Does Corruption Invade the Effectiveness of Foreign Aid on Income Inequality in Developing Economies?

Abstract

Foreign aid is critical for developing economies to meet their developmental objectives. Income disparity is a major problem that can be addressed with foreign resources; however unscrupulous behaviors such as misappropriation of funds for personal gain might diminish the effectiveness of foreign aid. This paper analyses the influence of foreign aid (ODA) on income inequality for a panel of 62 developing nations, including regional and income categories by using the Generalized Method of Moments (GMM) on model, with two specifications. The results have shown a negative impact of foreign aid on income inequality in developing economies overall and in regional and income groups of economies except Sub-Saharan Africa (SSA) particularly in the first specification where corruption has not been included in the model. In the second specification where corruption has been included in the model, the corruption has shown boosting impact on income inequality in developing economies as well as in all the regional and income groups of the economies. However, the effect of ODA on income inequality has become insignificant in developing economies but positive in all groups except SSA. It explains that corruption leads to foreign aid ineffectiveness in developing economies. In the control variables, FDI has a diminishing effect on income inequality in the panel of developing economies as well regional and income groups of the economies. It is proposed that to reap the benefits of foreign aid in developing economies, corruption is necessary to be eliminated.