Foreign aid of different form and size has been given to a multitude of countries suffering from various crises. Since, in most cases, the amount of money provided as financial aid can be as large as several million dollars (or even several billion dollars in the long term), it is highly important to identify the effect this help makes on the receiving sides. The impact foreign aid makes on the countries’ economies has been tested in a variety of ways using quantitative and qualitative methods.
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This paper presents a literature review that explores the research question “does foreign aid affect a country’s economy?” The review will first present general opinions of the scholars concerning this question. Further, the studies related to this subject will be organized based on the investigations of the impact of foreign aid in several specific countries located in different areas of the globe. Finally, the findings of the review will be described.
Also, the analysis of the findings, followed by the conclusion, will be presented at the end of the paper. The hypothesis that the present paper attempts to test is that the effect of the foreign aid on a country’s economy depends on such conditions as the geographical locations of the recipient countries, their levels of income, and the allocation of the provided foreign aid.
The mechanisms based on which the foreign help can affect the economies of the recipient states are multiple. For instance, some of the outcomes of the aid are the better ability to import technology or capital goods, the growth of the investment in human and physical capital, the increase of the recipient’s productivity and capacity of change, also, the aid adds to the savings of the state and provides more opportunities for development.1
The impacts mentioned above are positive. However, scholars point out that there are a number of influences that may complicate the process of aid allocation and use. Some of such issues include the effectiveness of aid that may differ depending on versatile geographic locations and climatic conditions of the receiving states, political situations that produce a powerful impact on the allocation of aids, the institutional quality of the countries that may decrease the effectiveness of aid, and the low returns on them.2 In addition, scholars have noticed a correlation between the rise in the amount of foreign aid granted to a state and the decrease in the foreign direct investment that seems to be in connection.3
The recipients of foreign aid are the developing countries that have shortages of resources. In most cases, such countries are rather dependent on the aids which they receive on a regular basis.4 The researchers who explore the relationship between economic growth and foreign aid inflow reveal mixed results5. According to the literature, in all the recipient countries, the government plays the most significant role in the allocation of aid.6
However, then treated fairly and transparently, the aid is helpful in terms of addressing such problems as the gaps of export-import, technological-knowhow, and saving-investment.7 Regardless of all the potential positive outcomes, the primary negative influence of the regular foreign aid provided in large amounts is the creation and maintenance of an external state debt that will create major pressure on a developing economy, preventing it from growing.8
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The researchers sum up that the provision of foreign aid is beneficial only in some cases and turns out to be harmful in the others.9 All in all, it is up to the state leaders to decide whether or not the aid should be accepted and what kind of consequences it may produce for the domestic economy.
Many countries decide to receive the aid and accept the adverse effects that are likely to occur along with it.10 Sahoo and Sethi also add some more factors to the list of the contributors to the effectiveness of aid for the recipients; these factors include the bureaucratic efficiency, socioeconomic development level, and technological progress, and the institution’s influence and role.11
Naturally, in different countries, the effects of foreign aid would vary. That is why the vast majority of the researchers prefer to explore the issues of the impact of foreign aid on the countries’ economies in a more specific manner and focus on the variables of the particular recipients or unite them in groups based on the shared contributing factors. It is important to note that the findings of the researches often depend on the level on which they approach the question and the perspectives they follow investigating it.
