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An Aid or a Boon? Measuring Foreign floundered with the continued receipt or Assistance’s Contribution to Economic withdraw of foreign assistance. Does foreign Growth in Less Developed Countries P. Brian Bartels Introduction. Foreign assistance, defined as the assistance contribute to economic growth in less developed countries? Modern foreign assistance arose from the ashes of the Second World War with the transfer of resources from one government to United States’ implementation of the Marshall another without expectation of repayment or Plan for Europe’s reconstruction. Policymakers reciprocation (Abbot 1970), represents a in the United States believed the best way to substantial annual flow of international capital. assist Europe in restoring its economy was to According to the World Bank (1999), in 1997 provide capital and technical assistance to alone over forty-eight billion dollars was rebuild European infrastructure. Economists transferred between countries in the form of and political scientists followed the progress of foreign assistance. Donors provide foreign the Marshall plan, took notice of its success, and assistance to less developed countries for a formulated lessons to apply to other variety of reasons, including temporary famine underdeveloped areas. Capital’s critical role in relief, natural disaster clean-up operations, catalyzing economic growth became the central macroeconomic stabilization, political support, lesson of the Marshall Plan. Throughout the education initiatives, infrastructure creation, 1950s and into the 1960s scholars and environmental protection, and other development practitioners focused on capital’s development projects. At bottom, ceteris ability to ignite economic growth and foster paribus, donors of foreign assistance intend to development. Research primarily focused on foster and promote broad-based economic how capital shortages in less developed growth that can be sustained in the long-term by countries inhibited broad-based economic the recipient. Donors hope to encourage long- development. Foreign assistance became the term domestically sustainable economic growth mechanism of choice to address capital in the recipient country by providing near-term deficiencies, thus spurring economic growth. economic assistance. However, the actual Providing sufficient amounts of capital to a practice of international foreign assistance stagnant economy would create the necessary indicates mixed results in its ability to foster conditions for long-term, broad-based economic sustainable long-term economic growth in growth to occur. Thus, using Europe’s growth recipient countries. Some recipients have experience under the Marshall Plan as a model achieved high levels of sustained economic for development, developed countries growth, while economies of other countries have inaugurated foreign assistance programs to foreign assistance expenditures. Negative, often channel capital to developing economies. inaccurate public perceptions of foreign The Cold War skewed foreign assistance assistance, domestic budget constraints, practices in the United States, Soviet Union, and recessions, and a general feeling of apathy other developed countries. The onset and toward foreign affairs contributed to the decline entrenchment of the Cold War shifted of foreign assistance in developed countries. By policymaker’s motives for foreign assistance the end of the 1990s, real foreign assistance away from catalyzing economic growth and expenditures had fallen to levels seen decades toward developing strategic political and before. military allegiances. Specifically, the United The contribution of foreign assistance to States shifted foreign assistance expenditures economic growth varies along a host of from less developed countries truly needing variables. Some regions of the world, such as foreign assistance, choosing instead to “reward” Southeast Asia, experience tremendous growth loyalty and allegiance to countries sympathetic and development with the introduction of and committed to the United States’ ideologies foreign assistance while economies of other and policies. Similarly, the Soviet Union shifted areas, such as Africa, seem to stagnate or even its foreign assistance expenditures toward its decline in the presence of foreign assistance. allies and less developed countries it believed The population of a recipient country also could be lured into aligning with the Soviet affects the utilization of foreign assistance. Union against the United States. The Cold War Some small countries utilize foreign assistance altered the incentive structure for providing effectively while others do not, just as some foreign assistance. Instead of viewing foreign large countries employ foreign assistance assistance as a critical opportunity to promote efficiently while others do not. Foreign development, donors perceived foreign assistance’s achievement record in promoting assistance as a critical foreign policy and human development and economic growth is military tool to be wielded for strategic fraught with inconsistencies. Ultimately, foreign geopolitical purposes. assistance has been a success for a number of During the 1980s and 1990s, as the Cold countries at one period while, at other times, it War concluded and the need for strategic has caused immense economic and human expenditures diminished, the United States, hardship. Soviet Union, and other foreign assistance Studying the effects of foreign donors once again altered their donation assistance on economic growth in less developed behavior. Governments in developed economies countries is important for three reasons. First, consistently and systematically diminished their the large annual funding developed countries allocate to foreign assistance1 necessitates an political issue. Foreign assistance expenditures examination of the effectiveness of assistance are politically sensitive, with constituents in inflows in achieving long-term sustainable major developed countries strongly opposing aid economic growth. Developed countries provide to other nations (Graham and O’Hanlon 1997; foreign assistance to less developed countries as The Economist 23 March 1996). Overall, most a form of investment. Donors hope to ignite the citizens of donor countries perceive foreign process of long-term economic growth by assistance in negative terms (Smillie 1998), providing the catalyst, resources, to less viewing it as a major component of central developed countries. The expectation is that government budget allocations. Negative views recipients will spend and invest foreign of foreign assistance persist for a number of assistance wisely in a manner that fosters and reasons, including misinformation and distortion nurtures development and economic growth. by the media, ethnocentrism, tax fears, and a Determining if the controlling principles and belief that foreigners should be responsible for goals of foreign assistance are being met and solve their own problems domestically. The requires an in-depth study of whether or not electorates of donor countries do not examine foreign assistance actually acts as a positive the long-term, positive effects foreign assistance force in fostering economic growth in less can elicit in less developed countries; instead, developed countries. Donors of foreign they think narrowly and look at the short-term assistance require concrete data on the costs to themselves and their own countries. effectiveness of aid to ensure their contributions Although foreign assistance may be effective are being spent efficiently and in a manner and desperately needed by less developed consistent with their intent. Examining the countries, the perpetual negative perceptions of effectiveness of foreign assistance in initiating foreign assistance make alterations and additions economic growth provides donor countries with to foreign assistance budgets extremely definite evidence of the effects of their troublesome. Opponents of foreign assistance contributions, which can be used to make can easily mobilize popular opinion whenever rational decisions in future foreign assistance foreign assistance matters arise, rendering expenditures. foreign assistance a delicate political operation. Determining the effect foreign Determining the effectiveness of foreign assistance exerts on economic growth in less assistance on economic growth in less developed developed countries is also an important countries provides the opportunity to establish balanced, empirical reasons to support, oppose, 1 For a list of contributors and amounts, see “Aid flows from Development Assistance Committee Members.” 