Arnoldshain Seminar XV
“The EU and Latin America Facing Globalization”
September 4 – 6, 2017

Nowak-Lehmann, Felicitas, University of Goettingen , and Nathalie Desplas, Does development aid stimulate investment (in recipient countries)?
This paper analyzes the effectiveness of aid to stimulate investment using different measures of investment and different aid indicators. Most importantly, it investigates whether certain environments are more prone to stimulate or impede aid effectiveness. Considering different settings in which aid takes place seems warranted given that the heterogeneity in the aid-investment impact is immense. To improve econometric techniques, the aid-investment relationship is estimated using a fixed effects approach that allows to actively control for endogeneity and autocorrelation and that works with standard errors that take heteroscedasticity and cross-sectional correlation of the residuals into account. The estimates show that there is mostly a positive and significant relationship between aid and investment which however depends on whether countries exhibit a favorable or unfavorable environment in terms of unchangeable country characteristics, inflation, risk, external indebtedness, or institutional quality. As to the empirical results, first there is evidence that aid is not effective in countries with unfavorable time-invariant country characteristics. Second, we find aid to be more effective in countries which obtain above-median amounts of aid, in countries with relatively poor institutions and with below-median macroeconomic conditions (in terms of high inflation, high indebtedness, high volatility). Purely investment-related aid does not seem to be effective. An exception is aid to improve institutions. Keywords: Foreign aid, investment, panel regressions controlling for endogeneity and controlling for autocorrelation, heteroscedasticity and cross-country dependence of the residuals JEL Classification Codes: F35; E22; C22; C23