Graduate Programme in International and Development
Facultés Universitaires Notre-Dame de la Paix,
Université Catholique de Louvain
Academic Year 2005-2006
The Effectiveness of Aid to
Focus on the Aid-Growth
Promoter: Professor Jean-Philippe Platteau Tutor: Christian
Project presented as part of the requirements for the award of
the Master in
International and Development Economics
Table of Contents
2. The objectives of aid to development
3. Aid effectiveness
4. The aid-growth relationship
5. The aid-growth literature
5.1. The optimism of Hansen and Tarp (2000)
5.2. The swinging pendulum of Clemens, Radelet and
6. New look at the aid-growth literature
6.1. The first part of the literature
6.2. Two turning points for a new aid-growth
6.2.1. Boone: the methodological turning
6.2.2. Burnside and Dollar: the ideological turning
7. The second part of the literature: reactions to
Burnside and Dollar (1997) 7.1. The indicator for «good» economic
7.2. Sensitivity to model specification
7.3. Other conditioning variables than economic
7.4. Sensitivity due to the data base
7.5. Problem with the definition of aid
7.6. The detrimental consequences of the selectivity
8. Contemporary consensus and controversy
I wish to thank sincerely Christian Tritten for his precious
availability. His assistance and his advices have been particularly helpful. I
also would like to acknowledge Professor Jean-Philippe Platteau for the
enlightening comments he made. Finally, I am grateful to Professor Michel
Mignolet, Marie-Eve Mulquin and all my colleagues of the CREW who gave me the
necessary flexibility to realise this work.
The question of the effectiveness of aid is a particularly
sensitive issue as it may have colossal implications for many developing
countries. However, it is quite difficult to have a clear opinion about the
ability of international assistance to contribute to development. The existing
literature seems to be abundant but very diverging. Between optimistic donor's
rapports, contradictory scientific publications and militant pleas of some NGOs
the question is apparently difficult to answer. We decided to investigate in
this direction to clarify as far as possible this important issue.
After a brief presentation of the diversity of aid objectives,
we will see how the effectiveness of aid to development has been circumscribed
to its impact on economic growth. We will then analyse two articles which tried
to synthesize the existing literature on this topic. Next, we will propose our
own interpretation of this literature. We will discuss the important
shortcomings and failures of the ongoing debate about the efficiency of foreign
assistance. Finally, we will observe the surprising fragility of nonetheless
influent studies with crucial policy implications.
The objectives of aid to development
The concept of international assistance appeared in the
19th century but the real expansion of foreign aid to development
started with the launch of the Marshall plan and the creation of the Bretton
Woods institutions in the aftermath of World War II. Since then, the history of
international cooperation has been largely influenced by the evolution of
geopolitics and development thinking.1 Initially widely considered
as a weapon against the soviet influence the objectives of foreign aid took
various directions following the donors and their motivations. Hence, aid has
been attributed for many different purposes and in many different forms. Even
if we stick to official objectives of bilateral development agencies, they
appear to be very diverse.2 They go from self-sustaining growth to
poverty reduction through good governance. But the variety gets even larger as
we consider donor's real intentions. Amongst
1 See Kanbur (2003 p 4-9)
2 See Lensink and White (1999, p 15-16)
the latter, some are hardly avowable3. As Boone
(1996, p306) writes: «Despite the popular belief that aid is primarily
motivated to assist the poor, substantial evidence points to political,
strategic, and welfare interests of donor countries as the driving force behind
For Alesina and Dollar (1998), there is general agreement
about what matters for aid allocation, namely poverty of the recipients,
strategic interests, colonial history, trade, political institutions, etc. But
the dominant variable can be very different from a country to another. After
looking at several studies analysing the determinants of foreign aid, Boone
(1996) concludes that aid flows primarily reflect donor's interest rather than
recipient needs. In this sense, Alesina and Dollar (2000) find evidences that
assistance allocation was essentially dictated by political and strategic
consideration much more than by economic needs and policy performance of the
recipients. In a more recent study, Berthelemy (2004) find that the vast
majority of donors behave in a rather selfish way.
3. Aid effectiveness
The question of whether aid globally works or not has always
been highly controversial and the debate is constantly and rapidly evolving.
The diversity of goals, donors and types of aids makes the concept of «aid
effectiveness» quite unclear. In consequence, the efficiency of aid has
been approached from different methodological and ideological point of views.
Some studies have concluded that aid was only able to increase bureaucracy,
enlarge inequalities or develop corruption. On the other hand, many economists
have argued that growth would have been lower and poverty worse without
As well mentioned by Kanbur (2000, p15): «Given the great
ideological divides in development doctrines and in aid policy, and given the
ambiguities in the theoretical analysis of the impact of aid [...] empirical
literature on aid evaluation has taken on special significance.» This
empirical literature can roughly be divided in two main streams. The first one
investigates the effects of foreign aid on receiving countries. The other one
studies the determinants of foreign aid allocation and the behaviour of donor
agencies. Both have led to
3 Hjertholm and White (2000, p81) attempt to synthesize the
core evolution of aid throughout the last decades. But their schematic
synthesis does not reflect the large diversity of objectives going form very
altruistic behaviour to perfectly selfish interests.
numerous analysis and fierce debates. However, for the purpose of
this work, we will essentially focus on the first part of this literature.
4. The aid-growth relationship
In order to make cross-country studies feasible, it was
necessary to choose some kind of «common denominator» able to reflect
the general efficiency of aid despite de diversity of its objectives. The
aid-growth relationship is incontestably the most common relationship used in
the literature to measure the macroeconomic effectiveness of foreign aid.
Concretely, in the regressions, positive and significant coefficients on the
aid variable is interpreted as evidence that aid was effective in enhancing
growth. As Quibria (2004, p17-18) expresses: «Although poverty reduction
has been accepted as the overriding objective of international development
assistance, this concern has not found adequate reflection in the current
research: paradoxically, much of the current research effort has been couched
in terms of economic growth rather than poverty reduction.» In fact, this
«second best» indicator of efficiency is essentially motivated by the
poor availability of data in most developing countries4. It can also
be explained by the unfortunate tendency among economist to consider growth and
poverty reduction to be synonymous. The following statements of Easterly (2003,
p34) reflect this misunderstanding: «the aid bureaucracies [these days]
define their final objective as «poverty reduction, [which is] today's
more politically correct name for `growth'.»