1999 World Development Indicators. World Bank: 1999. or alter foreign assistance packages and their implementation. Ascertaining the actual economic experiences of foreign assistance policies become framed in reference to foreign recipients and publicly disseminating the assistance. That is, foreign assistance becomes information provides an excellent opportunity to the primary impetus and focus for development educate electorates on the need and effects of policy. Unfortunately, such heavy reliance on foreign assistance. Foreign assistance could foreign assistance may be unsubstantiated or become de-politicized and publicly legitimated incompatible with more effective alternatives. by empirically demonstrating the actual effect Less developed countries may adopt a policy foreign assistance has on the development course that firmly relies on foreign assistance, experience of less developed countries. even though the effects of foreign assistance are Finally, the effect foreign assistance has unproven and not the most desirable policy on economic growth in less developed countries prescription. These countries may also choose a must be studied to determine the course foreign assistance-based development strategy economic policies should take in these countries. that blocks better, more effective solutions. Less developed countries often rely heavily on Determining the effect of foreign assistance on international foreign assistance to contribute economic growth will provide less developed large amounts to annual budgets (Friedmann, countries more precise prescriptions for Wolfgang, Kalmanoff, and Meagher 1966). In development policy. Understanding and general, these countries depend on foreign evaluating the actual effect foreign assistance assistance to supplement domestic sources of has on economic growth will generate insight revenue, which are often difficult to assess and into which development policies promote collect. Since foreign assistance originates economic growth efficiently, thus providing less outside the country from legitimate, reputable developed countries with better suggestions for sources, it represents a dependable source of long-term development strategies. revenue for less developed countries that can be Literature Review. exactly measured and allocated during the Although a significant amount of budget process. Furthermore, because literature has investigated the effect of foreign policymakers and other government officials in assistance on economic growth in less developed both donor and recipient states perceive foreign countries, researchers remain divided in their assistance as a primary catalyst for economic conclusions regarding its effectiveness. growth, officials tailor development programs Economists and political scientists achieve and projects around foreign assistance. The varying results and subsequent conclusions perception that foreign assistance is an essential depending on a host of variables, including ingredient to economic growth creates a climate sample year, number of countries included in the where questions of economic and development sample, longevity of study, geographic regions represented in the study, type of foreign Furthermore, recipients must undertake assistance measured, and methodology. Overall, institutional reforms to ensure their success at the research indicates a dichotomous split in economic development. Specifically, tax conclusions; one branch suggests foreign collection, private savings, investment, and assistance is an effective method of promoting export promotion must be supported by foreign long-term economic growth, while the other assistance recipients. Donor countries must maintains foreign assistance is ineffective and, at broaden the type of assistance provided to times, counterproductive. supplement and complement the recipient’s Chenery and Strout (1966) develop an pattern of investment and production. Donors intellectual framework from which to judge the should also tie future assistance levels to the effectiveness of foreign assistance at recipients’ effectiveness at increasing their level encouraging economic growth in less developed of domestic savings and investment rates. countries. Their work also provides broad Papanek (1973) analyzes the effect of prescriptions for both donor and recipient foreign resources on growth and the relationship countries to enhance the efficacy of foreign between foreign resources and savings. Papanek assistance inflows. Chenery and Strout argue adopts a linear regression model to measure the that domestic resource limitations and effect of foreign assistance on economic growth constraints act as the critical obstacle to in less developed countries. Papanek constructs economic growth in less developed countries. his model regressing savings, foreign assistance, The introduction of foreign assistance allows foreign private investment, and other foreign recipients to supplement and utilize their limited inflows against annual rates of gross domestic resources in the most productive manner. product (GDP) growth. Papanek’s model Chenery and Strout find that recipients of indicates that foreign assistance possesses a foreign assistance achieve average growth rates statistically significant coefficient twice as great higher than they would in the absence of such as the other independent variables, indicating inflows. The growth rate of less developed foreign assistance does contribute to economic countries would be approximately 3.4 percent, growth. Papanek reasons that foreign or less than 1 percent per capita, without the assistance’s large contribution to economic introduction of foreign assistance. Chenery and growth occurs because it can fill the foreign Strout’s conclusion provides a list of policy exchange gap as well as the savings gap, which prescriptions for donors and recipients to bolster the other independent variables are unable to the effectiveness of foreign assistance. For accomplish. Papanek’s theory supports Chenery recipients, Chenery and Strout prescribe and Strout’s contention that foreign assistance measures to increase output and increase skills. encourages economic growth by supplementing the gap between savings and investment. regimes. After constructing a three-part regime Papanek also discovers that foreign assistance typology, he argues that various regime types and domestic savings are inversely (negatively) will utilize foreign assistance receipts in related. Papanek concludes that foreign different manners. An elitist government will assistance has a more significant effect on maximize the welfare of a fixed ruling coalition. growth than savings or other forms of foreign An Egalitarian government tries to maximize the resource inflows in less developed countries. welfare of those with low resource endowments. Foreign assistance does contribute significantly Finally, a laissez-faire government will to economic growth, as