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The Effectiveness of Aid to Development. Focus on the Aid-Growth literature.

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par François Defourny
Facultés N-D de la Paix de Namur - Université Catholique de Louvain - Master in International and Development Economics 2005

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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 aid.

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.

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