Differently put, the examinations of the micro-level impacts of the foreign aids in different countries do with the help of cost-benefit analyses often reveal positive result and show that the air is helpful in a variety of ways; however, the cross-country studies that employ macro-level approaches and prefer to view the “bigger picture” show mixed and ambiguous results; this phenomenon is referred to as the “micro-macro paradox12
Edwards evaluates the problem of effectiveness and impact of the foreign aid on the recipient states from the historical point of view and explores such factor as “aid ownership”; according to the author, this contributor is one of the most important in terms of planning and allocation of the resources received from abroad.13 That way, the question of the aid impact and efficiency becomes multidimensional and has various sides that carry different factors contributing to the final result. Moreover, the author emphasizes the importance of knowledge of the recipient’s history and development story for the donor to be able to evaluate the future level of the aid’s effectiveness.14
Overall, characterizing the studies that explore the effectiveness of foreign aid on the economies, Veiderpass and Andersson mention that they can be grouped into three types – the first generation studies that have the link between savings and aid as the main focus, the second generation studies that concentrate on the aid-investment-growth relationships, and the third generation ones that take into consideration multiple factors such as the “improved country coverage, use of regressors representing the policy environment, acceptance of non-linearity in the aid-growth relationship”.15
In order to explore the effects foreign aids have had on the economies of the specific countries, the further review will specifically focus on various regions of the globe and the states located there.
Foreign Aid Effects in the Countries of Asia
Studying the provision of foreign aid for Pakistan, Awan and Moeen-ud-Din point out that the country has developed a dependency on the externally given capitals, and this dependency is counterproductive.16 According to the evaluation and estimations of the authors, Pakistan has not benefited from the foreign aid in terms economic growth over the period between 1980 and 2012; at the same time, the researchers have noticed that the factor that produced the most significant positive effect on the economic growth of the country was the domestic investment.17
Moreover, discussing the situation in East Asia, Soesastro mentions that the ambitions of the countries of that region have been inspired by the successful development demonstrated by their Northeast neighbors such as Japan and Korea, who have managed to make use of the foreign aid and build up their economies.18
During the Cold War, the countries of Northeast Asia have received quite large amounts of aid from the United States which helped their economies to form a base sufficient for a powerful take-off and a future development, the aid was used to create stronger and more efficient domestic infrastructure (ports, highways, power generation), import, and export activities.19
Discussing the case of Bangladesh as a recipient of the foreign aid, Quibria also raises an argument that many scholars agree that the absorptive capacity of the developing countries can be rather limited; this statement means that such countries are unable to spend the aids effectively and in many cases, portions of it are wasted.20 The author mentions that the discussion of the causes of the limited utilizing capacity in the developing states has been spoken about for several decades, and the professionals maintain that the main barriers to the efficiency of the foreign aid are the shortage of human capital and the insufficiency of infrastructure.21 That way, the more aid is provided, the more of it is wasted.
Foreign Aid Effects in the Countries of Africa
Rena emphasizes that “Foreign aid can only be valuable, if the recipient country benefits from it in the reduction and elimination of poverty, inequality and unemployment through promotion of work-culture”.22 In other words, ideally, the aid is supposed to stimulate the recipient nation to help itself develop and progress. Rena mentions that there is a substantial body of research that argues that the foreign aid does not generate any significant positive outcomes as most of the aid projects are supported by the foreign forces and as soon as they pull out, the project inevitable close down as the local leaders do not have the resources to support them.23
This is the case in Namibia that is growing dependent on the foreign aid which depreciates the country’s economy, facilitates corruption, and leads to the aid to be spent on the projects that do not promote national growth.24 Moreover, another threat that aid presents in a corrupt and dependent country is a risk of a civil conflict that may erupt around the capital package.25
The countries of Africa are the most frequently used examples of the developing economies unable to allocate the aid effectively and, as a result, wasting most of it. The gap between the rich and the poor states of the world growth, and thus, the third world countries located in Africa are faced with the need to request aid from abroad which does not seem to be making much positive impact on the economic situations of the receiving sides.26
Discussing the aid effectiveness problem among the African countries, Andrews asks a question which factors are outlined as those under development and concludes that apart from the growth of the GDP and the improvement of the quality of life of the local population, the overall development is the factor that counts (it involves economic, cultural, and social progress) and also “economic opportunities, political freedoms, social freedoms, transparency and protective security”.27
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The author maintains that the main reason for the failure of the aid to produce any significant positive effect in a long-term period is that it aims short-term problems (epidemics and seasonal challenges) and omits more general needs (infrastructure advancement, roads, energy generation).28
The study by a Juselius, Moller and Tar argues in favor of the foreign aid effectiveness in the counties of African and provides a quantitative research that proves the positive impact on the GDP and investment in the majority of the assessed African economies, whereas negative effect of the foreign aid on the GDP and investment was detected in only five states.29
In addition to the positive effects demonstrated by the previous study, the research conducted by ReCom that covered the provision of aid and its impacts on a variety of countries located all over the world throughout the 1990s and the beginning of the 2000s shows a significant decrease in the rates of poverty many regions including Sub-Saharan Africa.30 However, the research fails to specify the exact mechanisms according to which the foreign aid was recognized as the driver of the poverty decrease. That way, the effect of aid does not seem to be direct. Instead, it may be concluded that the aid impacts some factors that stimulate the improvement of the economic situation and the quality of life of the population.