measured by rate of maximize the welfare of a minimum fraction of change in GDP. the population. Boon contends that regime type Levy (1987) builds on Papanek’s influences the goals of the government and its research by examining what proportion of channels of choosing and implementing policy. foreign assistance is used to finance current He suggests that all types of political regimes consumption. Levy hypothesizes that assistance allocate foreign assistance to the benefit of high- transfers include heterogeneous components that income political elites. Foreign assistance maintain different marginal propensities to raise programs do not alter the incentive structure of consumption. Levy contends that less developed governments to implement or deliver programs countries treat foreign assistance the same as and services to those in need. domestic income; the marginal propensity to Burnside and Dollar (1997) follow consume and the marginal propensity to save for Boone’s research by focusing on the institutional both domestically generated revenue and foreign quality of foreign assistance recipients. assistance receipts are identical. Levy finds that Burnside and Dollar contend that the the marginal propensity to consume from effectiveness of foreign assistance in facilitating foreign assistance funds is .4. Levy concludes economic growth will depend on the overall that foreign assistance not intended for institutional structure and policy environment of emergency or disaster relief is not consumed but the recipient. Countries with sound financial invested by the recipient government. Levy also institutions, a strong regulatory environment, concludes that foreign assistance was effective economic stability, and fiscal discipline will at promoting economic growth during the 1970s. utilize foreign assistance better than states More recent empirical works has lacking these qualities. Using panel regression focused on the macroeconomic environment’s for fifty-six less developed countries and six 4- affect on foreign assistance’s utilization. Boone year periods between 1970 and 1993, Burnside (1996) hypothesizes that the effectiveness of and Dollar conclude that foreign assistance does foreign assistance is a function of political have a positive effect on economic growth when the necessary institutions and policy frameworks statistically significant at the one percent level, exist. Foreign assistance facilitates economic implying that increases in foreign assistance growth in an economic environment with good would increase economic growth in less fiscal, monetary, and trade policies. The World developed countries. Bank (1998) reaches similar conclusions. The Griffin and Enos (1970) provide a World Bank argues that foreign assistance can contrasting view of foreign assistance and its stimulate economic growth and development contribution to economic growth in less when the recipient creates the proper economic developed countries. Griffin and Enos seek to environment through stable fiscal, monetary, and determine which countries lend foreign trade policies. Hence, the effectiveness of assistance, the motives for providing assistance, foreign assistance in facilitating economic and the consequences for the recipients. First, growth in less developed countries depends on Griffin and Enos contend that foreign assistance the fiscal and economic environment of the is a tool powerful countries wield against the recipient. less powerful to promote ideology and control in Fayissa and El-Kaissy (1999) develop the world arena. Foreign assistance is an an explanatory model for economic growth in instrument of foreign policy that safeguards less developed countries that attempts to explain relationships and perpetuates the status quo. why some countries utilize foreign assistance Second, Griffin and Enos argue that foreign better than others. The major contribution of assistance is not correlated with economic their work is the incorporation of political and growth. Using a linear regression model of the human capital variables in their model of amount of foreign assistance received and the economic growth. Fayissa and El-Kaissy rate of GNP growth for fifteen African and include an index of political and civil liberties, Asian countries between 1962 and 1964, Griffin as well as a measure of investment in human and Enos conclude that there is no relationship capital to determine if foreign assistance between amount of aid received and economic contributes to economic growth in less growth as measured by GNP. Griffin and Enos developed countries. Using a data from eighty conclude that foreign assistance undermines less developed countries between 1971 and economic development in several ways. First, 1990, their results confirm that foreign foreign assistance lowers domestic savings. assistance positively affects economic growth in Second, foreign assistance distorts investment less developed countries for the observed time composition, which raises the capital-output period. Their research concludes the ratio. Third, foreign assistance hinders the relationship between foreign assistance and development and emergence of an indigenous growth of real gross domestic product is entrepreneurial class. Finally, foreign assistance prevents institutional reforms that are and controls for the effects of per capita income. prerequisites for economic growth. Snyder’s model relates domestic savings as a In subsequent research Bowles (1987) function of per capita income and foreign tests Griffin and Enos’ conclusion that foreign assistance, where foreign assistance is assistance undermines economic growth in less determined by need. Snyder employs a panel developed countries by retarding domestic data set covering fifty low- and middle-income savings rates while subsequently increasing countries across the 1960s, 1970s, and 1980s. aggregate consumption. Bowles concludes that Snyder concludes that Griffin and Enos’ a statistically significant relationship between argument that aid-switching occurs in less foreign assistance and domestic savings rates developed countries is unfounded; foreign does not exist in nine of the twenty countries assistance has little influence on domestic examined. Furthermore, in ten of the twenty savings. countries studied, no causal relationship could Mosley, Hudson, and Horrell (1987) be established between foreign assistance and study the effectiveness of foreign assistance domestic savings. Given the results, Bowles across countries to determine why foreign argues that generalizations concerning causal assistance stimulates economic growth in some relationships and mechanisms between foreign regions while not others. Mosley, Hudson, and assistance and domestic savings rates must be Horrell criticize previous studies for employing treated with caution. Bowles maintains that the linear regression models to explain the effect of complex social, economic, political, and social foreign assistance on economic development. structures of less developed countries prevent They contend foreign assistance does not one unified theory of how foreign assistance operate in a straightforward manner, as implied affects economic growth. by regression techniques, but operates instead Snyder (1990) further critiques Griffin through three subtle, indirect channels. Mosley, and Enos’ research. Following Papanek (1973), Hudson, and Horrell create a sophisticated Snyder first notes that numerous factors, such as model where governments attempt to maximize per capita income, wars, terms-of-trade changes, their own welfare in the face of budgetary natural disasters, and political disturbances can constraints, with foreign assistance facilitating significantly affect the distribution and use of the removal or diminishment of budget foreign assistance. The existence of