Abstract
The effectiveness of foreign aid has been a hotly debated issue in the growth and development literature. This thesis contributes to the existing literature on the effectiveness of foreign aid and its impact on development and growth in developing countries. Also, it provides an empirical and theoretical framework for understanding the incentives behind the decision making of aid donors. This thesis evaluates whether donor governments provide more foreign aid to countries where they exert more influence. The additional empirical results obtained here permit a re-evaluation of the existing literature on foreign aid, as well as adding some verification of previous results by other researchers and, hopefully, providing extra evidence in the area of foreign aid studies. The main contributions of this thesis are the following: first, the panel data methodology has been applied to all empirical analysis in this work. In contrast, most of the previous work has been done using the time series or cross section estimations separately. Second, I have reexamined the findings of the earlier work done by Levy (1987). Third, I have analysed the effect of corruption on foreign aid as one of the factors that affects its effectiveness. The empirical evidence in this area is not very well researched and can be described as mixed and inconclusive, which has intensified the arguments. Fourth, I have reassessed the link between foreign aid and economic growth by considering the potential link between aid and structural transformation in sectoral production terms, as well as explored the possible presence of 'Dutch disease' in provision of foreign aid. Fifth, the motivations of donor countries have been assessed to examine whether they provide foreign aid as an altruistic gesture or for political and economic gains. The literature on this issue has so far presented mixed results. The main aim of this thesis is to try to have a better understanding of the issues surrounding the questions: Is foreign aid effective. Does foreign aid help to promote growth and development? It then tries to address more specific issues as: What are the main motives of donor governments in the provision of foreign aid. Are there signs of 'Dutch disease' in the provision of foreign aid. Can failure of foreign aid be a result of the presence of corruption in the recipient countries? This thesis will attempt to provide a satisfactory, and as exhaustive as possible, an answer to each of the above questions. Also, this work includes a literature review on all subjects addressed in this thesis. The main findings of this thesis are the following: the reassessment of the findings by Levy (1987) suggest that most of the official development assistance is going for consumption in low-income countries and not on the investment. These results strongly contradict the results obtained by Levy (1987). The contribution to the empirical literature on the possible presence of 'Dutch disease' in provision of foreign aid suggest that, while the theory on 'Dutch disease' and structural transformation may imply the presence of 'Dutch disease' when a country receives foreign aid, our empirical tests were inconclusive. Although there are clear signs of structural transformation, the results for the effects of aid are small. Overall, results are not robust, which makes it difficult to establish whether aid drives structural transformation or leads to 'Dutch disease'. The empirical results on the main motivations of donors and more precisely donors from the Development Assistance Committee (DAC) towards the main objectives behind aid provision suggest that DAC donors take into account the need of the recipient countries, though donors look after their own interests to a great degree as well. This analysis implies that countries tend to pay more attention to the 'need' factor in the low-income countries and to a lesser extent in lower-middle- income countries. An interesting finding is that donors tend to give more aid to countries where they have a higher share of aid to overall aid received by a country. This 'reputation effect' has an impact on the provision of aid by donor countries. This can be explained that by doing this, donor economies tend to indirectly show their power and dominance. The empirical results on a panel and on a cross-section of countries to measure the effect of corruption and aid shows that aid has no impact on growth, while countries with higher levels of corruption have lower growth rates.