Foreign Aid Effects in the Countries of Europe
The study by Zupcevic and Causevic explores the aid provided to Bosnia and Herzegovina, a part of the former Yugoslavia that has faced a major crisis during and after a massive military conflict that burst out in the 1980s. After the conflict was over, the country was actively aided from the side of the European Union and the United States and the programs called CARDS and USAID accordingly. The programs targeted the reconstruction of the post-war damage, the democratization of the power in the country, legislative development, the improvement of the quality of life of the domestic population, and economic development.31
Discussing the barriers to the effective allocation of resources from abroad, the authors notice that “Donors often implement similar projects with similar outcomes, which leads to inefficiency in the disbursement of funds”.32 In order to avoid inefficiency, the aids are supervised by the IPA (the Instrument for Pre-Accession Assistance in the European Union); and in addition, Bosnia and Herzegovina has a detailed development plan that includes the steps that need to be put into practice within certain periods of time.33
There is another European country that has been facing a lot of serious problems over the course of the last couple of decades. This country is Ukraine, one of the most frequently discussed states undergoing multiple crises at the same time and consuming large amounts of the foreign aid annually. Studying the current situation in Ukraine, Adarov et al. mention that the military conflict in the eastern part of the country has resulted in the rapid outflows of the capitals from the country; one more source of massive damage is the civil that is still in progress; overall, the country has lost billions of dollars over just a couple of years.34
However, Ukraine has been a frequent and active recipient of the foreign aid decades before the war began. Regardless of the period, the larger portions of the provided funds were wasted and made no significant positive impact on the country’s economy.
The current situation in the state is characterized by a high level of unemployment, and ongoing military conflict, the displacement of hundreds of thousands of people, the lack of trust of the population to the government, and high rates of corruption are some of the most significant barriers to the aid efficiency in Ukraine.35 The war has thrown the country several decades back in its development, and as a result, it became rather difficult to evaluate the impacts of the foreign aid in the prior years as well as to date.
To sum up, the findings in the studies examined in this review demonstrate that the foreign aid tends to have different effects on the economies if various recipients. Mainly, the outcomes of the aid are determined by the internal conditions and situations of the receiving states. The scholars outline a multitude of factors that contribute to the effectiveness of aid; among them, there are geographical locations, domestic incomes, the spheres where the aid is directed, the policies employed by the government, the political and economic environments within the countries. This set of factors remains the same regardless of the region where the recipient is located.
The finding of Andrews concerning the causes of the aid inefficiency in the counties of Africa states that the resources fail to make any long-term positive effect simply because they fail to target sustainable long-term projects.36 This finding is in tune with the example used by Soesastro in reference of the successful allocation of the aids granted after the Cold War to Korea and Japan. Basically, the author emphasizes that the positive effect was achieved because the primary aims of the foreign aid in those countries were the projects such as power plants, highways, and other infrastructure improvements that further served as the ultimate basis for the development leaps of the economies.37
Rena supports the argument of Soesastro and states that a developing state “must be allowed to trade its way out of poverty through utilizing its own resources, by reinforcing its participation in international trade”.38 In other words, many scholars whose studies emphasize the adverse outcomes of the foreign aid provision maintain that the ongoing donations do not contribute to the development of the economies. On the contrary, the most likely outcome is the growing dependency, corruption, and the chances of internal conflicts.