these constraints. Mosley, Hudson, and Horrell argue variables can create a spurious relationship that foreign assistance inflows allow between foreign assistance need and foreign governments to finance re-occurring assistance receipts. Snyder analyzes the effect expenditures that would not be possible without of foreign assistance on domestic savings rates foreign assistance. Mosley, Hudson, and Horrell’s budgetary constraints model of foreign re-occurring project expenditures that cannot be assistance corresponds with the theory outlined supported without foreign assistance. Dacy by Griffin and Enos. Mosley, Hudson, and concludes that the marginal propensity to save Horrell conclude that aid in the aggregate had no and government consumption patterns are the demonstrable effect on economic growth in critical factors affecting foreign assistance’s recipient countries during the 1970s or 1980s. It long-term effectiveness. Higher levels of the is impossible to establish any statistically marginal propensity to save will likely stimulate significant correlation between aid and the economic growth once foreign assistance is growth rate of GNP in less developed countries. withdrawn. Lower levels of government Dacy (1975) demonstrates that under consumption during periods of foreign certain conditions less developed countries may assistance increase the likelihood that foreign experience lower growth rates after termination assistance will be effective in promoting of foreign assistance than they would have had economic growth in the long-run. foreign assistance not been introduced. The Khan and Hoshino (1992) study the post-aid growth rate for an aid recipient may be impact of foreign assistance on the behavior of lower than it would have been in a non-aid recipient governments in South and Southeast environment. Dacy argues that foreign Asia. They hypothesize that the expenditure and assistance is a substitute for domestic savings. revenue efforts of recipient governments are Recipient countries increase both consumption affected by foreign assistance through and investment with the receipt of foreign categorical budgetary reallocations. Khan and assistance, resulting in an overall decrease in Hoshino sample five South and Southeast Asian domestic savings, causing lower levels of countries and create a regression model with economic growth once donors withdraw foreign pooled time-series, cross-sectional data. They assistance. Dacy contends that the introduction conclude that foreign assistance is distributed of foreign assistance facilitates government between consumption and investment in less consumption of expensive re-occurring developed countries. Khan and Hoshino also expenditures that require sustained foreign find that foreign assistance may divert resources assistance. Foreign assistance allows recipient from investment to consumption under certain governments to increase consumption without conditions. Governments treat foreign undertaking difficult institutional and fiscal assistance as an increase in income which, changes that would otherwise be necessary to combined with a positive income elasticity, support greater consumption. Foreign assistance allows an increase in consumption to occur. The erodes the incentive for prudent government marginal propensity to consume from foreign expenditures, so governments undertake costly assistance inflows is less than one, indicating that some investment does occur with the time and then deduced broad conclusions for introduction of foreign assistance. Finally, Khan entire regions, this research examines a broad and Hoshino discover that foreign assistance in section of less developed countries across the form of loans achieves higher rates of multiple regions. Adopting this approach investment than does grants. Ceteris paribus, permits cross-regional comparisons and allows governments invest eighty-five cents of every hypotheses to emerge to account for regional loan dollar, whereas only thirty-two cents of differences in foreign assistance-led economic grant inflows are invested by less developed growth. countries. Hypothesis and Theory. I hypothesize that foreign assistance This research will contribute and supplement the current literature on foreign positively affects economic growth in less assistance’s contribution to economic growth in developed countries. Countries that receive high less developed countries in three ways. First, levels of foreign assistance should experience this study incorporates more recent data, thereby greater levels of economic growth, ceteris supplanting the older data of previous studies. paribus, than countries that receive little or no Second, this study employs a large scope and inflows of foreign assistance. A positive breadth of statistical observations to determine relationship should exist between receiving the effect of foreign assistance on economic foreign assistance and achieving economic growth in less developed countries. Unlike growth. previous studies that analyze a small sample of Aside from foreign assistance, I control less developed countries for a relatively brief for six other independent variables that influence time period, this research examines eighty-two economic growth in less developed countries. countries for the seventeen year period 1976 to The focus of this research is how the level of 1992. More numerous observations of time- foreign assistance affects economic growth in series data allow greater confidence in the less developed countries holding other political results, statistical models, and conclusions and economic variables constant. As such, I will drawn by the research. Finally, this study will briefly describe the six other independent contribute to the empirical literature by variables’ hypothesized effect and then provide introducing a cross-regional approach to the a detailed account of how foreign assistance examination of foreign assistance’s effect on specifically influences economic growth. economic growth in less developed countries. Domestic savings, domestic consumption, Whereas previous research only focused on imports, exports, level of democracy, and infant select, isolated examinations of a relatively mortality rate significantly affect economic small number of countries for a short period of growth. Economic theory indicates that domestic savings should be positively related to democratic countries better protect property the level of economic growth. Higher levels of rights, contracts, and economic transactions, domestic savings provide the necessary capital thereby creating the proper incentive structure to develop a country’s infrastructure and expand for firms and individuals to develop output. Consumption should also be positively infrastructure and invest in long-term, value- related to economic growth. Economic growth added projects. Economic growth is negatively requires consumption to occur; when related to infant mortality; as infant mortality consumption levels for government, firms, and rates increase, economic growth decreases. individuals are high, the economy may expand Boone (1996) and Boone and Faguet (1998) through the Keynesian money multiplier effect. argue that infant mortality rate acts as a proxy Higher levels of aggregate consumption increase variable for overall human capital and general demand for goods and services, facilitating population health. A high infant mortality rate economic growth. The effects of the import and suggests that a country does not possess the export variables can best be understood by necessary resources or infrastructure to analyzing them together as a country’s net adequately deliver basic nutrition and healthcare export position. Net exports’ affect on to its citizens. An unhealthy, undercapitalized economic growth will depend on whether the