Nevertheless, this decision to consider the efficiency of aid
only in terms of its ability to enhance national growth entails important
limitations. Restricting the evaluation of aid effectiveness to its impact on
national growth means that we make somehow the underlying assumption that
economic growth benefits to the targeted people, namely the inferior social
classes. In other words, we make the well known hypothesis that growth
«trickles down» to the poor. In the late nineties, different studies
found a positive relationship between growth and poverty reduction5.
Some kind of consensus emerged then about the positive contribution of growth
to poverty decline. But, this hypothesis is not equally valid
everywhere6. As Rodrik
4 The reliability of such a statistic may be deeply questioned,
as we know the importance of informal activities in developing economies.
5 We refer to Dollar and Kraay (2000) and Gallup, Radelet and
Warner (1999) for the concept of relative poverty, whereas Ravallion (2000) and
Collier and Dollar (2001, 2002) analyze the impact of growth on absolute
poverty. They all come to the conclusion that growth is «good for the
6 This is especially the case in some countries where economic
growth is mainly fed by the exploitation of natural resources. (e.g. the well
known «oil curse»)
(2000, p1) writes: «the poverty-reduction payoff from
growth depends in part on the specific circumstances and policies in each
country.» Furthermore, if the majority of authors agree on the idea that
growth increases small revenues, the extent of this gain is still subject to
fierce debate. In many cases inequalities appear to widen with economic
growth7. So, if growth has been accompanied by an improvement in
Gini coefficients in countries like Taiwan, Bangladesh and Egypt, it may also
worsen social inequalities in others such as Chile, China, and Poland. This
argument leads us to the discussion about the different concepts of absolute,
relative and even subjective poverty. It cannot unconditionally be said that
one kind of poverty should be targeted rather than the others in order to
improve people's welfare. For statistical ease, «absolute poverty» is
usually preferred by economists. It does not mean that it is the best indicator
of (dis)satisfaction. On the other hand, is increasing inequality necessarily
detrimental if it at the same time everyone has a higher income? At least, this
question requires careful thought.
In addition, looking at this aid-growth relation to estimate
its ability to reach its objectives may lead to other limitations. As we will
see later there exist many kinds of assistance and some categories of aid may
not target economic growth at all. We find it particularly frustrating to limit
the assessment of support to fields like human rights, cultural emancipation,
gender equity or nature protection to there impact on growth. In comparison, it
is a bit like restricting the benefits of scientific research to its marketable
Finally, even if the analysis is limited to economic
variables, one can wonder if it is appropriate to limit the concept of
development to economic growth. It is a frequent mistake in the economic
literature to confuse economic growth, development and welfare8.
What is the contribution of economic growth to development when human
indicators are pointing in the opposite direction? This important issue wanders
from the purpose of our work. It is nevertheless important to remain critical
when we narrow the scope of an analysis for technical reasons.
Despite all these arguments that reduce seriously the
explanatory power of the aid-growth relation, the overwhelming majority of
attempts to measure global aid effectiveness have been couched in terms of
impact on growth. As Amprou and Chauvet (2004, p45) say, the real
7 See for instance De Janvry and Sadoulet (2000) for the case of
8 We refer to Cassiers and Delain (2006)
issue of foreign aid is poverty reduction. But very few
econometric studies departed from the aid-growth relationship to analyse the
real effectiveness of aid. This has given birth to a fierce and apparently
inconclusive debate that deserves some critical analysis. For this reason, we
will stick to this aid-growth relationship as well. In the following, we should
keep in mind the previous limitations to interpret cautiously what we mean by
5. The aid-growth literature
The literature on aid-growth linkages started during the 1
960s with the rising question of whether aid works. «There are some
periods when assessing aid effectiveness becomes particularly intensive. These
coincide with cycles of doubt on the efficacy of aid as an instrument of
foreign development.» (Kanbur, 2003, p 15) Over time, the successive
empirical studies have given some strong contradictions. Some authors have
tried to structure chronologically the debate. This seems to be an important
step to clarify the ideas on this issue. We will here discuss two of these
5.1. The optimism of Hansen and Tarp (2000)
In a quite optimistic article, Hansen and Tarp (2000)
distinguish three generations among 131 cross-country regressions. They
essentially consider the methodology applied to measure the efficiency of aid.
The first generation looked at the impact of foreign aid on domestic savings.
Already, the question turned into debate. After more than a decade of
consensual optimism, Griffin (1970), Griffin and Enos (1970) and Weiddkopf
(1972) launched the discussion with their pessimistic conclusions. They found
rates of growth negatively linked with the amount of foreign capital inflows.
They argued that aid may retard development by decreasing domestic savings. To
retort to this «revisionist» literature, Papanek (1972) was the first
to regress growth on aid. After disaggregating capital flows into foreign aid,
private capital and other inflows, he found a strongly significant positive
correlation between aid and growth for a sample of 51 countries observed from
1950 to 1965. Provided the convincing arguments of Papanek, Hansen and Tarp
(2000, p7) conclude: «The overwhelming evidence from these studies is that
aid lead to an increase in total savings, although not by as much as the aid
flow... aid spurs growth.»
