Aid versus Foreign Direct Investment: Efficiently Producing Growth in Developing Countries
Numerous studies have debated if aid and foreign direct investment (FDI) positively affect economic growth in developing countries. This paper uses a stratification of aid developed by Clemens et al. (2004) that separates out aid intended for short-term growth, and compares it to inward FDI flows that can similarly be expected to produce aggregate growth. The analysis uses instrumental variables to parse out endogeneity in the aid variable, using both clustered standard errors and two-way fixed effects models. It finds that short-impact aid and FDI have a positive, significant effect on growth in real GDP per capita. In fact, the model finds that the growth effects of FDI and short-impact aid are statistically identical. The robust, significant core results indicate that from a macroeconomic perspective, both aid and FDI flows should be further encouraged. In fact, collaboration between the private and public sector, as well as subsidized investment and guarantees, are an excellent way to leverage future growth.
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