society cannot fully appreciate its productive country exhibits a positive or negative balance potential. of trade. A positive net export position enhances Foreign assistance facilitates long-term a country’s economic growth by improving its economic growth in less developed countries in balance of payments. Positive net exports two ways. First, foreign assistance introduces a indicate more resources are flowing into a stream of resources that would fail to exist country than are exiting, which facilitates otherwise, thereby stimulating economic growth. economic growth. Conversely, countries with Foreign assistance inserts previously unavailable negative net export positions suffer from balance resources into the less developed country’s of payment problems, which hinder economic economy, which provides the necessary impetus growth. An increasing level of democracy to inaugurate economic growth and should positively affect economic growth in less development. Initially, foreign assistance developed countries. According to Boone loosens domestic economic constraints facing (1996), Dollar and Burnside (1997), Boone and governments of less developed countries. Faguet (1998), and Riddell (1987), as countries Foreign assistance supplants domestic revenue, become more democratic, they develop the thereby relaxing budget constraints. Relaxed legal, political, and economic frameworks to budget constraints allow government facilitate economic growth. Specifically, more consumption to increase. Government consumption stimulated by foreign assistance projects, including large infrastructure programs causes an aggregate increase in demand for such as dams, hydroelectric plants, electrical numerous goods and services, thereby creating grids, communications systems, railroads, ports, the foundation for broad-based economic and highways. The construction of major development. The increase in demand caused infrastructure projects encourages the by greater government consumption ripples development of broader markets and national throughout the economy, subsequently linkages. As communities become effectively stimulating supply and demand reactions in connected to one another through highways, firms and individuals. Increased government railroads, ports, and communications lines, a demand for products and services encourages greater dependency develops between firms to increase production, generating communities for trade and the exchange of additional revenue for those firms. The labor goods, services, and information. Through force increases in response to growing public national linkages, communities that were once and private sectors. As the labor force grows isolated and self-dependent achieve the ability to and finite labor resources diminish, wages begin specialize and gain from regional comparative to rise. Additionally, a larger participating labor advantages. force means an equally greater consumer The national linkages created through market, so consumer spending also increases. infrastructure development encourage economic More consumer spending and savings further growth by broadening and deepening national stimulates economic growth, creating its own markets. First, infrastructure development and rippling effect on the economy. Thus, foreign subsequent national linkages allow firms access assistance encourages economic growth in less to mass consumer markets. Firms gain the developed countries in a circular pattern by ability to reach more consumers and take allowing consumption to expand, which causes advantage of economies of scale. Second, a an aggregate rise in demand and supply of goods system of national linkages and access to vast and services, thereby broadening labor markets consumer markets acts as a catalyst to accelerate and increasing wages, leading to greater savings the growth of indigenous firms. Firms have an and consumption patters. incentive to develop because of greater demand Second, foreign assistance stimulates from mass consumer markets. Potential economic growth in less developed countries by entrepreneurs perceive consumer markets as encouraging infrastructure development and the untapped revenue sources that entice them to creation and entrenchment of national linkages. incorporate. Third, the introduction of more As Levy’s research indicates, governments firms throughout the country implies a greater invest foreign assistance into development quantity and variety of products. A richer diversity of firms distributed throughout a received, domestic consumption, domestic country creates the opportunity for more savings, domestic investment, net exports, level products to be developed. The combination of a of democracy, and infant mortality rate all vary greater number of firms and more products across time and across countries in the sample. contending for consumer loyalty and spending Given that the independent variables do change generates competition. Competition, in turn, on an annual basis, it logically follows that the eventually translates into lower prices for dependent variable, level of economic growth, consumer and higher product quality. also changes on an annual basis because of Ultimately, once national linkages and the changes in the independent variables. For the subsequent markets have developed, the country level of economic growth to change, the will begin to attract outside investment. As the economic and social variables on the dependent economy grows and markets strengthen, the side of the equation must first change. country will become more attractive for Economic growth only occurs when there is a investors, who will infuse capital into the change in the independent variables. country. The infusion of foreign capital will Additionally, my hypothesis exhibits co- encourage its own wave of economic growth variation. Given that the dependent variable, throughout the country. Thus, foreign assistance economic growth, depends on changes in the can encourage economic growth in less independent variables, it follows that as the developed countries by acting as the catalyst that independent variables change, so to will the develops the essential prerequisites of economic dependent variable. If the economy expands and development. Foreign assistance allows the independent variables increase substantially, governments to undertake initially large capital the dependent variable should capture the investments that are crucial in developing economic expansion and report tremendous infrastructure and national linkages. Once annual economic growth. Finally, my infrastructure and national linkages are in place, hypothesis represents a non-spurious markets may develop and create self-sustaining relationship. I include regional dummy economic growth. variables to control for geopolitical differences My hypothesis meets the three criteria in the receipt of foreign assistance. The regional necessary to establish causality. First, my dummy variables control for the possibility that hypothesis demonstrates time order; changes in foreign assistance’s true affect depends on the independent variables precede changes in the belonging to a particular geographic region. I dependent variable. The values of the also report the independent variables as a independent variables change on an annual percent of gross domestic product to control for basis. The amount of foreign assistance economy size and country size, two factors that could influence foreign assistance’s affect on of foreign assistance receipts by not accounting economic growth. for a recipients’ contributions to international Data and Method. foreign assistance efforts. I employ the Polity I employ three sources of data to III database of democracy to measure the level determine the effect of foreign assistance on of democracy on an annual basis for each