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The Long-Run Effect of Foreign Aid on Domestic Output

Dierk Herzer and Oliver Morrissey

No 1, Proceedings of the German Development Economics Conference, Hannover 2010 from Verein für Socialpolitik, Research Committee Development Economics

Abstract: This paper makes two main contributions. First, we examine the long-run effect of foreign aid on domestic output for 59 developing countries using heterogeneous panel cointegration techniques to control for omitted variable and endogeneity bias and to detect possible cross-country differences in the output effect of aid. The main result is that aid has, on average, a negative long-run effect on output, but there are large differences across countries (in about a third of cases the effect is positive). Second, we use a general-to-specific variable selection approach to systematically search for country-specific factors explaining the cross-country differences in the estimated long-run effect of aid. In contrast to previous studies, we find that aid effectiveness does not depend primarily on factors such as the quality of economic policy, the share of a country's area that is in the tropics, the level of democracy or political stability. The results suggest that the cross-country heterogeneity in the output effect of aid can be explained mainly by cross-country differences in law and order, religious tensions and government size.

Keywords: Foreign aid; Domestic output; Heterogeneous panel cointegration techniques; General-to-specific approach (search for similar items in EconPapers)
JEL-codes: F35 O11 C23 C52 (search for similar items in EconPapers)
Date: 2010
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