The second generation of studies switched to the
aid-investment relationship to estimate the impact on growth. This period was
also considered by Hansen and Tarp (2000) to be optimistic since all but one
article show a positive impact of aid on growth. The only exception was the
much cited Mosley et al. (1987, 1992). In consequence, the conclusion of the
authors was that the aid-investment link was positive, leading probably to a
higher growth rate. As we will see later, Hansen and Tarp's positive perception
of the early literature is a bit surprising. Other authors conclude at best
that the first decades of research about the aid-growth linkages was rather
Finally, by the end of the nineties, analyses became more and
more sophisticated. With one emblematic article of Burnside and Dollar (1997),
this can be considered as the third and last generation of studies. Hansen and
Tarp (2000) review a few of these recent papers10 but found only one
outlier11 concluding that aid has no effect on growth. All the
remaining articles they analyse found a significant impact of aid on growth
either conditional on appropriate economic policy or not. This allows them to
say about aid that: «There is a significant effect on growth, either alone
or in combination with a policy variable.» (Hansen and Tarp, 2000, p16).
Before providing our own discussion on all this literature we would like to
account for another way to analyse its evolution.
5.2. The swinging pendulum of Clemens, Radelet and
In another exercise to distinguish successive trends in the
empirical literature of aid effectiveness, Clemens, Radelet and Bhavnani (2004)
focus on the outcomes of the different authors in their quest to define
different phases. For them the literature is comparable to a swinging pendulum
alternating between optimistic and pessimistic periods. We think this
conclusion is a little bit excessive since they tend to drop a number of
contradicting regressions in order to provide a more convincing
characterisation of a period12. After a first period of dominating
optimism, they found a surge of criticism in the early seventies against aid to
development13. Immediately after, this revisionist literature has
9 See for example Easterly (2003, p26)
10 Burnside and Dollar (1997), Hadjimichael et al. (1995),
Durbarry et al. (1998), Hansen and Tarp (1999)
11 Boone (1996)
12 For example, the second phase of Clemens, Radelet and
Bhavnani (2004) running from 1972 to 1980 is thought to be an optimistic period
regarding the aid-growth relation. Nevertheless, the articles of Gupta (1975)
and Newlyn (1973) presented very ambivalent results.
13 Griffin (1970), Griffin and Enos (1970)
by Papanek (1972) with his positive correlation between aid
and growth. Thereafter, a period of controversy14 lasted until the
key paper of the last decade, namely the very pessimistic one of Boone (1996).
Since then, the literature can be divided into its sceptic supporters and its
opponents arguing that foreign aid has an unconditional positive effect on
As we can see, these two approaches offer interesting
structures to analyse the past literature. However, they sometimes interpret a
particular article in a way that suits them best. In other words, they tend to
choose the best interpretation of a study in order to remain consistent with
the proposed framework. An illustration of this practice is the appreciation of
the link between the article of Boone (1996) and the one of Burnside and Dollar
(1997). On the one hand, Hansen and Tarp (2000) clearly oppose the pessimistic
Boone (1996) and the rather optimistic Burnside and Dollar (1997). On the other
hand, Clemens et al. (2004) range Burnside and Dollar (1997) among the studies
that «take Boone to be more or less correct».
This leaves us with an ambiguous feeling. Is it impossible to
find one single conclusion about the impact of foreign aid on economic growth?
Rajan and Subramanian (2005, p5) summarize explicitly our intuition about this
empirical literature: «The literature has sometimes followed a cycle in
which one paper finds a result, and is followed by another paper with a twist,
either overturning or qualifying the previous result, followed by another, and
so on. This has had some undesirable effects on policy with advocates
selectively using results to bolster their preferred view on aid.» In the
next part we will try to reconsider the entire aid-growth literature in a
6. New look at the aid-growth literature
Contrary to the two previous analyses, we prefer to divide the
aid-growth literature in two major periods separated by two almost simultaneous
turning points in the second half of the nineties. If we want to clarify a
little bit the debate about aid effectiveness, we need to focus on the recent
literature published after the mid-nineties. This does not mean that earlier
articles are useless but they were quite contradictory and have been abundantly
criticised. Nevertheless, we think necessary to discuss this early literature
despite all its shortcomings to understand the transition to the last
generation of studies.
14 Mosley (1980), Mosley et al. (1987) and Boone (1994) were then
opposed to Gupta & Islam (1983) and Levy (1988)
6.1. The first part of the literature
In the early nineties, after a few decades of inconclusive
assessments of aid, emerged some kind of «micro-macro paradox» as
named by Mosley (1987). There was indeed a striking contrast between the
relative optimism of a majority of studies conducted at the micro level and the
relative pessimism regarding the ability of aid to increase growth performance
at the country scale. Projects appeared to be successful whereas there was no
visible impact of aid at the macro level. At that time, a few pessimistic
studies such as Bauer (1993) have been particularly influential in promoting
the idea that aid is wasted or even detrimental for recipient's
If we except Hansen and Tarp (2000, p16) which is, to our
knowledge the only article to consider that «A very few highly influential
studies in each generation have argued the negative», the majority of
authors agree about the pessimistic evolution of the first decades of
McGillivray (2006, p16): «For many decades the research
literature on the country-level impacts of aid often sent ambiguous messages as
to whether aid was effective in promoting growth and reducing poverty... The
overall consensus about these impacts was rather pessimistic ... «
Clemens et al. (2004, p7): «(after a decade of
controversy)... Many researchers have taken Boone (1996)'s findings as
confirmation of the «macro-micro paradox»... «
Kanbur (2003, p16): «Throughout the assessments of aid
that have been carried out over the last few decades, there seems to have
emerged a micro-macro paradox.»
Lensink and White (1999, p64): «Overall, the strict
macroeconomic studies... seem to be inconclusive with respect to the
effectiveness of aid... Most authors argue that the macroeconomic impact of aid
was modest or that aid did not have any affect on economic growth.»
Hudson (2004, p1 85): «Hence, until recently, the
dominant view within economics had become pessimistic with respect to the pas
effectiveness of aid...»
In the early nineties, the «micro-macro paradox» due
to the general pessimistic conclusions of macro studies led to an unprecedented
crisis of legitimacy of aid to development. In consequence the overall aid
flows to developing countries fell drastically. Nowadays this paradox is well
understood. Indeed, a particular project may reach its own objectives and
create simultaneously important distortions. If the evaluation at the local
level is not
15 Schwalbenberg (1998) argues that their evidence is largely
anecdotal and denies their finding that aid has led to the adoption of
damageable economic policies.
conducted at «shadow price» its conclusion may be
positive even if the global balance sheet is in deficit.