economic growth in less developed countries. I country in this study. Polity III ranks countries collect data from all sources for the years 1975 on a democracy scale of 0 to 10, with 0 to 1992. Data for the dependent variable, indicating a lack of democracy and 10 indicating economic growth as measured by the annual complete democracy. The database also uses – percent change in gross domestic product, comes 77 and –88 to indicate periods of revolution or from World Tables 1994 (1994) published by regime change. Appendix I lists the less the World Bank. The same edition of World developed countries employed in regression Tables 1994 also serves as the data source for analysis by region as delineated by World the independent variables public consumption, Tables 1994 (1994). domestic savings, imports, and exports. Public Papanek (1973) develops a linear consumption and domestic savings are each regression model to determine the effect of measured as a percent of annual gross domestic foreign assistance on economic growth in less product. Imports and exports are both measured developed countries. Chenery and Strout (1966), in millions of current United States dollars. I Mosley, Hudson, and Horrell (1987), and Khan calculate annual imports as a percent of gross and Hoshino (1992) adopt similar permutations domestic product by dividing the value of of the model to determine the effect of foreign imports by the value of gross domestic product assistance receipts on economic growth. and then multiplying the quotient by one Papanek’s model holds that economic growth is hundred. I use the same procedure to calculate a function of gross domestic savings, foreign annual exports as a percent of gross domestic assistance, foreign private investment, and other product for each year in the study. Data for net foreign inflows. Papanek’s model understands annual foreign assistance receipts comes from economic growth to be the annual rate of the 2000 Organization for Economic increase in gross domestic product (GDP). Cooperation and Development (OECD) database Papanek expresses each independent variable as available on the Internet. I use net annual a percentage of GDP to hold the unit of analysis foreign assistance receipts because it measures constant in the model. Papanek’s model takes the real amount of assistance a country receives the form: in a particular year. Using gross foreign assistance would overestimate the actual amount % ∆ GDP = c + β1(s / GDP) + β2(a / GDP) + β3(i / GDP) + β4 (f / GDP) where c is a constant, s represents gross differences of the less developed countries under domestic savings, a signifies total amount of investigation. The dummy variables control for foreign assistance, i is foreign private regional biases in the data, including number of investment, and f represents other foreign countries represented in each region and inflows. Papanek justifies this model of differences in foreign assistance received by economic growth by contending that the each region. I exclude foreign investment as an multiple components of investment provide the independent variable because it exhibits a high largest impetus to economic growth. degree of multicollinearity with the domestic Furthermore, Papanek argues that the primary savings variable. focus on the effect of foreign assistance on My model builds on and enhances economic growth permits his model. Among previous models in several important ways. others, Chenery and Strout (1966) and Dacy First, this model incorporates two important (1975) also acknowledge the importance of independent variables, imports and exports, that including both savings and investment in a Papanek (1973) and others contend significantly model of economic growth when investigating affects economic growth in less developed the effects of foreign assistance inflows. countries. Second, Khan and Hoshino (1992) I employ linear regression analysis stress the importance of consumption in similar to Papanek’s to create a formal determining economic growth in less developed mathematical model of foreign assistance’s countries. They contend that consumption affect on economic growth in less developed contributes to economic growth, so it must be countries. I contend that economic growth is a included and controlled for when determining function of foreign assistance, domestic savings, the effect of foreign assistance on economic domestic consumption, imports, exports, level of growth. The model also controls for regional democracy, and regional dummy variables. differences through the dummy variables, a Specifically, the percent change in annual gross component not utilized by previous research. domestic product is a function of foreign Finally, my model incorporates a measure of assistance as a percent of GDP, domestic regime type which Przeworski and Limongi savings as a percent of GDP, domestic (1993), Haan and Siermann (1995), and consumption as a percent of GDP, imports as a Gasiorowski (2000) contend significantly affects percent of GDP, exports as a percent of GDP, the level of economic growth in less developed level of democracy, and regional dummy countries. Their research collectively indicates variables. Expressing each independent variable that regime type must be controlled when as a percent of gross domestic product controls analyzing economic growth because of the for the geographical and population size special structural, legal, and economic average democracy scores for years when the institutions inherent to democratized states. democracy score is -77 or -88. For every year t The dependent variable, annual percent and every country c where the democracy score change in gross domestic product, is calculated equals -77 or -88, I average the democracy by subtracting the gross domestic product of scores of t-1 and t+1 to create a new non-outlier year t-1 from the gross domestic product of year democracy score for year t. If multiple years t1 t and then dividing the difference by the gross … tk contain –77 or –88 for a particular country, domestic product of year t-1. The quotient is I replace the multiple t1 … tk years with the then multiplied by one hundred to yield the average of t1-1 and tk+1 for the years percent change in gross domestic product immediately preceeding and following the between year t and t-1. The dummy variables transition period of years t1 … tk. I complete two unique types of control for regional differences inherent to the data. Each region as specified by the World regression models for years 1976 to 1992 to Bank’s World Tables 1994 is assigned a specific estimate the effect of foreign assistance on number for differentiation. Dummy variable 1 economic growth in less developed countries. (d1) represents Sub-Saharan Africa, dummy The first regression series employs ordinary variable 2 (d2) delineates South Asia, dummy least squares (OLS) regression analysis to variable 3 (d3) represents East Asia, dummy determine the coefficients and statistical variable 4 (d4) signifies Latin America and the significance of the model: Caribbean, and dummy variable 5 (d5) identifies Yt = β0 + β1(St) + β2(Ct) + 3(Xt) the North Africa and the Middle East. The + β4(Mt) + β5(Ot) constant of the regression model indicates the + β6(At) + β7(D1) final region, Eastern Europe and Central Asia. + β8(D2) + β9(D3) Each dummy variable is coded so one indicates + β10(D4) + β11(D5) + et a country belonging to that particular region, while zero signifies all other countries. The democracy rank for several countries contains successive -77 or -88 rankings. These few -77 and -88 scores become outlier cases when plotted against annual economic growth. Including multiple outlier cases skews ordinary least squares regression analysis by substantially altering the sample mean. I correct the outlier cases by creating