Aid, domestic and foreign direct investment in small states

Abstract

Small States (SS) are economies whose population barely exceeds 1.5 million. Their small population size, small land size and location, mostly on coastal or Islands may act as a disadvantage to their rapid economic growth and makes them susceptible to the effects of external economic issues. Notwithstanding the disadvantages, some of them have enjoyed rapid growth over time and are classified as developed nations. This study examines the effect of aid, foreign direct investment (FDI) and domestic investment (DI) on economic growth in SS. Among SS, aid hurts the economic progress in underdeveloped countries. However, DI and FDI have a favourable impact on economic growth. In developed SS, aid, DI and FDI independently do not positively influence economic growth, however, aid with FDI, aid with trade openness and aid with domestic investment and FDI promoted growth. In the total sample (developed and developing SS), aid discourages economic growth, but FDI and DI enhance economic growth. Also, aid together with FDI positively affects economic growth. Policies should therefore be directed at moving from accepting ‘consumption aid’ to ‘productive aid’, increasing the amount of net FDI and increase in DI.

Keywords:

• Aid
• domestic investment
• economic growth
• foreign direct investment
• Small States

JEL CODES:

• F21; F35; F43; H84; P45

Disclosure statement

No conflict of interest has been reported by the authors.