The Big Picture

Aid, Growth, and Macroeconomic Management

Lucy Scott and Annett Victorero

The ReCom—Research and Communication on Foreign Aid programme held its first results meeting on the topic of ‘Aid, Growth and Macroeconomic Management’ at the University of Copenhagen on 27 January 2012. Implemented by UNU-WIDER and funded by the governments of Denmark and Sweden, ReCom is motivated by a desire to improve understanding of four key questions about aid. What works? What could work? What is transferrable? And what is scalable? This results meeting focused on the overarching story of whether aid supports or impairs economic growth and development.

The debate

Debates about whether aid works rage on. Popular literature frequently expresses the view that aid does not work, it is a futile endeavour, and should be ended. UNU-WIDER aims to move the discussion beyond ideology through rigorous analysis of the existing data to assess whether aid works or not. Clearly there are situations where aid has not worked, but this should not be used to attack the premise and principles behind aid. Rather, it should encourage researchers, practitioners and policy makers to redouble their efforts to investigate further the reasons why aid has not worked in some contexts, as well as the situations where aid does work and why.

Economists talk about a micro–macro paradox with respect to the impact of development aid. That is, at the micro level ex-post project evaluations by and large show positive impacts of aid, while sector interventions are also generally assessed to have positive impacts, for instance on educational enrolment. In contrast, there is frequently said to be no detectable impact of aid on economic growth in the econometric literature which investigates the issue at the aggregate level across countries. The macro literature has long been the outlier.

Does development aid help achieve economic growth?

UNU-WIDER ReCom research on the relationship between aid and growth takes as its starting point the existing body of econometric work on the topic. An influential subset of this work claims that, as no statistically significant positive relationship has been uncovered between aid and growth, a relationship does not exist or is negative. It is interesting that different conclusions have been drawn in the aid–growth debate, taking into account that all the studies are based on the use of the same publically available data. These differences are due to the choice of econometric methods, particularly how the assumptions about the mechanisms through which aid may effect growth, and vice versa, are disentangled.

The major findings presented at the ReCom results meeting on 27 January clarify the picture of the relationship between aid and growth, concluding that:

  1. Aid has facilitated economic growth at the aggregate level over the long term.
  2. Views that posit a non-existent or negative impact of development aid on growth have been based on miss-specified models and errors in data interpretation.
  3. Physical and human capital investments of development aid are the best statistically discovered transmission channels for economic growth.
  4. Development aid has had a 16% internal rate of return on investment since the mid-1970s.
Moving beyond growth

While the impact of aid on economic growth was the focus of the meeting, growth is just one objective for development aid. Many intermediate outcomes, including those related to health and education, are valued in their own right regardless of their contribution to growth. It is not just the rate of growth which is of concern. Growth volatility, and whether this growth is pro-poor, is of great importance. The relationship between economic growth and social outcomes is complex. Recent research in Mozambique, for instance, shows that despite economic growth over the last 6-7 years poverty, as measured using consumption indicators, has not fallen.

What the big picture does show is that aid works differently under different circumstances. Cross-country evidence must not be used to give country-specific advice. While overall aid has contributed to economic growth, it is clear that it has not worked in all places at all times. It is now important to gather and communicate evidence about ‘what works’ for specific country contexts and particular aid modalities—the aid story needs to be unpacked. In doing this debates and discussions can move forward and offer policy-oriented advice.

Through the video playlist below Angle readers have a chance to take part in the first ReCom results meeting. The playlist contains:

  1. Welcome and overview, Finn Tarp, Director, UNU-WIDER
  2. What is the aggregate impact of aid on growth?, Channing Arndt, Professor at the Department of Economics, University of Copenhagen, and Project Director, UNU-WIDER
  3. Unpacking the impact of aid: how does aid work?, Sam Jones, Research Associate, UNU-WIDER
  4. Insights from meta-analysis, Tseday Mekasha, Research Associate, UNU-WIDER
  5. Time-series analysis of 36 African countries, Katarina Juselius, Professor, University of Copenhagen
  6. Macroeconomic management of aid: key challenges, Tony Addison, Chief Economist-Deputy Director, UNU-WIDER

Lucy Scott is a Research Associate, UNU-WIDER, and Annett Victorero is Communications Assistant, UNU-WIDER.