2016 Economic Development, Public Administration Other

Is Development Aid a Complement or a Substitute to Foreign Direct Investment?

Ulrika Ahrsjö

Can foreign aid contribute to attracting private investment to developing countries? This paper applies an instrumental variable strategy developed by Galiani et al. (2014) to data from 35 countries that traversed the middle income country threshold between 1987-2013, attempting to capture the causal effect of aid on foreign direct investment.

Main findings

  • The findings confirm the hypothesis that aid functions as a complement to foreign direct investment.
  • One per cent more aid will on average lead to 0.5 per cent more foreign direct investment three years later for the studied countries.
  • Aid encourages foreign direct investment in countries less involved in international trade, and in times of political and economic risk.
  • The results suggest that aid can catalyse new private investment, which in turn contribute to growth.

Ulrika Ahrsjö, Master’s Student, Department of Economics, Stockholm University