Differently put, instead of stimulating growth of the developing countries, the foreign aid disrupts their viability and prevents them from boosting their domestic resources and heading towards financial independence.
To answer the research question, the majority of the reviewed studies and sources reported negative impacts of the foreign aid on the economies of the receiving countries regardless of their regions. Some studies indicated positive influences such as the reduction of poverty, growth of the GDP, and the attraction of the foreign direct investment, however, it was not explained how exactly the aid was related to all of these results.
At the same time, all of the reviewed sources mentioned that the effectiveness and the influence of the aid on an economy of the recipient is determined by a multitude of factors, which proves the hypothesis of this review that states that the effect of the foreign aid on a country’s economy depends on such conditions as the geographical locations of the recipient countries, their levels of income, and the allocation of the provided foreign aid.
As noted by Soesastro, “foreign aid is generally the outcome of an internal rough-and-tumble bureaucratic and political process” and the barriers to the efficient allocation of aid are inflicted by the domestic issues, that way, it may be concluded that the countries that were deliberate about making change and progressing would succeed even without aid while those with significant obstacles would be likely to let the aid go to waste.39
As Quibria raises the subject of the recipient countries’ absorptive capacity, the author also adds that it is difficult for a donor to measure this feature because there is no specific tool that would help to identify which amount of aid would be actually utilized with the use for the state.40 This tendency makes the provision of aid even more risky and unclear in terms of outcomes that would be faced by the recipient.
Focusing on the countries’ historical backgrounds as some of the primary contributing factors to the effectiveness of the foreign aid allocation, Edwards points out the fact that the concept of foreign aid is rather recent; it only occurred and became a practice during the Cold War.41 Prior to that time, most of the Western countries with powerful and influential economies were reluctant to embrace this activity.
It is likely that during the Cold War the richer states of the globe were more open about directing funds to the developing countries for a purpose to strengthen their positions in the world and gain more allies in the worldwide fever inflicted by the recent ending of the Second World War the devastations that were still fresh and the horrors that were well-remembered. Struggling to prevent the War, the competing sides started to accumulate power, and a part of these strategies was ensuring the support of the developing states.
As a result, the powerful economies such as the USA and the USSR started to engage in the provision of aid to those who were attempting to grow. That way, the donor’s interest in the help provision is undeniable. However, it may be also true that the lack of growth in the recipient economies followed by the wasteful absorption of the money and goods that makes the receivers dependent on the aid is one of the primary benefits pursued by the donors. Such air providers are likely not to bother about the recipient’s readiness for aid, or if they have a plan of the resource allocation. Instead, it is possible, that the point of air is to make the developing economies dependent on the help from abroad and easy to manipulate for whatever resources or use they may have.
The perspective explained above is related to the Marxist and neo-Marxist view of the relationship between the donor and the recipient. The proponents of these theories maintained that the dependencies between the countries providing and receiving the aids and funds are artificially maintained, especially to bring back the former dominator-dominated relations between the former colonies and colonizers.42 According to the dependency theory of this type, the developing countries are pressurized into searching for the donors and then falling into the ongoing vicious circles of asking for aids, wasting them, accumulating the external debts, and sinking their weak economies.
Moreover, the Marxist theory that relies on the notion of the deliberate facilitation of the economic dependency of the developing recipients from the powerful donors (making the latter even more powerful) aligns with the smart power theory presented by Armitage and Nye; this approach combines the qualities of realism referred to as the hard power and the soft power that does not involve violence or aggression.43
As an element of smart power strategies, the provision of foreign aid benefits the donors ensuring the support of the recipients and allowing the former to count on favors from the latter. However, from the perspective of the receiving sides, the foreign maid seems like a good way out of crises and economic challenges, but in reality, it is more likely to harm the economy in the long run than produce benefits for it.
