Foreign Aid vs Economic Growth A Critical Dissertation

Excerpt from Dissertation :

Foreign Aid vs. Economic Growth: A critical evaluation of the success/Failure of foreign aid in Africa (Ethiopia)

In this paper, explore the concept of foreign aid and economic development in an African. We focus on a critical evaluation of the success as well as failure of foreign aid in Africa (Ethiopia). What are investigated are the factors that affect growth, the scopes behind foreign aid and reasons for failure. The aim of the study however, is to explore and survey the impact of foreign aid on economic growth and the country as a whole. We then focus on five major objectives. The first one is such as the relationship that exists between foreign aid and a country's economic growth. The second objective is the investigation of the economic impact of foreign aid on consumption and investment. The third objective is the investigation whether recipient government misuse aid as a result of corruption and inefficiency of the governance. The fourth objective is then the investigation of the contribution/failure of aid conditionality in Africa as a result of lack of good domestic policies and institutional capabilities. We then evaluate if African countries really need foreign aid on order to survive as well as achieve economic growth.


Financial aid also known as development assistance, or technical assistance or international aid, or overseas aid, or Official Development Assistance (ODA) refers to the assistance that is given by governments and other agencies to support the economic, political, social and environmental, developments of other developing countries. It can be distinguished from humanitarian aid by the fact that it lays much focus on the alleviation and eradication of poverty in the long-term, rather than a short-term response. The term financial aid, which is used, for instance, by the World Health Organization (WHO) expresses the idea that there should be partnership existing between the donor and recipient, instead of the traditional situation in which the relationship was dominated and was under the control of the wealth and specialized knowledge of one side. WHO (2008). Most financial aid comes from the Western industrialized countries but some poorer nations also contribute financial aid. Financial Aid may be bilateral. This is when it comes from one country directly to another; or it may be multilateral when it is given by the donor country to an international organization such as the World Bank or the United Nations Agencies which includes UNDP, UNICEF, UNAIDS among others, which later distributes it to the developing countries. The proportion currently lies at about 70% bilateral and 30% multilateral.

Aproximately between 80-85% of financial aid comes from government sources as official development assistance. The 15-20% that remains comes from privately owned organizations like non-governmental organizations (NGOs), other foundations and other development charities like the Oxfam. On top of that, remittances received from migrants working and residing in the Diaspora also form a considerable amount of international transfer.

Some governments also include military assistance in the notion of foreign aid, despite the fact that numerous NGOs try to disapprove and to oppose this.Privately owned consulting firms, like PricewaterhouseCoopers and Deloitte, are increasingly being contracted by donor agencies to effectively manage and implement elements of their aid program, due to their perceived ability to perform higher quality program management and delivery.

Scope of foreign aid

The aim of foreign aid in the growth process of developing nations in Africa has been a topic of great debate. Foreign aid has become an important topic because of its implications for the alleviation and eradication of poverty in the developing countries.

Recent empirical studies based on foreign aid and economic growth has generated mixed outcomes. For instance, Burnside and Dollar (2000), Papanek (1973), Karras (2006), Gomanee, et al. (2003), Hansen and Tarp (2000),Dowling and Hiemenz (1982), Gupta and Islam (1983), Dalgaard et al. (2004), find evidence for positive impact of foreign aid on growth. Burnside and Dollar (2000) and Brautigam and Knack (2004) find proof for negative effects of foreign aid and growth, while, Mosley, et al. (1987), Boone (1996), Mosley (1980)and Jensen and Paldam (2003) suggests that financial aid has no impact on growth. It should however be noted that, despite the fact that Burnside and Dollar (2000) summarized that foreign aid has got positive results, this summary is applicable only to economies which the foreign aid is combined with superb fiscal, monetary, and trade policies. Recent studies by Doucouliagos and Paldam (2009) stated that the effects of foreign aid on growth estimates differ considerably adding up to a negligible positive, but unimportant, effect on growth.

The main aim of foreign aid in invigorating economic growth is to complement domestic sources of finance like savings, thereby escalating the amount of investment and capital stock. As Morrissey (2001) states, there are numerous ways through which financial aid contributes to economic growth. First and foremost, financial aid increases investment not only in physical but also human capital. Secondly, financial aid improves the capacity of nations to import capital equipments and technology. Thirdly, financial aid has no indirect effects that reduce investment or savings rates and thirdly, financial aid is linked with technology transfer that is capable of increasing the productivity of capital and promoting local technical change.

According to McGillivray, et al. (2006), there are four main alternative views on the effectiveness of financial aid has been the following. Firstly, financial aid has declining returns. Secondly, financial aid's efficiency is determined by both external and climatic conditions, thirdly, financial aid's effectiveness is determined by political conditions, and finally, financial aid's effectiveness is dependent on institutional quality.It is fascinating to note that in the recent years there has been a great increase in financial aid flows to the developing nations despite the fact that other types of flows like foreign direct investment and other private flows are reducing. The budgets of numerous developing countries in Africa were hard hit by the increase in the prices of food and oil in the recent years and even up to now. Numerous countries are not in a strong fiscal position to look into the present financial crisis.

History of foreign aid

The history of foreign aid can be traced to the military assistance that was put in place in order to aid the parties that were at war and were considered to be strategically significant. Its application in the modern era commenced in the 18th century at a time when Prussia aided some of its important allies. Then the 19th as well as the 20th century European powers started providing huge amount of money to their various colonies in an effort to improve their infrastructure. The ultimate goal however is to increase the economic output of their colonies. The structure as well as scope of the foreign aid can be effectively be traced to two main developments that followed World War II. These are; The implementation of a package known as Marshal Plan which was sponsored by the U.S. In an effort to rehabilitate the poor economic status of 17 western as well as southern nations and the formation of important international organizations such as the United Nations (UN),World bank and the International Monetary Fund (IMF).These international organizations have a major role in the process of allocating funds internationally, determination of the qualifications for the aid's receipt as well as the assessment of the impact of the granted aid. The foreign aid that is granted in the contemporary society is meant to be a distinguished one and not just for the humanitarian purpose. This is to mean that the donor country has no self-interest. The granted aid should be offered with neutrality as well as utmost transparency. This is however marred with cases of ideological as well as political orientations/alignments continuing to be the decisive conditions for to the process of receiving the aid from both the donor countries and international organizations.

The recent news on foreign aid indicate that development aid did rise in 2009 and the report also indicated that most of the donor nations would meet their 2010 set donor aid targets (OECD,2010). The OECD figures also indicated that there is a continuing level of development aid growth despite the 2009 financial development aid.

Current issues surrounding foreign aid

There are various issues that surround the concept of foreign aid. The main ones include the main reasons behind the concept as well as if it is really important for the growth and development of the recipient countries. This is to say that it is debatable if foreign aid brings growth or lack of it as a result of political and ideological interference by the donor countries/organizations as well as corruption that is rife in the recipient countries.


The aim of this study is to explore the relationship between foreign aid and economic development. Previous studies that had been dedicated to the relationship between foreign aid and economic growth of a given nation have yielded mixed results and have in most cases been heavily criticized for having several methodological bottle-necks that are associated…

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