One of the most debated issues in development economics is whether Official Development Assistance (foreign aid) promotes GDP per capita growth in aid recipient countries. In recent decades there has been much research focused on the effects of aid inflows on growth rates, as well as on determining which socio-political, climatic, institutional, and economic factors undermine or enhance the effectiveness of foreign aid with respect to growth. However, overall, there is no consensus regarding aid effectiveness and disagreement remains as to what constitutes sufficient conditions for aid to have a positive impact on the GDP per capita growth of aid recipient countries.

A recent study by Museru et al finds strong evidence to suggest that aid’s impact on growth may have been eroded by the volatility of public investment (aid’s main transmission mechanism) which in turn may be linked to the volatility in government revenues and aid itself. This supports previous researchers who have argued that aid dis-incentivises the efficient collection and administration of tax revenue.  It also indicates that a move away from volatile trade taxes to the more stable domestic indirect taxes could facilitate the reduction of some of this volatility in public investment that is due to revenue volatility.

Another key finding from the paper was that aid volatility has a negative impact on economic growth in Sub-Saharan Africa.  As such, policy makers should attempt to reduce the volatility of aid flows and the instability that this brings into government revenues and planning. One option could be multi-year aid agreements that bring more stability in aid flows to specific countries. A specific innovation proposed is a form of “securitisation” (or effective front-loading) of future aid commitments through the sale of bonds backed by these commitments— a system used by the International Financing Facilities for Immunization (IFFIm) to make aid flows in support of global immunisation initiatives more reliable and predictable.

– Malimu Maseru
Senior Analyst, RisCura Fundamentals

Sources

Museru, M., Torien, F., & Gossel, S. (2014). The Impact of Aid and Public Investment Volatility on Economic Growth in Sub-Saharan Africa. World Development, 57, 138-147.

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