Foreign Aid Case Study

I. Introduction

Every year, donors from the Organization for Economic Cooperation and Development (OECD) give billions of dollars in foreign aid, with the United States contributing a large percentage of this sum (Eischen 2012) (Figure A). However, the amount and way in which this money is handled has given rise to heavy criticism. Books such as Dambisa Moya’s Dead Aid: Why Aid is Not Working and How There is a Better Way For Africa and the innumerable news articles lamenting the state of the corrupt bureaucracies of receiving countries not only discuss the inefficiencies of foreign aid but also accuse these programs of being harmful (Ayodele et al. 2005). One such article claimed that, due to inefficiencies and corruption, at least twenty percent of aid is completely lost (Chakraborty 2013).

Despite these criticisms, it is unlikely that foreign aid programs will be dissolved any time soon, and at least in the United States, there are two primary reasons for this. First, aid giving only accounts for one percent of the United States’ gross domestic product, thus there is not a large incentive for change (Eischen 2012). Secondly, aid has historically been used as a political tool, not solely for altruistic reasons (Alesina and Dollar 2000). It follows that even if aid were shown to hinder long-term economic growth in recipient countries, it would still be prevalent if it were effective at promoting donor state interests.

Since foreign aid programs are here to stay, it is important to focus on the enormous potential for foreign aid to be effective. One such way is through augmenting a state’s ability to attract foreign direct investment (FDI). FDI is a good option because it has the potential to be a more long-term solution than pub...

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...ts of many low-income states do not have the resources to supply these goods. This creates a bottleneck effect that deters private investment- thus foreign aid to infrastructure (economic aid) can have a positive impact on FDI inflows.

The paper first compared the broad categories of aid to physical capital with aid to complementary factors of production. It was found that aid to physical capital produces a crowding out effect for private investment but that aid to complementary inputs attracts private investment. Within the category of complementary inputs was social aid and economic aid. Though development in both human capital and infrastructure is important in promoting FDI, foreign aid was found to be relatively unsuccessful in fostering growth in human capital. Therefore, aid to infrastructure was shown to be the most effective form of ODA in attracting FDI.