Effect of sectoral foreign aid allocation on growth and structural transformation in sub-Saharan Africa—Analysing the roles of institutional quality and human capital

Abstract

The study analyses the effectiveness of aggregate as well as sectoral foreign aid on growth and structural transformation for 32 sub-Saharan African (SSA) countries over the period from 2002 to 2019. For this purpose, a structural transformation index (STI) has been constructed using the value-added and employment shares of the economy. There is a lack of studies in the aid effectiveness literature that examine the effects of sectoral aid on overall growth and development of the economy. Comparing the effectiveness of different types of aid on growth and structural transformation is a novel approach. In this analysis, we also take into account the roles of institutional quality and human capital on aid effectiveness. To this end, we have used Driscoll–Kraay Fixed-Effect estimators, Fixed-Effects Panel Threshold regression and Method of Moments Quantile regression to analyse the effectiveness of aggregate and sectoral foreign aid. Our estimation techniques are robust to cross-sectional dependence and slope heterogeneity. We find that both agricultural and social-sector aid have positive significant effects on growth but negative significant effect on structural transformation. This suggests that foreign aid should be increased in these sectors, conditioned by the level of institutional quality. Human capital is found to increase the effectiveness of foreign aid. Aid to economic infrastructure is the only type of aid which is found to increase structural transformation significantly. This study helps in designing aid allocation strategies, so as to promote both growth and structural transformation in the SSA countries.