No Evidence that Aid Stimulates Growth

... regardless of the situation -- for example, in countries that have adopted sound economic policies or improved government institutions -- or the type of assistance involved, aid does not appear to stimulate growth over the short or long term.

Challenging the simplistic but seductive view that increased assistance from rich countries is likely to put many poor countries on the path to prosperity, a new study on the impact of foreign aid finds "little evidence" that it ever has a positive effect on economic growth. In Aid and Growth: What Does the Cross-Country Evidence Really Show? (NBER Working Paper No. 11513), co-authors Raghuram Rajan and Arvind Subramanian conclude that regardless of the situation -- for example, in countries that have adopted sound economic policies or improved government institutions -- or the type of assistance involved, aid does not appear to stimulate growth over the short or long term. They point out that their exhaustive analysis should not be taken as an argument that aid cannot ever help the growth of countries that receive it, only that there is "no discernible robust impact of aid on growth, positive or negative" in the past.

This work emerges at a particularly auspicious time. The world's wealthy nations have committed to overhauling and significantly boosting aid to poor countries as part of the United Nations Millennium Development Goals (MDG), which aim to cut global poverty in half by 2015. A key assumption of the so-called MDG process is that rich countries can be particularly successful in the developing world by ramping up aid to countries where political and institutional reforms or other favorable conditions, such as geography, will allow the aid to rapidly spark growth. But Rajan and Subramanian report that they "find virtually no evidence that aid works better in better policy or institutional or geographical environments or that certain kinds of aid work better than others."

The authors examine aid from a variety of angles. They consider the effect of aid over various 10, 20, 30, and 40-year time periods from 1960 to 2000. They also look at the effect of different kinds of aid, such as aid intended as food assistance and aid targeted at economic or social sectors. And, they consider the source of the aid, including whether it was "bilateral" (from one country to another) or came from a multilateral entity, such as the World Bank.

For example, they note that "food aid should typically not be expected to affect long-run growth while economic and social sector aid should because they lead to an increase in physical and human capital." Similarly, aid from multilateral institutions might be expected to have a greater chance of achieving growth than bilateral assistance because it is less likely to be influenced by a political agenda. But in all cases, the results were the same. "No sub-categories have any significant impact."

Rajan and Subramanian observe that there is a tendency in analyzing the impact of aid for economists to take sides and conclude that it is good or bad for growth. But the authors argue that neither assertion is valid because the data supporting either argument is so "fragile" that with only minor tweaks, it can yield the opposite result. For example, they take an analysis claiming to prove that economic aid works well when directed to countries with sound economic policies and show that with only subtle changes in the supporting data, the analysis argues the opposite, "signifying that economic aid works better in worse policy environments." "In our view, all that one can conclude is that it is difficult to discern the effects of aid," they write.

Rajan and Subramanian caution that they are not advancing an argument that foreign aid has no role to play in helping poor countries escape from poverty. Rather, they believe that acknowledging the lack of evidence that aid can stimulate growth and thus help countries become more self-sufficient can help both providers and recipients make assistance more effective.

"It should be stressed that our findings, which relate to the past, do not imply that aid cannot be beneficial in the future," they state. "But they do suggest that for aid to be effective in the future, the aid apparatus (in terms of how aid should be delivered, to whom, in what form, and under what conditions) will have to be rethought."

In particular, Rajan and Subramanian believe their analysis should prompt a closer look at why they could not find situations where aid clearly emerges as having "indisputable growth enhancing effects." That is, "what is it that offsets the transfers and subsidized credit inherent in aid and prevents it from having a robust positive effect on growth?" they ask. "Further research of this kind is essential to improve aid effectiveness.

-- Matthew Davis