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Types of Foreign Aid

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Lessons on Foreign Aid and Economic Development

Abstract

Most studies treat aid flows as a unitary concept with a standard result that aid does not affect long-run economic growth or development. This chapter argues that the standard finding may be misleading if different types of aid have different effects. To alleviate this problem, I use factor analysis to separate aid flows into different types observed in the data, interpretable as aid for economic purposes, social purposes, and a smaller category consisting of reconstruction aid; a residual category covering approximately 2% of all aid captures the remaining purposes. Estimating the growth effects of separable types of aid suggests reconstruction aid has direct and sizeable positive effects. Aid for economic, social or residual purposes has no significant effects.

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Notes

  1. 1.

    Dreher et al. (2018) provide suggestive evidence that foreign aid disbursed to countries for purely political reasons tend to consist of or fund projects that are poorly designed and implemented, or simply designed to benefit political insiders. As such, a larger share of aid given for political purposes means a smaller impact as many politically motivated projects are not really designed to have a development impact.

  2. 2.

    In addition, the dataset enables researchers to assess donors’ administrative costs from delivering foreign aid. Administrative costs have almost entirely been reported after 2000, but the available evidence shows that only 0.32% of total reported aid in the total AidData database consists of administrative costs. Only 14 country-year observations on administrative costs are above 2% of total aid to the country in a given year, and only two of those are not small island states.

  3. 3.

    The Herfindahl-Hirschmann index is the sum of all squared shares of total aid flows for each of the 24 (or 4) categories. If all aid is disbursed in a single category, the index will be 1 while smaller scores indicate that the aid distribution is less concentrated.

  4. 4.

    I use the Oblimin rotation procedure with a gamma of 0.5; results are almost identical with a gamma of 0. The alternative orthogonal rotation technique Varimax, which is standard in most studies, yields comparable results.

  5. 5.

    While procedures exist that can rescale factor components back to the original scale of the variables entering the analysis, these procedures all rest on first performing factor analysis based on the covariance matrix. They are therefore not practically applicable in the present situation, as analyses based on the covariance matrix are highly sensitive to differences in variance of the raw variables. As the averages, and thus the variances, of the 24 aid variables vary widely, such procedures merely identify factors based on the absolute levels and thus rely on very little relevant information.

  6. 6.

    An earlier working paper version of this paper provides a full discussion of the robustness of the aid typology to, for example, using different rotation techniques, only using observations receiving more than 1% of GDP as foreign aid, that is, avoiding spurious correlations due to a large number of zero-observations, and basing the analysis on aid per capita instead of aid as a percent of GDP.

  7. 7.

    Roodman (2009) notes that the Hansen test may be particularly weak in situations with multiple instruments and may in some cases approach non-credible values close to one. This is indeed presently the case, which may question the findings even if the standard moment restrictions are satisfied. In such cases, Roodman recommends performing robustness tests by reducing the set of instruments. When doing so, all main results in the following remain unchanged and Hansen tests remain far from significant. In particular, the estimate of reconstruction aid proves very stable.

  8. 8.

    In simpler fixed effects estimates in a working paper version, the residual category in the Clemens et al. (2012) typology is significantly negative. The social aid type is also significantly negatively associated with growth when endogeneity issues are ignored.

  9. 9.

    The additional tests of instrument strength consist of either excluding one of the additional instruments—UN voting shares with the US and Russia and a HIPC dummy, and adding voting shares with China and a dummy for membership in the UN Security Council.

  10. 10.

    Further tests (not shown) nevertheless provide additional information. When measuring the absolute number of disasters, instead of disasters per inhabitant, reconstruction aid only becomes significantly positive when countries are hit by more than one disaster per year. Measuring disasters relative to initial GDP suggests similar conclusions.

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  1. Aarhus University, Aarhus, Denmark

    Christian Bjørnskov

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  1. University of Wisconsin-La Crosse, La Crosse, WI, USA

    Nabamita Dutta

  2. Mississippi State University, Mississippi, MS, USA

    Claudia R. Williamson

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Bjørnskov, C. (2019). Types of Foreign Aid. In: Dutta, N., Williamson, C.R. (eds) Lessons on Foreign Aid and Economic Development. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-22121-8_3

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  • DOI: https://doi.org/10.1007/978-3-030-22121-8_3

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