FOREIGN AID AND ECONOMIC GROWTH: NEW EVIDENCE FROM PANEL COINTEGRATION

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1 JOURAL OF ECOOMIC DEVELOPME 7 Volume 30, umber, June 005 FOREIG AID AD ECOOMIC GROWH: EW EVIDECE FROM PAEL COIEGRAIO ABDULASSER HAEMI-J AD MAUCHEHR IRADOUS * Unversy of Skövde and Unversy of Örebro he relaonshp beween foregn ad and economc growh s nvesgaed for a panel of developng counres (Boswana, Ehopa, Inda, Kenya, Sr-Lanka, and anzana) over he perod he resuls reveal ha he varables conan a panel un roo and hey conegrae n a panel perspecve. he long-run elasces (close o one for mos counres) show ha foregn ad has a posve and sgnfcan effec on economc acvy for each counry n he sample. A polcy mplcaon whch may be drawn from he sudy s ha foregn capal flows can have a favorable effec on real ncome by supplemenng domesc savngs. Keywords: Foregn Ad, Economc Growh, Panel Un Roo ess, Panel Conegraon, Afrca, Asa JEL classfcaon: F35, C3, 0. IRODUCIO Foregn ad s a sgnfcan source of ncome o developng counres, especally n Afrca, where averages.5 percen of gross domesc produc and esablshes by far he mporan source of foregn capal (Pallage and Robe (00)). In such an envronmen, foregn ad has a poenal o play a key role n promong developng counres economc growh. here exs wo srands of leraure on he role of foregn ad on economc growh. he frs sudes or he proponens of foregn ad asser ha overseas capal nflow s necessary and suffcen for economc growh n he less developed counres. hey clam ha here exs a posve relaonshp beween ad and economc growh because complemens domesc resources and also supplemens domesc savngs. Furhermore, foregn ad assss o close he foregn exchange gap, provdes access o modern * We would lke o hank he edor of he journal and an anonymous referee for useful commens. We also hank Peer Pedron for kndly provdng hs program procedures ha we could modfy and use o es for panel un roos and panel conegraon. he usual dsclamer apples.

2 7 ABDULASSER HAEMI-J AD MAUCHEHR IRADOUS echnology and manageral sklls, and allows easer access o foregn marke (Chenery and Srou (966); Papanek (973); Gula (975); Gupa (975); Over (975); Levy (988); Islam (99)). he second sudes are relaed o he emergence of he vew ha exernal capal exers sgnfcan negave effecs on he economc growh of recpen counres. Accordng o hs vew, foregn ad s fully consumed and subsues raher han complmens domesc resources. Furhermore, foregn ad assss o mpor napproprae echnology, dsors domesc ncome dsrbuon, and encourages a bgger, neffcen and corrup governmen n developng counres (Grffn (970); Grffn and Enos (970); Wesskoff (97a, b); Boone (994); (996); Easerly (999)). On he oher hand, a seres of sudes argue ha he negave relaon ha mgh exs beween foregn ad flows and economc growh s oucome of facors such as economc polces, sae nervenon, busness cycles, and sably of foregn ad flows n he recpen counres. Sngh (985) consders governmen regulaory acves no consderaon. He concludes ha sae nervenon n he economy has a negave mpac on economc growh and renders he ad-growh relaonshp sascally non- sgnfcan. Burnsde and Dollar (000) fnd ha he relaonshp beween foregn ad and economc growh may depend on wheher he recpens are pursung sound economc polces. Lensnk and Morrssey (000) analyze he mpac of ad uncerany on economc growh n developng counres. hey fnd ha he effec of foregn ad on economc growh s a funcon of ad levels and he sably of ad flows. Fnally, Pallage and Robe (00) explan emprcal regulares n he foregn ad flows o developng counres. hey reveal ha for he vas majory of recpens, ad flows are a major source of ncome ha s hghly volale and overwhelmngly pro-cyclcal. hs means ha, even f foregn ad were mean solely o help foser economc growh, serous problems would noneheless sem from he fac ha ad dsbursemen paerns nensfy he volaly of developng counres dsposable ncome whch affecs growh negavely. However, he bulk of he leraure has so far produced nconssen and elusve resuls concernng he poenal relaonshp beween foregn ad and economc growh. he purpose of hs sudy s o examne he relaonshp beween he Swedsh foregn ad and he economc growh n developng counres. he sample counres are: Boswana, Ehopa, Inda, Kenya, Sr-Lanka, and anzana and he sample perod s We have resrced he sample o hs perod due o he avalably of he daa. he reason for he choce of hese counres s ha hey are mporan recpens of ad from Sweden. he deparure from earler sudes of he role of foregn ad flows on economc growh s n he mehodology used o examne he neracon beween varables. Here we make use of panel un roo ess and ess for panel conegraon suggesed by Pedron (997, 999). One of he major advanages of usng a panel conegraon es s a sgnfcan ncrease n power when he cross-seconal dmenson of he panel s expanded as compared wh he well-known low power of sandard conegraon es for

