We examine the effects of aid on growth in cross-sectional and panel data—after correcting for the possible bias that poorer (or stronger) growth may draw aid contributions to recipient countries. Even after this correction, we find little robust evidence of a positive (or negative) relationship between aid inflows into a country and its economic growth. We also find no evidence that aid works better in better policy or geographical environments, or that certain forms of aid work better than others. Our findings suggest that for aid to be effective in the future, the aid apparatus will have to be rethought.

Why is there little robust evidence that foreign aid significantly enhances the economic growth of poor countries? The search for an explanation is becoming immensely important as industrial countries are being exhorted to increase their aid budgets in order to help developing countries achieve the Millennium Development Goals. Perhaps one should not expect an impact on growth from the mere infusion of additional capital into a country. But, perhaps, any beneficial effects are offset by adverse spillover effects, and academic focus should shift to determining what these are and how to mitigate them. In this regard, Figure is suggestive. We plot the log of the manufacturing to gross domestic product (GDP) ratio in a country against the log of the ratio of aid received to GDP for that country for two separate time periods (the late 990s and the early 980s), conditional on a number of variables. As the figure suggests, the more aid a country has received, the smaller its share of manufacturing. The coefficient estimate suggests that a percentage point increase in the ratio of aid to GDP is associated with a reduced share of manufacturing in total GDP of about 0.2 to 0.3 percentage points.