The present study was focused on the exploration of the question concerning the effectiveness of the foreign aid for the receiving economies. The paper presented a literature review combining the information collected from multiple studies that examine the problem of the aid effectiveness and outcomes in general as well as the specific cases and estimations of the impacts of aids on the economies of the states of Asia, Africa, and Europe throughout several decades.
The findings presented by the reviewed studies are ambiguous and inconclusive. Some researchers emphasize the positive influence of the aids on the gross domestic product and the reduction of the poverty rates. However, the majority of the scholars provide evidence on the opposing opinion that maintains that the foreign aid has predominantly negative outcomes for the countries that receive it.
The developing economies tend to grow dependent on the aids and consume them on the regular basis failing to develop any domestic resources and work towards financial freedom. In addition, some more adverse impacts of the aids for the receivers include the growing risk of internal conflicts, a large external debt, and corruption. Analyzing the findings, one may conclude that foreign air allocation is a process that involves multiple dimensions and results in versatile outcomes depending on the factors that are included.
In order to make use of the foreign aid, a country’s leadership is to have a very clear and detailed plan of its allocation and far-sighted perspectives based on the long-term needs of the country. Unfortunately, in many cases, the developing economies cannot provide thorough panning and spending of the aid due to flawed leadership, weak infrastructure, and corrupt authorities. When it comes to the acquisition and allocation of the foreign aid, just one error is enough to put a country into the vicious circle of dependency on the foreign capitals. Such error is very easy to make and extremely difficult to fix as its consequences would be likely to snowball over some time and lead to irreparable adverse outcomes on a country’s economy.
Adarov, Amat, Vasily Astrov, Peter Havlik, Gábor Hunya, Michael Landesmann, and Leon Podkaminer. “How to Stabilise the Economy of Ukraine.” WIIW, (2015): 1-100.
Andrews, Nathan. “Foreign aid and development in Africa: What the literature says and what the reality is.” Journal of African Studies and Development, 1, no. 1 (2009): 008-0015.
Armitage, Richard L. and Joseph S. Nye. CSIS Commission on Smart Power. New York: the Center for Strategic and International Studies, 2007.
Awan, Abdul Ghafoor, and Muhammad Moeen-ud-Din. “The Impact of Foreign Aid on Pakistan’s Economy.” Science International, 27, no. 4 (2015): 3455-3459.
Edwards, Sebastian. “Economic Development and the Effectiveness of Foreign Aid: a Historical Perspective.” NBER Working Paper, no. 20685 (2014): 1-49.
Ekanayake. E. M., and Dasha Chatrna. “The effect of foreign aid on economic growth in developing countries.” Journal of International Business and Cultural Studies, (2009): 1-13.
“Does aid promote development?.” ReCom. Web.
Durbarry, Ramesh, Norman Gemmell, and David Greenaway. “New Evidence on the Impact of Foreign Aid on Economic Growth.” CREDIT, 98, no. 8 (n. d.): 1-47.
Juselius, Katarina, Niels Moller, and Finn Tar. “The Long-Run Impact of Foreign Aid in 36 African Countries: Insights from Multivariate Time Series Analysis.” Oxford Bulletin of Economics and Statistics, 76, no. 2 (2014): 0305-9049. Web.
Moreira, Sandrina Berthault. “Evaluating the Impact of Foreign Aid on Economic Growth: a Cross-Country Study.” Journal of Economic Development, 30, no. 2 (2005): 25-48.
Quibria, M. G. “Aid Effectiveness in Bangladesh.” (2010): 1-60.
Rena, Ravinder. “Is Foreign Aid Panacea for African Problems? The Case of Namibia.” Managing Global Transactions, 11, no. 3, (2013): 223-241.
Sahoo, Kalpana, and Narayan Sethi. “Effect of Foreign Aid on Economic Growth and Development in India: An Empirical Analysis.” South Asian Journal of Management, 20 no. 1 (2013): 1-13.