Moreover, the high number of pessimistic macro studies can be
explained as well by analysing the framework of this early literature. Growth
models have been important in influencing the specification of empirical
relations. Until recently, the most widespread models used to examine the
macroeconomic impact of aid were the different types of «gap
models»16. In short, these models consider the availability of
capital goods as the constraining factor to enhance economic growth in less
developed countries. In this sense, aid may spur growth by raising investment.
In other words, foreign aid fills the gap created by insufficient savings or
This early literature has been extensively criticized. Apart
from the poor quality of the data available for these different articles, the
criticisms focused essentially on two unrealistic assumptions of the «gap
models». The first problematic hypothesis concerns the assumed linear
relationship between investment and growth through a constant capital-output
ratio. As Easterly (2003, p31) emphasises: «Most economists since Solow
(1957) have felt uncomfortable with a Leontief-style production function that
does not allow the substitution of labour for capital.»
The second critical assumption of the «gap models»
has been exposed by Boone (1996). It is the strong hypothesis that aid
necessarily finances investment rather than consumption. Morrissey (2005)
points out that there is probably not more than one third of total foreign aid
devoted to productive investment. The largest part of aid is actually dedicated
to health expenditures, education, emergency aid or debt cancellation which
will have very little impact on growth in the short run.
As a consequence of these two core assumptions, until the
mid-nineties, economists only tested linear relationships between aid and
growth despite the improvements in growth literature. As Durbarry et al. (1998,
p1) document: «Many aid-growth investigations ignore many of the recent
advances in growth theory». Easterly (2001) tests the credibility of
16 There exist different variant of the «gap
models». The most employed one is the so called «two gap model»
of Chenery and Stout (1966), combination of the trade gap model (Balassa, 1964)
and of the saving gap model (Rosenstein-Rodan, 1969; Fei and Paauw, 1965).
gap models for a sample of 88 recipient countries. For only one
case, Tunisia, the «gap» approach seems to hold empirically.
There are definitely many reasons to expect a nonlinear
aid-growth relationship. Diminishing return of aid is actually very plausible.
First, Hadjimichael et al. (1995), Durbarry et al. (1998) or Lensink and White
(1999) refer to the limited absorptive capacity of recipient
countries17. Hence, there can be «too much» aid intended
for a particular country if aid inflows can not be productively utilized. This
can for example happen if country's management capacities are not sufficient.
Another explanation of these diminishing returns could be the fact that aid
does not flow neutrally into a country. The recipient economy can be made worse
of because of the immiserization problem18. This may happen
when domestic inputs required for a particular project are greater than its net
output. In other words, this is the case of a very costly project leading to a
net loss for the «beneficiary» country19.
Secondly, Lensink and White (1999) present several early
studies pointing at a negative relationship between foreign aid and domestic
savings. They also argued that development aid could enable countries to hold
an overvalued currency and thereby stimulating capital flight and depressing
the competitiveness of a country. Finally, aid may encourage unproductive
public expenditures so that the positive impact of foreign assistance could be
off set by government reaction. This has been called the fungibility
problem20. All these arguments demonstrate the weak theoretical
background and the abundant empirical failings of the first part of the
Therefore, in the early nineties, the only realistic statement
was given by White (1992, p121) «We know surprisingly little about aid's
macroeconomic impact. The combination of weak theory with poor econometric
methodology makes it difficult to conclude anything about the relationship
between aid and growth.»
17 There can be first diminishing and even negative returns to
aid. This can be illustrated by the aid of a Laffer curve. Estimates of the
turning point at which the impact of aid on growth turns negative vary
extremely: Some authors (Dalgaard and Hansen, 2001; Burnside and Dollar, 1997)
estimated this turning point below 20% of GDP whereas others (Lensink and
White, 2001; Gomanee et al., 2002) found it higher than 40%.
18 The famous «Dutch disease» is a particular case of
this problem. (See Kanbur, 2003, p1 1)
19 This could be the case of development agencies' projects
requiring important co-financings from the «beneficiary» country but
leading to relatively small output.
20 However Lensink and White (2000) underline that fungibility is
not necessary a problem if recipient countries pursue appropriate growth
6.2. Two turning points for a new aid-growth
Actually, two major turning-points took place in the
literature during the second half of the nineties. Though they are very
different in their philosophy, together, they gave birth to a new generation of
aid-growth empirical studies leading to both improved methodology and
modifications in the conclusions.
6.2.1. Boone (1996): the methodological turning point
Boone's (1996) pessimistic conclusions are quite in line with
most of precedent articles and so it confirms Mosley's idea of the
«micro-macro paradox». As we already mentioned, he finds
that aid does not increase growth nor benefits the poor because it tends to
finance consumption rather than investment. So, the main result of aid seems to
be an increase of the size of governments. Nevertheless, this article is a kind
of turning-point in the sense that it is probably the first one to initiate the
movement of a methodological revolution. Compared to previous studies the new
generation of articles brings several significant innovations.
First, they are now working with panel data covering a larger
number of countries and years. As Hudson (2004, p1 87) explains, data are more
reliable than ever: «The problems relating to data are declining gradually
over time as both more and better quality data becomes available.»
Secondly, authors are now taking account of innovations in matters of growth
theory. Variables reflecting the quality of institutions and economic policies
of the beneficiary countries are now included in the regression. Third, it has
become the rule to address explicitly the possibility of endogeneity of
aid21. Last but not least, the inclusion of regressors such as
aid² and aid×policy enables a non-linear aid-growth
relationship22. Quibria (2004, p9) confirms this major innovation:
«Perhaps the principal contribution of the Boone study has been to
stimulate further professional interests in a research area that was fast
approaching rapid diminishing returns.»