Where: Y equals percent change in gross domestic product between years t and t-1; S equals savings as a percent of gross domestic product in year t; C equals consumption as a percent of gross domestic product in year t; X equals exports as a percent of gross domestic product in year t; M equals imports as a percent of gross domestic product in year t; analysis should be used. The second model I specify employs WLS analysis to each annual O equals level of democracy in year t; regression model to correct for the A equals foreign assistance as a percent of gross heteroskedastic error of the cross-sectional data. domestic product in year t; D1 … D5 indicate the regional dummy variables as previously specified; and et represents the error term. The null hypothesis for this model is: Weighted least squares transforms heteroskedastic data into homoskedastic data that conforms to the assumption that the error term is homoskedastic with equal variance for all levels of x. Each parameter of the equation is H0: β6 = 0, which indicates that foreign divided by the square root of At to weight the assistance has no affect on economic growth. data. The transformed model is: ⎞ ⎛ ⎞ ⎛ ⎞ ⎛ ⎞ ⎛ ⎛ 1 ⎞ ⎞ ⎛ ⎞ ⎛ ⎟ + β ⎜ St ⎟ + β ⎜ Ct ⎟ + β ⎜ X t ⎟ + β ⎜ M t ⎟ + β ⎜ Ot ⎟ + β ⎜ At ⎟ = β0 ⎜ 1 2 3 4 5 6 ⎜ A ⎟ ⎜ A ⎟ ⎜ A ⎟ ⎜ A ⎟ ⎜ A ⎟ ⎜ A ⎟ ⎜ A ⎟ At ⎝ t ⎠ ⎝ t ⎠ ⎝ t ⎠ ⎝ t ⎠ ⎝ t ⎠ ⎝ t ⎠ ⎝ t ⎠ yt ⎛ D ⎞ ⎛ D ⎞ ⎛ D ⎞ ⎛ D ⎞ ⎛ D ⎞ + β 7 ⎜ 1 ⎟ + β 8 ⎜ 2 ⎟ + β 9 ⎜ 3 ⎟ + β10 ⎜ 4 ⎟ + β11 ⎜ 5 ⎟ ⎜ A ⎟ ⎜ A ⎟ ⎜ A ⎟ ⎜ A ⎟ ⎜ A ⎟ ⎝ t ⎠ ⎝ t ⎠ ⎝ t ⎠ ⎝ t ⎠ ⎝ t ⎠ The alternative hypothesis for this model is: where the coefficients and variable symbols H1: β6 > 0, which indicates that foreign conform to the specifications of the original assistance has a positive affect on economic model. I transform the original variables into growth. weighted variables for all years in this study. Hill, Griffiths, and Judge (1997) indicate The weight for WLS regression model is foreign that cross-sectional data generally exhibits assistance as a percent of gross domestic product heteroskedasticity, a violation of the for year t when the dependent variable is homoskedasticity assumption of ordinary least economic growth between t and t-1. The squares analysis. Heteroskedasticity must be weighted least squares model is computed by controlled for two reasons. First, linear SPSS when the foreign assistance variable is regression models with heteroskedasticity no selected as the WLS weight in the regression longer generate the best linear unbiased model specification menu. estimators. Second, the standard errors I create seventeen models to computed for least squares estimators with demonstrate the effect of foreign assistance on heteroskedasticity are incorrect (Hill, Griffiths, economic growth in less developed countries for and Judge 1997). To correct for heteroskedastic both ordinary least squares regression and error, weighted least squares (WLS) regression weighted least squares regression. I apply the model to a pool of eighty-two countries on an assistance has a statistically significant affect on annual basis for the period 1976 to 1992. For economic during 1977, 1978, 1981, 1986, and each year of the test period a model is 1992. The 1977 and 1978 coefficients are constructed to determine the β6 coefficient and statistically significant at the 10% level. The its statistical significance. Appendix II details 1986 coefficient is statistically significant at the results from OLS regression analysis, and 5% level, while the 1981 and 1992 coefficients Appendix III details the WLS results. are statistically significant at the 1% level. Results. Examining only the statistically significant Overall, both the OLS and WLS foreign assistance coefficients generated by OLS regression models indicate that foreign techniques indicate that, overall, foreign assistance does affect economic growth in less assistance negatively affects economic growth in developed countries. However, the analysis less developed countries. The OLS estimates does not fully support my hypothesis that suggest that countries that receive higher levels foreign assistance positively influences of foreign assistance will exhibit lower levels of economic growth in less developed counties. economic growth than non-assistance recipients. The OLS regression indicates that foreign In 1977, for every one percent increase in assistance positively contributed to economic foreign assistance as a percent of gross domestic growth in 1976, 1982, 1984, 1985, 1987, 1988, product, economic growth decreased by .509 and 1989, while the other years of this study percentage points holding all other independent maintained negative coefficients. WLS variables constant. Similarly, a one percent regression analysis shows that foreign assistance increase in foreign assistance as a percent of positively influenced economic growth in 1976, gross domestic product reduced economic 1981, 1982, 1983, 1984, 1985, 1987, 1988, growth by .413 percentage points in 1978, .815 1989, and 1990. The remainder of the years in percentage points in 1986, and .485 percentage this study possess negative coefficients. Table points in 1992. In 1981, for every one percent 1.1 details the annual foreign assistance increase in foreign assistance as a percent of coefficient (β6), t-value, and p-value generated gross domestic product, economic growth by both OLS and WLS regression techniques increased by .836 percentage points. holding all other independent variables constant. The coefficients in Table 1.1 indicate The WLS estimates of foreign assistance’s affect on economic growth in less that foreign assistance does have a statistically developed countries provide a slightly more significant affect on economic growth in less optimistic prediction. WLS regression generates developed countries for several of the years of statistically significant foreign assistance this study. Using OLS regression, foreign coefficients for years 1976, 1977, 1978, 1980, Table 1.1: Annual Foreign Assistance Coefficient Year B6: OLS t-score p< B6: WLS t-score p< 1976 0.461 1.634 0.108 0.677 3.431 0.001 1977 -0.509 -1.739 0.087 -0.460 -2.276 0.027 1978 -0.413 -1.703 0.094 -0.515 -0.259 0.012 1979 -0.016 -0.390 0.698 -0.0003 -0.023 0.981 1980 -0.546 -1.160 0.251 -0.609 -2.561 0.013 1981 0.836 3.623 0.001 1.199 7.073 0.000 1982 0.123 0.444 0.660 0.089 0.645 0.523 1983 -0.060 -0.241 0.810 0.097 0.797 0.429 1984 0.169 0.738 0.463 0.123 0.781 0.438 1985 0.302 1.099 0.276 0.340 1.802 0.077 1986 -0.815 -2.086 0.041 -1.259 -4.482 0.000 1987 0.002 0.067 0.947 0.008 0.473 0.638 1988 0.130 0.378 0.707 0.197 0.851 0.398 1989 0.027 1.545 0.128 0.021 5.800 0.000 1990 -0.102 -0.057 0.955 0.216 0.668 0.507 1991 -0.010 -0.180 0.858 -0.008 0.457 0.650 1992 -0.485 -3.108 0.003 -0.565 -4.044 0.000 1981, 1985, 1986, 1989, and 1992. The 1985 increased economic growth by 1.199 percentage coefficient is statistically significant at the 10% points in 1981, .34 percentage points in 1985, level. The 1977 coefficient is statistically and .021 percentage points in 1989. However, significant at the 5% level. The 1976, 1978, in 1977, for every one percent increase in 1980, 1981, 1986, 1989, and 1992 coefficients foreign assistance as a percent of gross domestic are statistically significant at the 1% level. The product, economic growth declined by .46 WLS estimates are fairly evenly split in their percentage points. Likewise, for every one predicted effects. The 1976, 1981, 1985, and percent increase in foreign assistance as a 1989 coefficients indicate that foreign assistance percent of gross domestic product, economic positively contributes to economic growth in growth declined by .515 percentage points in less developed countries. In 1976, for every one 1978, .609 percentage points in 1980, 1.259 percent increase in foreign assistance as a