Foreign aid and economic growth in developing countries.

Abstract

Foreign aid is a relatively new form of economic exchange between nations, yet in only a few decades it has become a persistent structural element of the modern world-system. Conventional theories of economic development view foreign aid as a "flow" of financial resources into an economy and argue that it accelerates economic growth in the less developed countries by supplementing the domestic capital resources that are available for development. Dependency theory and the world-system perspective conceive of foreign aid as a "structural" feature of the recipient economy and suggest that it retards economic growth in these countries by reproducing the structural distortion of the economy that was originally established by colonialism and by systematically limiting the ability of the peripheral state to control the development of its economy. These theories suggest contradictory findings which are tested in this dissertation with multiple regression analysis. The analyses parallel the seminal research of Bornschier et al. (1978) on foreign investment and economic growth by simultaneously estimating the effects of both short-term flows and long-term stocks of foreign aid on economic growth. Using a sample of 91 Third World countries, the effects of foreign aid on economic growth are estimated both during a period of relative expansion of the world economy (1970-1978) and during a period of relative recession (1978-1986). My findings lend some support to both theoretical perspectives but the direction of the effects are opposite to those predicted by Bornschier et al. Foreign aid is found to have short-term negative effects on economic growth during both time periods but long-term positive effects on economic growth are statistically significant only for the later time period. The findings from this research clearly suggest that the dependency and world-system perspective must modify its theoretical explanations concerning the relationship between foreign capital flows and economic development to take into account the varied uses of different types of financial resources. They also highlight the importance of recognizing that different phases of the expansion and contraction of the world economy may condition the effects of specific types of core-periphery interactions.