What are the Impact of Foreign Aid to the Economic Growth? Time Series Analysis with New Evidence from Tanzania

Added: 08-21-2018

This paper studies the impact of foreign aid in economic growth of Tanzania between 1976 - 2014. It finds that over a long period of time, foreign aid had a negative impact on economic growth. The negative implications of foreign aid include distortion in domestic saving, increased domestic consumptions, lower tax revenue, and support of politically motivated unproductive projects.

Tanzania sub-Saharan Africa stability savings politics policy domestic macroeconomic human capital gross domestic product (GDP) foreign direct inflows (FDI) foreign aid external exportation economic development donation debt service consumption

Type Reading Time Author Date Source
academic 25 minutes ALBIMAN MM 04-06-2016 https://www.omicsonline.com/
Type Reading Time
academic 25 minutes
Author Date
albiman mm 2018-08-21 00:00:00 UTC
Source
https://www.omicsonline.com/
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Key Takeaways
  • This study examines the impact of foreign aid on Tanzania’s economic growth from 1976-2014 and finds that it has had a negative impact on the country’s gross domestic product (GDP). 
  • There have been many studies on the effects of foreign aid since the 1960s, however the results are inconclusive as some studies find a positive impact from foreign aid and others identify no impact or a negative impact on economic growth. 
  • A large portion of foreign aid is highly dependent on politics and political needs as opposed to economic needs, therefore aid may not always reach necessary and productive social projects at the time that it is most needed.

Summary

This paper examines the effect of foreign aid on the economic growth of Tanzania, a country that has experienced very poor economic performance since the late 1970s and is a major recipient of foreign aid (up to $1 billion US annually). Despite these efforts however, Tanzania continues to experience poor economic growth, poor level of technology, low income per capita and persisting poverty. “This situation raises doubts whether foreign aid inflows in these countries are effective in stimulating economic growth and improving the standard of living.” 

In the literature review, the author writes that the effectiveness of foreign aid has been a dominant topic of research since the 1960s and it is argued that theoretically, foreign aid fills "the saving gap in developing countries,” provides funds for goods import, enhances the 'human capital gap’ and provides an efficient source of revenue to support economic activities. 

However empirical research does not show any conclusive results of the relationship between foreign aid and economic growth. While some studies find that foreign aid has had a positive effect on economic growth, others find that it has not, and argue that its effect is highly dependent on macroeconomic policies, external debt services and political stability. Some of the reasons for a lack of consistency in conclusions is the difference in methods of analysis, measurement, sample size, area of the research and data span. 

To study the impact of foreign aid in Tanzania’s economic growth, the author uses an endogenous growth model and time series data from 1976-2014. The results show that over a short period of time, foreign aid has no impact on economic growth and over a long span of time, foreign aid has a negative impact on the economic growth. The negative implications of foreign aid that contribute to negative economic growth are: 

  • Distortion in domestic saving 
  • Increased domestic consumptions 
  • Lower tax revenue 
  • Economic problems that stem from supporting unproductive projects due to the fact that foreign aid is often given according to the political needs and not economic needs. 
The study finds that the three most significant factors affecting economic growth – from most to least – are human capital (1.7%), labor force (1.11%) and exports (0.26%), with foreign aid having a negative effect on GDP (-0.12%). 


The author concludes with the recommendation that Tanzania should reconsider the type of foreign aid it receives. Additionally, its government has to ensure that foreign aid is used productively in sectors such as industry development, infrastructures and human capital development and it has to control for corruption and funds embezzlement to ensure good management of the resources.