Foreign Aid and Economic Growth in Least Developed Countries: A Panel Data Analysis

Abstract

Background: The question of whether Foreign aid genuinely drives economic growth is one of the debates that has long baffled policymakers and governing bodies. Many of the existing research, relies on short time spans or individual country analysis, which leaves the bigger picture unclear and up in speculations.

Methods: This study examines the relationship using an unbalanced panel data for 19 LDCs (six in Asia and thirteen in Africa) over the time period of 1981–2021. We estimate a fixed effects panel regression with all variables using natural logs, World Development Indicators data. Additionally, data were used such as exports, gross domestic savings, gross fixed capital formation, and population growth.

Results: In this study Foreign aid shows a positive and statistically significant effect on GDP (coefficient 0.210, p < 0.01) and real GDP per capita. Robust to alternative time periods and dependent variables also show positive statistical significance. Exports and gross fixed capital formation are strong positive drivers, while population growth has a negative effect. Foreign Aid did not significantly affect GDP per capita growth rates. Mechanism tests that were done show aid also supports education, health, and labour force outcomes.

Conclusion: The conclusion is clear and points to the same direction, Foreign aid lifts income level and least developed countries but it doesn’t impact growth rates. To make aid work, it needs to complemented by concrete trade and investment polices as well as population growth management to promote sustainable development.

Novelty: This study provides insight by covering four decades of panel data from both Asian and African LDCs. It also goes beyond income levels and to examine human capital channels like education, health, and labour while giving region specific evidence on the pathways through which aid influences development.