Fostering economic growth in the least developed countries: what kind of aid actually works?

Abstract

This quantitative study examines the relationship between the growth oriented aid categories (economic infrastructure-, productivity enhancing- and budget supporting aid) and GDP growth in 40 least developed countries (LDCs), testing competing predictions from the modernization- and dependency theory. Furthermore, the analysis includes humanitarian aid and social infrastructure aid to explore whether non-growth oriented aid types have different outcomes on GDP growth. The study uses a quantitative approach with a panel data regression model estimated with fixed effects, controlling for governance effectiveness, exposure to drought and extreme precipitation. The results indicate that the effectiveness of foreign aid on GDP growth depends on the type of aid given. Social infrastructure- and budget supporting aid exhibited a positive significant effect on GDP growth, and humanitarian aid a negative significant effect, while productivity enhancing- and economic infrastructure aid lacked significant results. The results suggest that neither the modernization theory or dependency theory is fully capable of explaining the effects of aid on GDP growth. The findings strengthen the argument of differentiating between types of aid when evaluating aid effectiveness and distribution to developing countries.