Aid, growth, the incentive regime and poverty reduction

Abstract

Introduction Foreign aid has a strong positive effect on growth in low-income countries with good policies; it has no measurable effect in countries with severely distorted policy regimes (Burnside and Dollar, 1997). While that result is consistent with other econometric and case study work on aid, it leaves open a number of important questions. How exactly docs one measure ‘policy’? Is the finding robust to different measures of policy? And does it hold for other outcomes of interest, such as poverty reduction or improvement in social indicators? Spurring growth in the developing world is one stated objective of foreign aid; but the most commonly cited objective is poverty reduction. In general, poverty reduction and growth go hand-in-hand, but it is still possible that foreign aid has been successful at mitigating poverty but not had much measurable effect on growth. This chapter has several objectives. First, we revisit our basic results on aid, policies and growth – starting with our model and reviewing the empirical evidence. Second, in doing that we broaden our indicator of ‘good policy’ to include more micro or institutional dimensions. Third, we also examine the effect of foreign aid on infant mortality, an issue of interest for two reasons. First, infant mortality is an important social indicator in its own right. Second, changes in infant mortality provide indirect evidence about whether the benefits of development are reaching the broad mass of the population. The main findings of the chapter are as follows. The impact of aid on growth is conditional on the quality of policies. We get stronger results using the broad measure of policy that includes institutional features.