Does Old-Fashioned Foreign Aid Still Have a Place in the Twenty-First Century? Corroborative Evidence

By Hagen, Abdalla; Wilkie, Macil et al. | Journal of Economics and Economic Education Research, May 2003 | Go to article overview

Does Old-Fashioned Foreign Aid Still Have a Place in the Twenty-First Century? Corroborative Evidence


Hagen, Abdalla, Wilkie, Macil, Hassan, Morsheda, Journal of Economics and Economic Education Research


ABSTRACT

This study investigates the impact of foreign aid on the economic growth of recipients in less-developed countries. Using a sample of 81 of these countries over a ten-year period (1990-2000), this study reveals that foreign aid has a negative and insignificant impact on their economic growth.

INTRODUCTION

Foreign aid is granted for different purposes: humanitarian and disaster relief, military and security assistance, and development aids. For example, the United States, the largest contributor, provides about $14 billion a year in federal funding to these projects. Of this $14 billion, 38 percent is allocated to disaster relief, humanitarian assistance, security assistance, and military aid. Approximately 53 percent of the entire foreign aid budget is dedicated to development and economic aids, either bilaterally or through multilateral institutions. Another 5 percent is parceled as corporate welfare through various export promotion programs. The remaining 1 percent goes to supporting foreign aid programs. However, these programs have failed to help Less-developed countries (LDCs) develop economically (Johnson & Schaefer, 1997).

The Organization for Economic Cooperation and Development (2002) reported that development assistance from western nations was $56.378 billion in 1999, $53.058 billion in 2000, and $51.353 billion in 2001 (see Appendix 1). In addition, $1.4 trillion was transferred from developed countries to (LDCs) as foreign aid between 1960 and 1996 (The Economist, 1996). Such foreign aid from western nations can increase the welfare of both the recipient and the donor country. Foreign aid serves as an enforcement mechanism in the absence of any global organization that can rule on private contracts across borders. Foreign aid is not motivated by altruism in all cases. The rich country provides aid only if doing so increases its utility. If an altruistic motive to alleviate poverty is also present, this will result in an increase in aid and thereby further enhance the poor LDC's welfare (Villamil & Asiedu, 2001).

On the other hand, several researchers (e.g., Clad & Stone, 1993; Islam, 1992; Griffin & Enos, 1970; Boone, 2002) demonstrated that despite this huge amount of foreign aid received by many LDCs, there is no real evidence to prove that these resources improved their economic growth. In contrast, they are worse off today in terms of economic growth, poverty, and disease than they were in the 1960s. Recognizing that foreign aid may not contribute much to the economic development of LDCs, many authorities involved in the foreign aid business are calling for a shift in the orthodox ways of aiding these countries (Schmitz, 1996). Despite this realization, the clamor for foreign aid to LDCs continues unabated (Bowen, 1995; Dhakal, Upadhyaya & Upadhyay, 1996; Tanner, 2002).

However, it is appropriate that before we suggest the replacement of foreign aid by other types of capital inflows (foreign direct investment, portfolios, foreign loans, etc.), a proper investigation of the relative impact of foreign aid on the economic growth should be conducted. This study utilizes an extensive data set covering 81 LDCs over a ten-year period (1990-2000) in order to determine the effects of foreign aid on the economic development of LDCs.

BACKGROUND OF THIS STUDY

This section includes a brief classification and description of the world countries. In addition, it includes selected studies for and against foreign aid.

World's Classification and Description

Chaliand (2002) classifies the whole world into four categories: The "First World" is the developed world including the United States, Canada, Western Europe, Japan, Australia, and New Zealand. The "Second World" was the Communist world led by the Union of Soviet Socialist Republics (USSR). With the demise of the USSR and the communist block, there is no longer a Second World. …

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