21 The amount of aid allocated to a country is not independent
from its initial level of GDP since aid appears to go primarily to poor
22 Cfr. Arguments discussed earlier
6.2.2. Burnside and Dollar (1997): the ideological turning
In 1997, in this context of aid's legitimacy crisis and
constantly decreasing international assistance flows, Burnside and Dollar wrote
their «extraordinarily influential paper»23: Aid,
Policies and Growth. Initially known as a World Bank working paper it was
only published three years later in the American Economic Review. By
means of a new data base of the World Bank, they want to revisit the
pessimistic conclusions of Boone (1996) and other recent articles. In this
sense, it gave a new impulse to the debate. The following statements confirm
this new dynamism:
(Roodman 2004, p2): «The work of Burnside and Dollar has
brought corroboration and challenges.»
Easterly (2003, p26): «The Burnside and Dollar (1997)
paper gained prominence because it addresses the scepticism implied by Boone
and by the lack of consensus from the early literature». Although, from a
methodological point of view their innovation was quite minor, their
conclusions brought new arguments to the discussion about aid
Quibria (2004, p9): «The paper that has done the most to
stimulate the interest in the topic is the one of Burnside and Dollar
McGillivray (2005, p2): «The turning point in the
literature is defined by two, very well-known studies. The first is Burnside
and Dollar (1997) and the second is a Assessing Aid: What Works, What Doesn't
and Why (World Bank, 1998). The latter report results presented in the
Their major novelty is the inclusion in the equation of an
interaction term between foreign aid and economic policies. This
«aid×policy» interaction term enables to make a distinction
between countries with adequate economic policies and those with unfavourable
ones. Hence, the simple correlation of aid and growth appears to be close to
zero24 but this is only true for country with mean policy level.
Indeed, the impact of aid on growth appears to be significantly positive in
good policy environments. Their conclusion is that aid effectiveness in the
growth process is directly dependent on the quality of economic
policies25. Whereas Boone's (1996) conclusions offered no
opportunity to increase aid effectiveness, Burnside and Dollar (1997) suggest a
more encouraging discourse since better selectivity in aid allocation
should enhance its impact on economic growth.
Obviously, such a finding has led to important political
consequences: «This work has clear implications for how to make foreign
aid more effective... If they (donors) want to have a
23 See Easterly, Levine and Roodman (2003, p1)
24 In this sense Burnside and Dollar (2000) is in consistent with
Boone (1996). 25 They also found that foreign aid suffers from diminishing
larger impact on growth and poverty reduction, then they
should place greater weight on economic policies of recipient.» (Burnside
and Dollar, 1997, p4) In the years that follow this publication many
development agencies adapted their allocation behaviour to adopt the
selectivity principles recommended by Burnside and Dollar. The Economist
(June, 1999) also expressed this concept of selectivity that became so
popular at that time: «Countless studies have failed to find a link
between aid and faster economic growth.... Rich countries should be more
ruthless about how they allocate their largess, whether earmarked or not.
Emergency aid is one thing. But mainstream aid should be directed only to
countries with sound economic management. In other words, aid could work if
properly directed.» Such strong statements gave rise to abundant
reactions. As we will see, the application of the selectivity principle as
suggested by Burnside and Dollar (1997) was probably not a very opportune
7. The second part of the literature: reactions to
Burnside and Dollar (1997)
Because of its important political implications Burnside and
Dollar (1997) have provoked a huge amount of comments and criticisms. Because
of its emblematic role, it has attracted much attention26. But most
of the remarks that follow do not exclusively concern this initial article.
Therefore they can be extended to several other articles of the same
nature27. We think important to present that critical literature
since these reactions constitute the core of the ongoing debate. Dalgaard et
al. (2004, p197) write about this: «It should be clear by now that much of
the current discussion centres on the question if bad policies - in addition to
being detrimental to growth - imply that aid is wasted.»
7.1. The indicator for «good» economic
Burnside and Dollar (1997) estimate the quality of economic
policies by compiling a simple economic policy index28 out of three
measures of inflation, trade openness and budget deficit. This method presents
several shortcomings revealed in the following studies.
Berthélémy and Varoudakis (1996) demonstrate the limited impact
of trade openness for economies with underdeveloped financial system. Lensink
and White (2000) suggest that the relation between
26 It is important to notice that the following reactions to
Burnside and Dollar (1997) may be either more pessimistic or more optimistic
regarding the effectiveness of foreign aid.
27 For instance, «Assessing Aid: What Works, What Doesn't
and Why» of the World Bank (1998) was completely in line with Burnside and
28 This economic policy index was later referred as the Burnside
and Dollar policy index.
inflation and growth is probably non-linear and so could not
be catch by a fixed index. Amprou and Chauvet (2004), emphasize that budgetary
surplus is not automatically favourable for growth. Easterly (2003) criticizes
the subjective and opaque aspect of the trade openness variable29
used by Burnside and Dollar (1997). When he replaces the latter by more
sophisticated alternatives, despite a significant correlation between the new
policy variable and growth, the «aid×policy» interaction term
looses its significance.
Furthermore, restricting economic policy of a country to these
three variables may be a little too synthetic. Indeed, Dalgaard and Hansen
(2001), Hansen and Tarp (2000, 2001), Hudson and Mosley (2001) and Lensink and
White (2001) all test, in different ways, the relationship between aid and the
«Burnside and Dollar policy index». They all found insignificant
results. This means that the identification of which policies really matter for
growth remains problematic. In the following literature, authors usually prefer
the concept of «economic and institutional performance» illustrated
by the much more evolved CPIA index30, measured by twenty
institution and policy components31.
More fundamentally, as Quibria (2004) expresses, what donors
usually require as «good» polices may sometimes be historical,
contextual and path-dependent and so not widely accepted. Their selectivity
process is culturally biased. Hence, the basis for assessing one country's
performances should be the concrete and measurable results of foreign aid and
not «subjective assessments of policies and institutions against the
benchmark of the imaginary ideal setup» (Quibria, 2004, p.34).
7.2. Risky interpretation and sensitivity to model
First, Lensink and White (2000) and Guillaumont (1999)
indicate that the «aid×policy» interaction term needs to be
interpreted carefully. It can mean both that the impact of aid on growth
appreciates with the quality of policy, and that the impact of policy on growth
increases with the quantity of aid.
