Foreign Aid and Economic Growth in West Africa: Examining the Roles of Institutions

Abstract

This study examines the roles of institutions on the relationship between foreign aid and economic growth in the 16 West African countries. Relying on panel data obtained from the World Bank’s world development and governance indicators, from 1996 to 2017, the study employs the autoregressive distributed lag technique in investigating the relationship. The empirical findings depict that foreign aid exerts a neutral effect on economic growth; the effect turns negative when the institutional variable is incorporated into the analysis. Again, the interaction effect of foreign aid and institution on economic growth is such that it reduces the negative effect of foreign aid on economic growth. The other factors of growth included are trade openness and government size, whose effects are positive and largely negative on the growth of the West African region, respectively. A significant policy implication from these findings is that the efforts of governments of the region should be directed towards building formidable economic, social and political institutions. This would not only reduce the negative impact of aid on growth but would also promote the competitiveness of the countries for private domestic and foreign capital; thus, reducing reliance on foreign aid.

KEYWORDS:

• Foreign aid
• institution
• economic growth
• West Africa

JEL Classification Code:

• C23
• F35
• F43
• G28

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 Each of the independent variables (including TOP and Size, which are taken as control variables in order to avoid specification errors) is selected based on literature review, practical significance, parsimony, and theoretical relevance.

2 COC is control of corruption, GE is government effectiveness, PSAV is political stability and absence of violence, ROL is rule of law, RQ is regulatory quality, VOA is voice and accountability; each ranges from −2.5(extremely weak) to +2.5(extremely strong).

3 We measure institution both by its indicators and the index obtained using the principal component analysis; foreign aid is measured by the percentage of official development assistance in GNI (see Wamboye et al., 2014).

4 Governance and institutions have been used interchangeably in this study, in order to align with the World Governance Indicators’ definitions. We rely on these definitions and measurements, being one of the widely used and carefully constructed indicators (Maurseth, 2008 cited in Adeleke, 2014).

5 The use of the indicators is to examine the specific effects and the relative importance of institutions on growth, while the index is needed to measure the general effects. The use of both the index and indicators equally provides the basis for which each indicator should be restructured in order to enhance the foreign aid – growth nexus (see Adeleke, 2014).

6 Each of RQ, PSAV, VOA, ROL, COC and GE has 304 observations because of the missing data in 1997, 1999 and 2001.

7 Each of Levin, Lin, Chu (LLC 2002), Fisher-type (Choi, 2001), Breitung (2000; Breitung & Das, 2005) and Im–Pesaran–Shin (IPS; 2003) techniques defines the null hypothesis that the panels contain a unit root.

8 Fisher-type is better in the converse case (when N is finite or infinity and$T\to \mathrm{\infty }$); Breitung and Hadri-LM tests are more appropriate if$(N,T)\to \mathrm{\infty }$; IPS may be used if $(N,T)\to \mathrm{\infty }$ or if $N\to \mathrm{\infty }$ and T is fixed or if N and T are fixed.

9 Besides its use in the construction of indexes, PCA also reduces a large sum of correlated values into smaller uncorrelated values (referred to as components). This is done by employing their variances, while still maintaining the original information and addressing multicollinearity problem (see Adeel-Farooq et al., 2017). In line with several empirical studies (e.g. Adeel-Farooq et al., 2017; Slesman et al., 2015), while this variation is shown in Table 3, we extract a distinct uncorrelated measure of institutional index in order to study its influence on economic performance in West Africa.

Additional information

Notes on contributors

Sikiru Babalola

Sikiru Babalola is an experienced Lecturer at Modibbo Adama University of Technology in Nigeria. He obtained his PhD degree in development economics from Universiti Sains Malaysia. His areas of research interest include development economics and institutional economics. He has written a number of journal articles, which have been published in highly reputable journals.

Waliu Shittu

Waliu Shittu is a Research Consultant at Kainosedge Consulting Limited. He had his Master’s degree in Economics from Universiti Utara Malaysia and a Bachelor’s degree from Lagos State University in Nigeria. His areas of research interest include environmental economics, international economics, resources economics, macroeconomics and applied econometrics. His research materials have been published in reputable local and international journals.