Growth, Poverty and Development Assistance: When Does Foreign Aid Work?

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This is a survey paper on aid effectiveness in terms of the contribution of development assistance to economic growth and poverty reduction. The article focuses primarily on the most recent generation of cross-country studies. It concludes that there is a set of broad areas where the evidence reviewed shows signs of convergence that have direct relevance for policy decisions on aid and for aid-effectiveness discussions. These areas are: aid levels (meaning if the level of aid is too low or too high); domestic political institutions (including political stability and the extent of decentralisation); the composition of aid (including sectors, modalities, objectives and time horizons); and the volatility and fragmentation of aid. We also identify two areas where there is little sign of convergence in the evidence: the importance or otherwise of ‘good’, meaning orthodox macroeconomic policies and whether grants are more effective than loans.

Policy Implications

  • Aid is more likely to work in the correct ‘dosage’ but is ineffective if the level is too high or too low. One needs to consider existing levels of aid. Aid is likely to have diminishing returns as aid grows relative to the size of the economy, and those returns can even turn negative. In addition, at low levels aid may have little impact on growth.
  • Aid effectiveness depends on domestic political institutions; for example, political stability and the level of decentralisation.
  • The effectiveness of aid depends on the objectives, sectors, modalities and time horizons (essentially what the aid is intended for).
  • Aid is likely to be more effective if it is not volatile or fragmented.
  • There are two areas where there is little convergence in the evidence, despite oft-cited claims to the contrary: there is no consensus on if orthodox macroeconomic policies make aid more effective; and there is no consensus that grants are better than loans (or vice versa) in terms of aid effectiveness.
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