29 This indicator has been introduced by Sachs and Warner
30 CPIA = Country Policy and Institutional Assessment
31 This policy index has been criticised as well. See Dalgaard,
Hansen, and Tarp (2004) for three pertinent remarks.
Furthermore, some authors demonstrated the high sensitivity of
Burnside and Dollar's results to model specification. Among those, Hansen and
Tarp (2001) and Dalgaard and Hansen (2001) modify Burnside and Dollar (1997)
regressions in different ways. For example, when they add an
«aid²» term to the equation, the
«aid×policy» interaction term looses its significance. On the
other hand, aid appears to be effective on average, independently from policy
variables. They also observe diminishing returns.
For Beynon (2001, p29): «There remain significant
unexplained determinants of growth in all these models.» Hansen and Tarp
(2001) also argue that there probably exists other unobserved country-level
effects that give incorrect explanatory power to the
«aid×policy» term. Indeed, if the regression fails to catch
fully and properly all the determinants and constraints that influence economic
growth, the estimated coefficient of aid will be biased. In this sense,
Morrissey (2005, p1) underlines: «As aid is more likely to flow to poor
countries that suffer growth-retarding characteristics (that are not
specified), there is a greater likelihood of incorrectly drawing the conclusion
that aid is ineffective.»
7.3. Other conditioning variables than economic
The literature contains a large number of variables, other
than economic policy, that are presented to have a significant impact on
economic growth. In consequence, there is a high attendant risk that any
individual model does suffer from omitted variable bias and inconsistent
estimators. As Gunning (2004, p54) says: «The idea is that the effect of
aid on growth is conditional on a wide variety of country characteristics, not
just on the policies pursued.» We will briefly present the major
contributions to the discussion.
For Guillaumont and Chauvet (2001), aid is more effective in
economically vulnerable countries32. In those countries, exposed
to external shocks, it appears to be more difficult to maintain consistent
economic policies. They conclude that aid should be allocated in priority to
countries suffering from external shocks, terms of trade difficulties or
natural disasters in order to help them to stabilize. Suspend their assistance
because of poor policies would be very damaging. In the same sense, Collier and
Dehn (2001) say that aid has more impact on growth in countries suffering from
extreme fall of export prices.
32 Economical vulnerability can be measured by the instability of
the agricultural production, the instability of exports earnings, long-term
terms of trade trend and the size of the population.
Bloom and Sachs (1998) and Gallup et al. (1999) all find that
geography has a significant impact on growth33. From this, Dalgaard
et al. (2004) investigate the aid-growth relationship for countries with part
of their territory in the tropical areas. An advantage of this
variable is the absence of endogenity worries. On average, aid seems to
influence positively growth outside the tropics but not in them. In
consequence, Dalgaard et al. (2004) see tropical area as an exogenous
«deep determinant» of growth. If we refer to the principle of
selectivity of Burnside and Dollar (1997), it would obviously be particularly
unfair to penalise tropical countries because of their geographic situation.
The literature contains an extensive variety of other
variables that have been found to condition significantly the efficiency of
aid. Hence, Svensson (1999) highlights that aid is more effective in places
with democratic institutions, whereas Islam (2003) pretends exactly
the opposite, namely totalitarian governments reinforce the impact of
aid on growth. For Petterson (2004), the degree of fungibility of aid
in the recipient country is decisive. Collier and Hoeffler (2002) find out that
countries emerging from conflict have larger absorptive capacities.
All these variables plausibly influence the aid-growth
relationship and there probably exist others. However, Roodman (2003) find that
for most of these studies, the significance of the results were very sensitive
to observations and extensions of dataset. In any case, the conditional
efficiency of aid seems to be much more complex than suggested by Burnside and
7.4. Sensitivity due to the data base
Several authors have criticized the sensitivity of Burnside
and Dollar's results to small changes in the database. For instance, Easterly
et al. (2003), use exactly the same specification as Burnside and Dollar (1997)
but added new available data to the sample. Hence, the former database has been
updated to 1997 and earlier gaps have been filled. As a result, the
«aid×policy» interaction term becomes negative and
insignificant. In other words,
33 Tropical land area, tropical disease and landlockedness seem
to depress economic growth.
there is no support anymore for the finding that «aid is
more efficient in a good policy environment».
In the same logic, Hansen and Tarp (2000) indicate the
excessive sensitivity of Burnside and Dollar's conclusions. Actually, the
significance of the «aid×policy» term depends only on five
observations excluded deliberately from the sample34. As these five
«outliers» are re-included in the database, the conclusion of more
efficient aid in presence of sound economic policy is not valid anymore.
Moreover, Dalgaard and Hansen (2001) show that there is little logical basis
for choosing these particular outliers over other observations. On the basis of
predetermined criteria these five observations would probably have qualified.
Then, they demonstrate how the exclusion of five alternative outliers may
produce a regression that shows a positive impact of aid on growth. Once again
Burnside and Dollar's (1997) conclusions appear to be seriously weakened.
7.5. Problem with the definition of aid
The definition of aid chosen by Burnside and Dollar (1997) is
the «Effective Development Assistance». This original concept
involves only the grant element of aid and excludes for instance, the loan
component of concessional loans. In fact, the most usual definition of aid
comes from the Development Assistance Committee of the OECD and is called
«Official Development Assistance» (ODA). This second concept includes
grants and preferential loans net of repayments of earlier aid loans. For
example, this second definition of aid considers debt cancellation as effective
aid to development whereas the first one does not. Both approaches make sense
and their correlation is obviously high. But when using the alternative
measure, Easterly (2003) find the crucial «aid×policy»
interaction term not to be significant anymore. In the same vein, to test the
robustness of Burnside and Dollar's (1997) findings, Ram (2004) splits the aid
variable into multilateral and bilateral flows. This distinction is certainly
justified, since their allocation procedures are significantly different. He
also tries an alternative concept of policy. All this leads him to reject the
hypothesis of aid effectiveness conditioned by sound economic policy.
