The link between foreign aid and economic growth in Africa: does the source of aid matter

Abstract

This study empirically investigates the aid-growth nexus in 51 African countries composed of 25 low-income and 26 middle-income countries during the period 2000-2017. Within the context of the current changing global aid landscape since 2000, the study uses three proxies of aid, namely: total aid, traditional aid, and non-traditional aid to examine this nexus and the debate on aid effectiveness. The study investigates the impact of aid on growth, as well as the direction of causality between them based on a system generalised method of moments and a Granger causality analysis using the error correction model (ECM)-based multivariate panel causality approach, respectively. The main findings show that both the impact of aid on growth and their causal relationship depend on the different proxies of aid used to measure aid and country income groups in Africa. The study finds that traditional aid has been effective for growth in middle-income countries, while it was not effective in low-income countries. It also shows that total aid and non-traditional aid have been ineffective for growth regardless of country income groups. Furthermore, this study found that the direction of causality between aid and growth has been bidirectional for total aid and traditional aid in low-income countries, while it is unidirectional from total aid to growth, and from growth to traditional aid in middle-income countries in the short run. In the long run, there is evidence of unidirectional causality from growth to aid irrespective of the country’s income groups for total aid and non-traditional aid proxies. For traditional aid proxy, there is evidence of long-run unidirectional causality from growth to aid in middle-income countries. The main policy implications of this study are that: (i) traditional aid should continue to rise in middle-income countries; (ii) donors and governments of low-income countries should focus on designing more effective strategies to re-direct traditional aid towards the growth-enhancing productive sectors to support growth in their countries; and (iii) donors and governments of middle-income countries should work together to harmonise aid flows and at least replicate the success of traditional aid to make non-traditional aid supportive for growth in their countries.