percentage points in 1986, and .565 percentage percent of gross domestic product, economic points in 1992. growth increased .677 percentage points. Conclusions. Similarly, a one percent increase in foreign assistance as a percent of gross domestic product This study examined the effect of foreign assistance on economic growth in less developed countries. The purpose of the The existence of both negative and research was to determine whether foreign positive foreign assistance coefficients may be assistance was a statistically significant partially explained by global economic shocks contributor to economic growth in less and business cycles. Sign changes for the developed countries. I hypothesized that foreign foreign assistance coefficient roughly assistance would significantly contribute to correspond with major world economic events. economic growth. Based on the statistically The negative OLS and WLS coefficients for the significant estimates of the foreign assistance period 1977 to 1980 could be attributed to the coefficient, β6, generated by both ordinary least 1970s oil crisis and subsequent economic squares and weighted least squares regression slowdown. Higher oil prices, coupled with a techniques, I am unable to fully accept my decreased import demand in developed hypothesis. Foreign assistance positively economies, could disrupt domestic fiscal and contributes to economic growth in some years, monetary stability in less developed countries, while at other times it significantly decreases undermining the effectiveness of foreign economic growth in less developed countries. assistance. Similarly, a lag effect from the According to the ordinary least squares model, United States’ 1982 recession could explain the foreign assistance enhanced economic growth in negative OLS coefficient in 1983. The mostly 1981, while it reduced economic growth in positive coefficients between 1984 and 1989 1977, 1978, 1986, and 1992. The weighted least could be explained by the general improvement squares model indicates that foreign assistance in the overall global economy and the ripple facilitated economic growth in 1976, 1981, effect generated by the United States’ substantial 1985, and 1989. This model further economic expansion. A strong, robust demonstrates that foreign assistance diminished macroeconomic environment could improve the economic growth during 1977, 1978, 1980, terms of trade for developing countries, which 1986, and 1992. Collectively, these results would provide the fiscal and economic stability suggest that no firm, universal conclusion may necessary for foreign assistance to be harnessed be drawn on the effectiveness of foreign effectively. Finally, the negative coefficients for assistance. The annual foreign assistance 1990, 1991, and 1992 could be explained by coefficient signs do not follow any definite recession in the United States and the breakup of pattern or trend, making it difficult to the Soviet Union. The Soviet Union’s extrapolate firm predictions from the models. dissolution disrupted trade relationships, This problem could be addressed in future severely altered aggregate supply and demand, research by employing pooled time-series cross- and initiated a period of severe economic sectional regression techniques. hardship for its former members and trading partners. Furthermore, following Burnside and governments of these countries react to foreign Dollar (1997) and the World Bank (1998), the assistance inflows. First, more research must be Soviet Union’s collapse introduced political completed to determine why some regions instability and created a poor fiscal and perform better with foreign assistance inflows monetary environment, thereby undermining the than do others. Research should commence to effectiveness of foreign assistance. The severe determine why some regions are better able to political and economic disruption initiated by utilize foreign assistance and channel it to the Soviet Union’s demise introduced achieve significant rates of economic growth. tremendous political and economic shocks that Why are some regions better able to utilize disrupted foreign assistance’s delivery channels, foreign assistance than others? Tentatively, thereby hindering its effectiveness. population, level of poverty, unemployment rate, The estimates of foreign assistance’s literacy rate, and industrial composition of a effectiveness may be used by policymakers in region should affect how foreign assistance is donor and recipient countries to devise new, utilized and help determine the success of more efficient development strategies. My foreign assistance inflows in contributing to results indicate that foreign assistance does not economic growth. Future research should focus necessarily foster or impede economic growth. on the regional level of analysis and attempt to This study suggests that foreign assistance can explain why some regions perform better than play a significant role in economic growth, but it others when granted foreign assistance. does not guarantee success. Using this Second, additional research should be conclusion as a foundation, donors and completed to determine the influence foreign recipients may focus their attention on creating assistance exerts on the fiscal behavior of the necessary political and economic governments in less developed countries. environment that increases the probability for Research needs to be initiated to determine how foreign assistance to catalyze economic growth. the receipt of foreign assistance influence fiscal Understanding that foreign assistance may and monetary policy in less developed countries. generate economic growth creates an incentive As other researchers have noted, foreign for donors and recipients to undertake assistance inflows may allow governments of institutional, economic, and political reforms to less developed countries to undertake programs harness foreign assistance’s full development and policies that would otherwise be potential unobtainable. The results of these foreign More research needs to be undertaken to assistance-led programs and policies may not be examine how foreign assistance behaves in the sustainable in the long-term without the economies of less developed countries and how perpetuation of foreign assistance inflows. Research must be initiated to better understand how governments change their fiscal and monetary policies in response to foreign assistance inflows. Better policy prescriptions and foreign assistance packages may be developed once the international development community knows and understands how foreign assistance affects long-term fiscal and monetary behavior of foreign assistance recipients. Third, subsequent research needs to deconstruct foreign assistance data, fracturing in into its multiple components. For each country, the total foreign assistance receipts should be initially divided into two categories: foreign assistance from multilateral sources and foreign assistance from bilateral donors. Receipts in each category should be further separated into they method of foreign assistance transmission: loaned funds in the form of cash, donations in the form of cash, technical assistance, donations in the form of food products, donations in the form of physical capital, and donations in the form of medical equipment. Such an extensive partition of foreign assistance receipts will facilitate the creation of models that better conceptualize the multiple forms of foreign assistance, allowing researchers to determine what type of foreign assistance contributes the most to economic growth in less developed countries. That knowledge, in turn, will provide better prescriptions to policymakers, donor agencies, and foreign assistance recipients who seek to gain the greatest impact from each foreign assistance dollar.