A comparative analysis of the effect of aid and microfinance on growth

Abstract

This paper investigates the effect of official development aid (ODA) and microfinance (MF) on economic growth and compares the results. We identify and analyse the transmission mechanisms from ODA and microfinance to growth. We then study the effects of ODA and microfinance on growth, using an unbalanced panel of 67 countries for the period 2001–2011. Accounting for country and time effects, our results show that microfinance has a positive and statistically significant effect on economic growth through private investment, while ODA has no effect on growth. This suggests that deploying resources in the microfinance industry will foster economic development in poor countries.

Résumé

L'article compare les effets de l'aide publique au développement (APD) et de la microfinance (MF) sur la croissance économique. Nous analysons les mécanismes de transmission de l'APD et de la microfinance vers la croissance. Nous étudions ensuite leurs effets sur la croissance en utilisant un panel non cylindré de 67 pays pour la période de 2001 à 2011. En tenant compte des effets propres aux pays et à la période, nos résultats montrent que la microfinance a un effet positif et statistiquement significatif sur la croissance économique à travers l'investissement privé, alors que l'APD n'a aucun effet sur la croissance. Ces résultats suggèrent que le déploiement de ressources pour l'industrie de la microfinance favorisera le développement économique dans les pays pauvres.

Keywords:

• microfinance
• official development aid
• economic growth
• panel data

Notes

1. The terms aid and ODA will be used interchangeably in this paper.

2. ODA flows include grants and concessional loans whose grant component is at least 25 per cent (OECD 2013). The grant component of ODA has increased over the years. At present, almost all aid flows are grants. The average repayment rate of ODA (the difference between gross and net ODA) from 1960 to 2010 has been only 9.42 per cent.

3. Investment should be understood not only as fixed capital but also as the improvement of human skills and institutional change.

4. According to the Summit Report, “poorest clients” are those people living on less than USD 1.25 a day, adjusted for PPP.

5. All microcredit clients, not only the poorest.

6. These RCTs obtain mixed results but prove that microfinance does not cause harm. Duflo et al. (2013) concludes that some favorable impacts result from the poor having direct access to credit but that these impacts are not especially strong. The other four RCTs (Crépon et al. 2011; Attanasio et al. 2014; Augsburg et.al. 2012; Angelucci et al. 2013) obtain more positive results on decrease in expenditure on “temptation goods,” growth of self-employment activities, and increase in business revenues and profits.

7. The sample comprises all countries that are ODA recipients and that have an MF sector, that is, all countries for which there are data on ODA and microfinance. Other countries for which there is no data for ODA, microfinance, or even GDP have been eliminated. Zimbabwe, Democratic Republic of the Congo, Lao PDR, and Micronesia Fed. State have been excluded because their data is unreliable. Kosovo and Thailand have also been excluded because they have not received ODA in net terms in last five years. Any other exclusion is due to missing observations on microfinance data. The base sample is composed of 67 countries (see Appendix).

8. ODA has been instrumented by its own time lag, rule of law (rol), and malnutrition prevalence (malnut) as a proxy for poverty, plus the purely exogenous variables in each regression. MF has been instrumented by its own time lag plus private credits, as in Sodokin and Donou-Adonsou (2010), and the purely exogenous variables in each regression. The determination coefficient values for the regressions of ODA/MF on their corresponding instruments are all above 0.87 and 0.92, respectively.

9. Although ODA is not statistically significant in its corresponding first-step equations, we have also generated new residual variables for ODA's potential transmission mechanisms: public investment (gcfpures), government expenditure (cpubres) and imports (impores). Nonetheless, as stated above, only import is a significant regressor in the growth equation, although it was not found to be relevant as a mediator for ODA. The generated residual variables have been estimated from the following bivariate regressions: variable gfpures from gfpubl=13.85+0.38·oda, R²=0.04; variable cpubres from cpubl = 17.70+0.24·oda, R²=0.02; variable impores from import=19.68+0.20·oda, R²=0.02; variable gfprires from gfpriv=18.00+0.25·mf, R²=0.10; and variable cprires from cpriv=20.34+0.22·mf, R²=0.11

Additional information

Biographical notes

Maricruz Lacalle-Calderón is an associate professor at Universidad Autónoma de Madrid, Spain, and founder and academic director of the university's International Master in Microfinance for Entrepreneurship. Among her publications are “Civil Liberty and Economic Growth in the World: A Long-Run Perspective, 1850–2010” (coauthor; Journal of Institutional Economics, 2014) and the Handbook of Microcredit in Europe, Social Inclusion through Microenterprise Development (Edward Elgar, 2010).

Coro Chasco is an associate professor of econometrics and applied economics at Universidad Autónoma de Madrid, Spain, as well as a visiting professor of the University of Franche-Comté in Besançon, France. She is also the director of the Spatial and Regional Economics research group (ECONRES). She has worked on topics such as spatial and applied econometrics and has published in Economic Geography, Papers in Regional Science and Spatial Economic Analysis, among others.

Javier Alfonso-Gil is a professor of economics at Universidad Autónoma de Madrid, Spain. His interests include economic development and political economics. He has presented at conferences at the University of California Berkeley, Stanford University and East China Normal University at Shanghai. He has been editor of books published by Springer and Minerva and his articles have appeared in the Journal of Institutional Economics and Spanish Journal of Economics and Finance.

Isabel Neira was awarded a PhD in economics in 1998 and holds a full-time tenured position at the University of Santiago de Compostela, Spain. She is currently Vice-President of the Economics of Education Association (AEDE) and regional team director of Global Entrepreneurship Monitor (GEM). Her research interests include entrepreneurship, human and social capital, econometrics and quantitative analysis. She has published in Social Indicators Research and Regional Studies.