advanced economies has collided LDCs heavily resulting in reduced private financial flows and foreign aid, minimized workers' remittances and cut consumption demand; and accordingly prices of the export goods goes down. Consequently, these shocks have dwindled LDCs income growth rate by about 7 percent between 2007 and 2009 (Dang, Knack and Rogers, 2009). In addition, ODA is mostly connected with the development activities through some important sectors such as infrastructure, health, education etc. Therefore, it is important to investigate how financial crisis exerts an influence upon ODA disbursement. If it proves to affect it then, it will be essential to investigate whether a sudden cut of ODA disbursements will aggravate the problems already imposed by the crisis and further hinder the development process of these poor economies as a whole. Bulir and Hamann (2008), Treasurry (2005), Birdsall (2004), OECD (2003) and many others highlighted that volatility and unpredictability of ODA shocks is a severe macroeconomic management problem to the LDCs.

There is a few studies (Bulir and Hamann, 2008; Dang et al., 2009; Frot, 2009; Mendoza, Jones and Vergara, 2009; Minoiu, Zanna and Dabla-Norris, 2010; Mold, Prizzon, Frot and Santiso, 2010) that examine the effects of the financial crisis on donor countries ODA flows. Dang et al. (2009) points out that crisis affected donor countries have reduced their ODA flows by an average of 20 to 25 percent and bottom out only about a decade after the banking crisis; Roodman (2008), Frot (2009) argue that the recent financial crisis will slump the ODA flows. This is supported by the reduction of ODA disbursements following to the Nordic financial crisis in 1990's. He reports that Nordic banking crisis reduce donors' aid disbursements by 13 percent. …