34 They are: Nicaragua (1986-9, 1990-3), Gambia (1986-9, 1990-3)
and Guyana (1990-3).
More fundamentally, most studies contain two weaknesses when
they deal with the aid-growth relationship. First, they usually analyse the
relationship between total aid and growth whereas an important part of this aid
is not intended to promote growth. As we already mentioned, no more than thirty
percent of global aid flows are allocated to productive investments. For the
rest, food assistance and humanitarian assistance are not likely to have any
positive impact on growth. As pointed out by Morrissey (2005), the second
limitation has to do with time considerations. Most authors using panel data
for cross-country analysis analyse the aid-growth relationship over periods of
four years. As pointed out by Clemens et al. (2004), this is a very short
period for such an analysis. Financing health or education may only influence
growth over more than a decade. Nevertheless, the longer the period of
observation, the more difficult it is to isolate the specific influence of
To overcome this dilemma, Clemens et al. (2004) make the
distinction between three different kinds of aid flows following their expected
impact on economic growth. If aid is considered globally, it is logical to find
a small relation with growth. On the other hand, if we restrict the analysis to
the category of aid that is plausible to enhance growth in the short run, then
the impact appears to be more than two times larger than earlier, even for a
four years period of observation35.
Finally, there may be another explanation for the low return
of aid to development. This issue is strangely little discussed in the
scientific literature but recently exposed by some NGOs36. The major
NGO ActionAid International argues that about two third of funds
devoted to international cooperation is actually «phantom aid» that
never reaches its target37. This can be overpriced and ineffective
technical cooperation, tied aid, debt relief, administrative costs or budget
for the hosting of refugees. Actually, donor countries try to present the
largest cooperation budget as possible. But the presence of some particular
amounts within the official budget of development assistance is highly
discussable. Though they recognize the existence of «phantom aid»,
the amount computed by ActionAid International has been largely
contested by the OECD and other bilateral aid agencies. We will not enter
further into this debate. In any case, an important percentage of Official
Development Assistance is lost,
35 Unfortunately, Clemens et al. (2004) do not include an
«aid×policy» interaction term in their regression. For that
reason, the comparison with Burnside and Dollar (1997) is limited.
36 See ActionAid International, June 2005, «Real aid: an
agenda for making aid work».
37 The target is considered to be the improvement of the living
conditions of poor people.
wasted or diverted from its objectives. This has of course
important consequences on the macroeconomic assessment of aid effectiveness.
7.6. The detrimental consequences of the selectivity
The political recommendations of Burnside and Dollar (1997)
may have harmful implications to the neediest populations. As expressed by
Quibria (2004, p1 1), «Despite the putative merit of selectivity, its
implications for equity in poor countries can be quite adverse.» In fact,
there seems to be a high correlation between low income and poverty on the one
hand and limited administrative and institutional capacities on the other. If
aid resources are allocated only to countries that can design and implement
«good» policies, this would exclude automatically some poorer
countries which need foreign assistance the most. On the other hand,
selectivity will favour allocation to very few large countries with relatively
«good» policies and administrative capacities. In other words,
selectivity would affect countries where aid can have the greatest impact in
terms of equity.
More fundamentally, these results beg two important questions.
On the one hand, we may wonder whether it is really appropriate to measure aid
effectiveness through its impact on economic growth. On the other hand, is it
really optimal to have different kinds of aids with different objectives?
8. Contemporary consensus and controversy
After all these reactions, Burnside and Dollar's results
appear to be seriously weakened. The idea that «foreign aid has a positive
impact on recipient's economic growth provided that those countries have sound
economic policies» is not so well accepted anymore38. Actually,
while it is difficult to deny that «good» policies and institutions
could enhance aid effectiveness, there is still a strong controversy regarding
what constitutes good policies or institutions. Nowadays, an incontestable
majority of studies find some positive impact of aid on economic growth
irrespectively of policy variables39. We lack time to present in
38 Still, some studies confirm Burnside and Dollar (1997):
Burnside and Dollar (2004), Collier and Dollar (2001 2002), Collier and Dehn
(2001), Collier and Hoeffler (2002).
39 Some of these optimistic articles have already been mentioned
amongst the reactions to Burnside and Dollar (1997), in the previous
this optimistic literature40. In order to
illustrate this real consensus, we will rather present some extracts that speak
Dalgaard (2005, p1): «Recently, there appears to be an
emerging consensus that aid does increase growth - on average. By the same
token it is also well accepted that aid does not seem to be equally effective
in all countries.»
Dalgaard et al. (2004, p1): «In the last few years, the
pendulum has swung, and a gradually forming consensus view has emerged that aid
`works'... Nevertheless, controversy remains since it also seems clear from the
data that foreign aid is far from equally effective everywhere.»
Morrissey (2005, p5): «At one extreme is the Burnside and
Dollar (1997) view that aid is only effective in a good policy environment. At
the other extreme, is the Hansen and Tarp (2001) view that aid is effective
irrespective of policy... An intermediate position is that better policies will
improve growth performance and therefore may be associated with more effective
McGillivray (2005, p1-4): «The overwhelming majority of
recent, widely circulated empirical studies find that economic growth would
have been lower in the absence of aid... Inclusive Burnside and Dollar (1997),
36 studies have been conducted during 1997 to 2004, therefore. Thirty-four of
these studies conclude that aid works»
Beynon (2001, p29): «In summary, while the question of
whether aid is effective irrespective of policy remains disputed, there is at
least agreement that aid works better in good policy environments.»
Hansen and Tarp (2000, p16-17): «When all studies are
considered as a group, the positive evidence is convincing. The micro-macro
paradox is non-existent. Microeconomic studies indicating that aid is
beneficial are consistent with the macroeconomic evidence.»