Soesastro, Hadi. “Sustaining East Asia’s Economic Dynamism: The Role of Aid.” PRI-OECD Research Project, (2004): 1-31.
Veiderpass, Ann, and Per-Åke Andersson. “Foreign aid, economic growth and efficiency development.” SADEV Report 1, (2007): 1-35.
Zupcevic, Merima, and Fikret Causevic. “Case Study: Bosnia and Herzegovina.” The Worldbank, (2009): 1-56. Web.
- E. M. Ekanayake and Dasha Chatrna, “The effect of foreign aid on economic growth in developing countries,” Journal of International Business and Cultural Studies, (2009): 2.
- Ramesh Durbarry, Norman Gemmell and David Greenaway, “New Evidence on the Impact of Foreign Aid on Economic Growth,” CREDIT, 98, no. 8 (n. d.): 2.
- Kalpana Sahoo and Narayan Sethi, “Effect of Foreign Aid on Economic Growth and Development in India: An Empirical Analysis,” South Asian Journal of Management, 20 no. 1 (2013): 2.
- Ibid, 3.
- “Sandrina Berthault Moreira, “Evaluating the Impact of Foreign Aid on Economic Growth: a Cross-Country Study,” Journal of Economic Development, 30, no. 2 (2005): 26.
- Sebastian Edwards, “Economic Development and the Effectiveness of Foreign Aid: a Historical Perspective,” NBER Working Paper, no. 20685 (2014): 2.
- Ibid, 3.
- Ann Veiderpass and Per-Åke Andersson, “Foreign aid, economic growth and efficiency development,” SADEV Report 1, (2007): 4.
- Abdul Ghafoor Awan and Muhammad Moeen-ud-Din, “The Impact of Foreign Aid on Pakistan’s Economy,” Science International, 27, no. 4 (2015): 3456.
- Ibid, 3458.
- Hadi Soesastro, “Sustaining East Asia’s Economic Dynamism: The Role of Aid,” PRI-OECD Research Project, (2004): 1.
- M. G. Quibria, “Aid Effectiveness in Bangladesh,” (2010): 35.
- Ibid, 35.
- Ravinder Rena, “Is Foreign Aid Panacea for African Problems? The Case of Namibia,” Managing Global Transactions, 11, no. 3, (2013): 224.
- Ibid, 230.
- Ibid, 231.
- Nathan Andrews, “Foreign aid and development in Africa: What the literature says and what the reality is,” Journal of African Studies and Development, 1, no. 1 (2009): 008.
- Ibid, 009.
- Katarina Juselius, Niels Moller and Finn Tar, “The Long-Run Impact of Foreign Aid in 36 African Countries: Insights from Multivariate Time Series Analysis,” Oxford Bulletin of Economics and Statistics, 76, no. 2 (2014):176.
- “Does aid promote development?,” ReCom. Web.
- Merima Zupcevic and Fikret Causevic, “Case Study: Bosnia and Herzegovina,” The Worldbank, (2009): 16.
- Ibid, 17.
- Ibid, 18.
- Amat Adarov, Vasily Astrov, Peter Havlik, Gábor Hunya, Michael Landesmann and Leon Podkaminer, “How to Stabilise the Economy of Ukraine,” WIIW, (2015): 15.
- Ibid, 2.
- Andrews, “Foreign aid and development in Africa: What the literature says and what the reality is,” 009.
- Soesastro, “Sustaining East Asia’s Economic Dynamism: The Role of Aid,” 1.
- Rena, “Is Foreign Aid Panacea for African Problems? The Case of Namibia,” 235.
- Soesastro, “Sustaining East Asia’s Economic Dynamism: The Role of Aid,” 4-5.
- Quibri, “Aid Effectiveness in Bangladesh,” 35.
- Edwards, “Economic Development and the Effectiveness of Foreign Aid: a Historical Perspective,” 2.
- Ibid, 5.
- Richard L. Armitage and Joseph S. Nye, CSIS Commission on Smart Power (New York: the Center for Strategic and International Studies, 2007), 6.