Skip to main content

Advertisement

SpringerLink
Log in

Does foreign aid distort incentives and hurt growth? Theory and evidence from 75 aid-recipient countries

  • Published:
Public Choice Aims and scope Submit manuscript

Abstract

Foreign aid transfers can distort individual incentives, and hence hurt growth, by encouraging rent seeking as opposed to productive activities. We construct a model of a growing small open economy that distinguishes two effects from foreign transfers: (i) a direct positive effect, as higher transfers allow the financing of infrastructure; (ii) an indirect negative effect, as higher transfers induce rent-seeking competition by self-interested individuals. In this framework, the growth impact of aid is examined jointly with the determination of rent-seeking behavior. We test the main predictions of the model for a cross-section of 75 aid-recipient countries. There is evidence that aid has a direct positive effect on growth, which is however significantly mitigated by the adverse indirect effects of associated rent-seeking activities. This is especially the case in recipient countries with relatively large public sectors.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

References

  • Aghion, P., & Williamson, J. (1998). Growth, inequality and globalization. Cambridge: Cambridge University Press.

    Google Scholar 

  • Alesina, A., & Weder, B. (2002). Do corrupt governments receive less foreign aid. American Economic Review, 92, 1126–1137.

    Article  Google Scholar 

  • Angelopoulos, K., & Philippopoulos, A. (2007). The growth effects of fiscal policy in Greece 1960–2000. Public Choice, 131, 157–175.

    Article  Google Scholar 

  • Barro, R. (1990). Government spending in a simple model of economic growth. Journal of Political Economy, 98, S103–S125.

    Article  Google Scholar 

  • Barro, R., & Sala-i-Martin, X. (2004). Economic growth (2nd ed.). Cambridge: MIT.

    Google Scholar 

  • Baumol, W. (1990). Entrepreneurship: Productive, unproductive, and destructive. Journal of Political Economy, 98, 893–921.

    Article  Google Scholar 

  • Bhagwati, N. J. (1982). Directly unproductive, profit-seeking (DUP) activities. Journal of Political Economy, 90, 988–1002.

    Article  Google Scholar 

  • Boone, P. (1996). Politics and the effectiveness of foreign aid. European Economic Review, 40, 289–329.

    Article  Google Scholar 

  • Burnside, C., & Dollar, D. (2000). Aid, policies and growth. American Economic Review, 90, 847–868.

    Article  Google Scholar 

  • Chang, C., Fernandez-Arias, E., & Serven, L. (1998). Measuring aid flows: A new approach. Working paper. Development Research Group, World Bank.

  • Chatterjee, S., Sakoulis, G., & Turnovsky, S. (2003). Unilateral capital transfers, public investment and economic growth. European Economic Review, 47, 1077–1103.

    Article  Google Scholar 

  • Clemens, M. A., Radelet, S., & Bhavnani, R. (2004). Counting chickens when they hatch: The short-term effect of aid on growth. Center for Global Development, Working paper No. 44.

  • Collier, P., & Dollar, D. (2004). Development effectiveness: What have we learned? Economic Journal, 114, F244–F271.

    Article  Google Scholar 

  • Collier, P., & Hoeffler, A. (2005). Democracy and resource rents. Working paper. University of Oxford.

  • Conlon, R. J., & Pecorino, P. (2004). Policy reform and the free-rider problem. Public Choice, 120, 123–142.

    Article  Google Scholar 

  • Dalgaard, C. J., & Hansen, H. (2001). On aid, growth and good policies. Journal of Development Studies, 37, 17–41.

    Article  Google Scholar 

  • Dalgaard, C. J., Hansen, H., & Tarp, F. (2004). On the empirics of foreign aid and growth. Economic Journal, 114, F191–F216.

    Article  Google Scholar 

  • Drazen, A. (2000). Political economy in macroeconomics. Princeton: Princeton University Press.

    Google Scholar 

  • Easterly, W. (2001). The elusive quest for growth. Cambridge: MIT.

    Google Scholar 

  • Easterly, W., & Levine, R. (1997). Africa’s growth tragedy: Policies and ethnic divisions. Quarterly Journal of Economics, 112, 1203–1250.

    Article  Google Scholar 

  • Fredriksson, P. G., & Svensson, J. (2003). Political instability, corruption and policy formation: The case of environmental policy. Journal of Public Economics, 87, 1383–1405.

    Article  Google Scholar 

  • Grossman, H., & Mendoza, J. (2003). Scarcity and appropriative competition. European Journal of Political Economy, 19, 747–758.

    Article  Google Scholar 

  • Hansen, H., & Tarp, F. (2001). Aid and growth regressions. Journal of Development Economics, 64, 547–570.

    Article  Google Scholar 

  • Heston, A., Summers, R., & Aten, B. (2002). Penn world table, Version 6.1. Center for International Comparisons at the University of Pennsylvania (CICUP).

  • Jensen, P. S., & Paldam, M. (2006). Can the two new aid-growth models be replicated? Public Choice, 127, 147–175.

    Article  Google Scholar 

  • Knack, S. (2001). Aid dependence and the quality of governance. Southern Economic Journal, 68, 310–329.

    Article  Google Scholar 

  • Knack, S., & Keefer, P. (1995). Institutions and economic performance: Cross-country tests using alternative institutional measures. Economics and Politics, 7, 207–227.

    Article  Google Scholar 

  • Knack, S., & Keefer, P. (1997). Does social capital have an economic payoff? A cross-country investigation. Quarterly Journal of Economics, 112, 1251–1287.