Quibria (2004, p3 1): «The single most robust conclusion
that has emerged from recent cross-country regression studies is that aid has
in general been effective in developing countries across a wide
variety of policy environments. This result repudiates the idea of conditional
effectiveness, a much-vaunted notion that argues that aid works only in
countries with good polices and as such should be directed only to those
These few examples are convincing enough. Although the
dominating tendency in the present literature is bringing aid back into favour,
there is also some kind of agreement around the idea that aid's productivity is
subject to diminishing returns.
In addition, beside this optimistic stream, we should not
neglect a few influent outliers. Among this pessimistic resistance we find
Easterly et al. (2003), Rajan and Subramanian (2005), Jensen and Paldham
(2003), Ovaska (2003), Brumm (2003), etc41. These studies are
beneficial in the sense that they stimulate the debate and the production of
40 Not exhaustive list of recent optimistic aid-growth
studies: Durbarry et al. (1998), Hansen and Tarp (2000, 2001), Lensink and
Morrissey (2000), Lensink and White (2001), Dalgaard and Hansen (2000),
Guillamont and Chauvet (2001), Hudson and Mosley, (2001), Lloyd et al. (2001),
Lu and Ram (2001), Chauvet and Guillamont (2002), Dalgaard et al. (2004), Cungu
and Swinnen (2003), Dayton-Johnson and Hoddinott (2003, Gomanee et al (2003),
Ram (2003, 2004), Economides et al. (2004), Clemens at al. (2004), Heady et al.
(2004), Outtara and Strobl (2004), Roodman, (2004).
41 The «pessimistic» articles published in the
Cato Journal are amongst the most aggressive against foreign aid.
However, we have never seen them cited in any other article. They seem to be a
bit too committed to be really reliable.
Though, they also deteriorate the handsome consensus
abovementioned. On the other hand, they should not attract too much attention
as they clearly represent a small minority of the literature.
Another observation about the optimistic consensus seems to be
important. If the majority of studies agree on the fact that foreign aid
enhances economic growth, there is no harmony at all on the extent of this
improvement. This debate about the degree of unconditional efficiency of aid
remains largely inconclusive. Furthermore, as we have seen earlier, some
authors may observe a better effectiveness of aid in presence of some
conditioning variables. All this together encourages us to qualify the
statement that «aid works».
Our initial objective was to identify some conclusions about
the macroeconomic effectiveness of aid to development. Since important
implications are at stake, it has given birth to an abundant literature. Our
first statement has been that the overwhelming majority these studies focus on
the impact of foreign aid on recipient country's economic growth. After four
decades of various publications, the discussion seems, at first sight, to be
rather inconclusive. A couple of articles have already tried to clarify the
debate but they are not really compatible. So, we decided to design our own
framework of the literature.
Actually the whole aid-growth literature can be divided in two
major periods separated by a double turning-point in the second half of the
nineties. The first part has been dominated by inconclusive debate but it ended
with the pessimistic agreement around the «micro-macro paradox». At
the present time, this early literature appears not to be very reliable as it
is characterised by particularly weak theoretical basis, poor econometric
methodology and fragile databases. Then, some kind of methodological (Boone,
1996) and ideological (Burnside and Dollar, 1997) turning points took place in
the late nineties. These two influential articles really boosted the production
of new studies. Especially the innovative statement that aid works only if
sound economic policy, has given rise to numerous reactions. The related
principle of selectivity has extensively been discussed and criticized.
Nowadays, though there remain a few pessimistic resistances, the large majority
of recent scientific articles express the idea that foreign aid does globally
work in enhancing economic growth.
Nevertheless, intense discussions remain about the extent of this
efficiency as well as about the factors that could improve it.
More fundamentally, there are also some disagreements about
the opportuneness to restrict the essential of the discussion on development
effectiveness and economic growth. First, there exist many kind of aid to
development. Only a limited part of the entire assistance targets investment
that could have an impact on growth in the short run. Using the aid-growth
relationship as a macroeconomic evaluation tool does give little indications
about the efficiency of the majority of aid flows. Secondly, although there is
an undeniable link between growth and poverty reduction, the two concepts are
not synonymous. Unfortunately, economists are often inclined to confuse both
notions or to accept the underlying assumption that growth is automatically
beneficial for the poor. This has not been verified everywhere. Therefore, we
may ask the question of the value of such an improved growth if it does not
help the poor to catch up.
Throughout all of this work, we have tried to relate many
aspects of the aid-growth literature. Actually, the contradictions we find
between similar articles are mainly due to some striking shortcomings of this
empirical approach based on cross-country growth regressions. First of all, the
results appear to be extremely sensible changes in model specification.
Concretely, the estimation of growth regressions is troubled by many technical
econometric problems such as endogeneity, error correlation, parameter
heterogeneity or influential observations. Furthermore, non-economic and
structural factors may have constraining implication on aid effectiveness. Even
if all these limitations do not prevent to recognise its global utility, aid is
definitely not equally efficient everywhere. This may be due to either aid's
characteristics or recipient country's features.
In consequence, it is particularly difficult to derive any
robust policy recommendations. In light of all these technical difficulties, it
should be wise to abandon this cross-country approach in favour of individual
in-depth studies of countries that specify a growth model appropriate to the
observed economy. In this context, we may also wonder whether it is really
useful to look for global estimations of the effectiveness of foreign aid as a
whole. We personally think of cross-country growth regressions to be quite
inappropriate to assess aid effectiveness. Despite some improvements, the
criticisms addressed to the early literature
remain mostly valid for recent studies. Doubtful theoretical
background, unreliable data and technical difficulties are still topical.
The temptation is large to look for one single answer to the
question of whether aid works or not. Whatever the conclusion, this approach is
often misleading and it could have severe detrimental effects. Indeed, few
influential aid-growth regressions have given colossal political implications
despite their poor explaining power and their weak robustness. Since
development process is not just economic growth, future investigations should
concentrate on the impact of foreign aid on other issues such as poverty or
health indicators. Provided the important contextual disparities of recipient
countries, preference should also be given to individual case analysis. In any
case, there remains much work to do and forthcoming studies should be very
careful in their conclusions as they are very likely to provoke contradicting
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