Foreign aid and development: A test of the Burnside and Dollar 2000 hypothesis, that aid has a positive impact on growth in developing countries with good fiscal, monetary, and trade policies and is more effective than aid given to countries with poor economic policies, using new data from 1980-2007 and instrumental variables

Ravi Jonathan Asirvatham

Student thesis: Master thesis

Abstract

The aim of this thesis is to test the Burnside and Dollar (2000) hypothesis that aid given to countries with good policy environments is more effective than aid given to countries with poor policy environments. The methods employed by this study, to test the Burnside and Dollar (2000) hypothesis are ordinary least squared and two stage least squared regressions. Appropriate measures are taken to ensure that the methodology used by these authors is followed as closely as possible. Differences between this study and that of Burnside and Dollar (2000) are clearly documented and discussed in the text. In line with Burnside and Dollar (2000) a policy index is constructed using current account balance, inflation and a dummy variable representing openness of the economy. Data in this study cover 1980-2007. This study employs an Aid x Policy interaction term to test the Burnside and Dollar (2000) hypothesis regarding the effectiveness of aid in countries with good policy environments. An Aid2 term is also introduced in this study, which departs slightly from the Burnside and Dollar (2000) investigation, but is included in line with recent aid growth literature. Finally, the causal relationship between aid in good policy environments and GDP per capita growth is investigated. The instrumental variables used in this study are logarithm of population and the logarithm of land area. The main findings of this study show that aid has a significant negative impact on GDP per capita growth. The second finding of this study is the insignificant relationship between the interaction term Aid x Policy and GDP per capita growth. The arguments for these findings put forward in this study are discussed in terms of natural resource exploitation as well as the specification of variables used in the policy index. In addition, sample size and threshold for low and middle income groups are highlighted as a major cause of difference s between the two studies. Given these limitations, this study can nevertheless shed fresh light on the important debate which continues to surround the aid effectiveness debate. Further research is needed in this field to provide donors and recipients with better tools in order to improve development policy.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2010
Number of pages70