    Article  Google Scholar 

  • Krueger, A. (1974). The political economy of the rent seeking society. American Economic Review, 64, 291–303.

    Google Scholar 

  • Leite, C., & Weidmann, J. (2002). Does mother nature corrupt? Natural resources, corruption and economic growth. In G. Abed & S. Gupta (Eds.), Governance, corruption and economic performance. Washington: International Monetary Fund.

    Google Scholar 

  • Lensink, R., & White, H. (2001). Are there negative returns to aid? Journal of Development Studies, 37, 42–63.

    Article  Google Scholar 

  • Mauro, P. (1995). Corruption and growth. Quarterly Journal of Economics, 110, 681–712.

    Article  Google Scholar 

  • Mauro, P. (1998). Corruption and the composition of government expenditures. Journal of Public Economics, 69, 263–279.

    Article  Google Scholar 

  • Mauro, P. (2002). The persistence of corruption and slow economic growth. IMF Working Paper 02/213, Washington, DC.

  • Mehlum, H., Moene, K., & Torvik, R. (2006). Institutions and the resource curse. Economic Journal, 116, 1–20.

    Article  Google Scholar 

  • Mohtadi, H., & Roe, T. (1998). Growth, lobbying and public goods. European Journal of Political Economy, 14, 453–473.

    Article  Google Scholar 

  • Mohtadi, H., & Roe, T. (2003). Democracy, rent seeking, public spending and growth. Journal of Public Economics, 87, 445–466.

    Article  Google Scholar 

  • Moreira, S. (2003). Evaluating the impact of foreign aid on economic growth: A cross-country study (1970–1988). Paper presented at the 15th Annual Meeting on Socio-Economics.

  • Morrison, M. K. (2007). Natural resources, aid, and democratization: A best-case scenario. Public Choice, 131, 365–386.

    Article  Google Scholar 

  • Mosley, P., Hudson, J., & Horrell, S. (1987). Aid, the public sector and the market in less developed countries. Economic Journal, 97, 616–641.

    Article  Google Scholar 

  • Mosley, P., Hudson, J., & Verschoor, A. (2004). Aid, poverty reduction and the ‘new conditionality’. Economic Journal, 114, F217–F243.

    Article  Google Scholar 

  • Murphy, K., Shleifer, A., & Vishny, R. (1991). The allocation of talent: Implications for growth. Quarterly Journal of Economics, 106, 503–530.

    Article  Google Scholar 

  • Neeman, Z., Paserman, D., & Simhon, A. (2003). Corruption and openness. CEPR Discussion Paper, no. 4057, London.

  • Park, H., & Philippopoulos, A. (2003). On the dynamics of growth and fiscal policy with redistributive transfers. Journal of Public Economics, 87, 515–538.

    Article  Google Scholar 

  • Park, H., Philippopoulos, A., & Vassilatos, V. (2005). Choosing the size of the public sector under rent-seeking competition from state coffers. European Journal of Political Economy, 21, 830–850.

    Article  Google Scholar 

  • Persson, T., & Tabellini, G. (2000). Political economics: Explaining economic policy. Cambridge: MIT.

    Google Scholar 

  • Persson, T., & Tabellini, G. (2003). The economic effects of constitutions. Cambridge: MIT.

    Google Scholar 

  • Rodrik, D. (1998). Why do more open economies have bigger governments? Journal of Political Economy, 106, 997–1032.

    Article  Google Scholar 

  • Svensson, J. (1999). Aid, growth and democracy. Economics and Politics, 11, 275–297.

    Article  Google Scholar 

  • Svensson, J. (2000). Foreign aid and rent-seeking. Journal of International Economics, 51, 437–461.

    Article  Google Scholar 

  • Svensson, J. (2003). Why conditional aid does not work and what can be done about it? Journal of Development Economics, 70, 381–402.

    Article  Google Scholar 

  • Tanzi, V. (2002). Corruption around the world: Causes, consequences, scope and cures. In G. Abed & S. Gupta (Eds.), Governance, corruption and economic performance. Washington: International Monetary Fund.

    Google Scholar 

  • Tanzi, V., & Schuknecht, L. (2000). Public spending in the 20th century: A global perspective. Cambridge: Cambridge University Press.

    Google Scholar 

  • Tavares, J. (2003). Does foreign aid corrupt? Economics Letters, 79, 99–106.

    Article  Google Scholar 

  • Torsvik, G. (2005). Foreign economic aid: should donors cooperate? Journal of Development Economics, 77, 503–515.

    Article  Google Scholar 

  • Tullock, G. (1980). Efficient rent-seeking. In J. Buchanan, R. Tollison & G. Tullock (Eds.), Towards a theory of the rent-seeking society (pp. 97–112). College Station: Texas A&M University Press.

    Google Scholar 

  • World Bank. (1998). Assessing aid: What works, what doesn’t, and why. New York: Oxford University Press.

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Athens University of Economics and Business, Athens, 10434, Greece

    George Economides, Sarantis Kalyvitis & Apostolis Philippopoulos

  2. University of Glasgow, Glasgow, UK

    Apostolis Philippopoulos

  3. CESifo, Munich, Germany

    Apostolis Philippopoulos

Authors
  1. George Economides
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Sarantis Kalyvitis
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Apostolis Philippopoulos
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to George Economides.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Economides, G., Kalyvitis, S. & Philippopoulos, A. Does foreign aid distort incentives and hurt growth? Theory and evidence from 75 aid-recipient countries. Public Choice 134, 463–488 (2008). https://doi.org/10.1007/s11127-007-9239-9

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11127-007-9239-9

Keywords

JEL

Search

Navigation