Remittances, Foreign Direct Investment and Aid in Fragile States: Are They Complements or Substitutes?

Abstract

The idea according to which capital flow may be complements and/or substitutes is nowadays a recurrent theme both within academia and among international donors. However, little attention has been devoted to this issue in the specific case of fragile states. The main contribution of this paper is to fulfill this gap while testing whether remittances, foreign direct investment (FDI) and foreign aid are complements or substitutes in fragile states. We then use a cross-country panel data of 33 fragile states and an instrumental variable methodology, namely three stages least square. The results indicate that, foreign aid is complement for both remittances and foreign direct investment. However this effect partially vanishes after a certain level of GDP per capita. In our case, the threshold effect arise when the level of GDP per capita equal 305 USD for the whole sample of fragile states and 260 USD for Sub-Saharan fragile states. These results suggest that as far as foreign aid is complement for both remittances and foreign direct investment, an optimal policy in the case of fragile states should rely on the increase of foreign aid which can lead to the increase of remittances and foreign direct investments. Besides, the obtained results also show that economic growth can not be the end of AID.