Foreign aid—Economic Growth Nexus in Africa: Does Financial Development Matter?

Abstract

This study explored the role of financial development in foreign aid (measured by agriculture, humanitarian, health, economic infrastructure and services, and education aid) and economic growth relationship for 37 African countries spanning the 2002–2018 period. Using the instrumental variable generalized method of moments model, our findings indicated that while foreign aid impedes Africa’s growth, financial development spurs economic growth. The conditional effect analysis showed that financial development conditions foreign aid to spur economic growth. The country-specific analysis further showed that foreign aid has a higher growth elasticity in countries with relatively better financial systems, such as Mauritius, South Africa, Gabon, Tunisia, and Botswana, whilst the growth elasticity of aid is smaller in countries with a relatively weak financial system such as Malawi, Guinea Bissau, Sierra Leone, and the Democratic Republic of Congo. The study recommended the need for policymakers in Africa to implement innovative ways to improve domestic revenue mobilization. The study also recommended that policymakers in Africa should create an enabling environment that will enhance the development of Africa’s financial system to mitigate the adverse effect of aid on economic growth.

KEYWORDS:

• Foreign aid
• financial development
• economic growth
• Africa

JEL Codes:

• F35
• F43
• G20
• O55

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Algeria, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Central African Republic, Chad, Congo, Cote d’Ivoire, Democratic Republic of Congo (DRC), Egypt, Eswatini, Gabon, Gambia, Ghana, Guinea, Guinea Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mali, Mauritania, Mauritius, Mozambique, Niger, Nigeria, Rwanda, Senegal, Sierra Leone, South Africa, Sudan, Tanzania, Togo, and Tunisia.

Additional information

Funding

This work was supported by Ministry of Education of Humanities and Social Science Grant of China: [Grant Number 17YJC790127].

Notes on contributors

Isaac Appiah-Otoo

Isaac Appiah-Otoo received his Ph.D. degree in finance from the University of Electronic Science and Technology of China, Chengdu, China. His research interest lies in financial economics, financial technology (fintech), applied econometrics, development economics, energy and environmental economics, and international finance.

Alex O. Acheampong

Alex O. Acheampong is an Assistant Professor of Economics at Bond Business School, Bond University, Australia, and a sessional academic at the University of Newcastle Business School, Australia. Alex's research interest lies in applied econometrics, energy economics, environmental economics, macroeconomics, and development economics.

Na Song

Na Song received her Ph.D. degree in applied mathematics from the University of Hong Kong, Hong Kong, in 2013. She is currently an Assistant Professor of mathematical finance at the University of Electronic Science and Technology of China, Chengdu, China. Her research interests include mathematical finance, quantitative risk management, stochastic calculus, as well as their applications.

Camara Kwasi Obeng

Camara Kwasi Obeng is a Senior Lecturer at the School of Economics, University of Cape Coast, Ghana. His research interests are international trade and finance, fiscal implications of trade reforms, environment and poverty studies with a particular focus on the use of Computable General Equilibrium (CGE), Product Space Analysis, Randomised Control Trials methodologies, and currently, Machine Learning.

Isaac K. Appiah

Isaac K. Appiah is currently a Senior Research Officer at the Commission of Human Rights and Administrative Justice, Ghana. He studied at the University of Cape Coast and the University of Ghana and conducts research in the areas of Applied Statistics, Econometrics, and Surveys.