3 FOREIG AID AD ECOOMIC GROWH 73 small samples. hs sudy s probably he frs aemp o es he mpac of foregn ad on he economc growh n he developng counres usng panel conegraon echnques. he paper proceeds as follows: Secon deals wh mehodologcal ssues and he daa used n he emprcal analyss, whle n Secon 3 he emprcal evdence s presened. Fnally, Secon 4 offers conclusons and polcy mplcaons.. MODEL, DAA, AD MEHODOLOGY he model ha we ulze n he emprcal nvesgaon s a panel sysem and s defned as follows: lnyc α + β ln AID + ε, for, L, and, L,, () where ln denoes he log of real GP per capa for counry a me, YC lnaid s he log of he Swedsh ad o counry a me, and ε s he sochasc error erm. GP per capa seres consss of annual daa and s expressed n real US dollars. We deflae GP and ad seres usng each counry s consumer prce ndex and by usng populaon seres n each counry we calculae GP per capa. Daa for ad seres was colleced from SIDA (Sweden) and daa for GP seres and consumer prce ndex were obaned from Inernaonal Fnancal Sascs, varous ssues. he sample perod for each counry s he counres ncluded n he sample are Boswana, Ehopa, Inda, Kenya, Ser Lanka, and anzana. I s an acceped fac n he leraure ha he daa generang process for many economc varables s characerzed by un roos, whch can resul n spurous nference f he me seres properes of he daa are no carefully aken no accoun. One of he well-known es sascs for un roos s he augmened Dckey-Fuller es sascs. hs es n s smples form can be descrbed as follows: x γ x + e. () he null hypohess s one un roo,.e., γ 0. However, Shller and Perron (985) repored ha he Dckey-Fuller un-roo es has very low power n small sample szes. o enhance he power of he es, Levn and Ln (993) and Im, Pesaran, and Shn (003) (IPS hereafer) recommended panel versons of he es. A panel verson of he Dckey-Fuller un-roo es s he followng: For anoher applcaon of non-saonary panel daa analyss see Haem-J and Irandous (004).

4 74 ABDULASSER HAEMI-J AD MAUCHEHR IRADOUS x x M x γ x γ x M γ x e + e M e. (3) denoes he number of cross-secons. he error erms are assumed o be whe nose processes. he null hypohess of one panel un roo s γ γ L γ 0. he panel un roo es ha was developed by Levn and Ln (993) (LL) s based on he followng regresson: x γ x + e, for, L, and,,. (4) L he panel esmaor can be defned as he followng accordng o he auhors: x e ( ) γ ). (5) x he followng -sascs can be used o es for he null hypohess of panel un roo: γ ) ( γ ) x e. (6) he Mone Carlo expermens conduced by Levn, Ln and Chu (00) ndcae ha he power of he panel-based un roo es s much hgher compared o ndvdual un roo ess. he IPS es allows for a dverse coeffcen of un roo and hs advocaes an average of he ndvdual Dckey-Fuller ess. he es, whch has beer sze properes, s defned below:, (7) here s he ndvdual -sasc for esng H : γ 0,,...,. he alernave 0 I should be poned ou ha s possble o add ndvdual consan and rend erms n Equaon (6).

5 FOREIG AID AD ECOOMIC GROWH 75 hypohess n he IPS es s γ < 0 for +, +,, such ha: L lm c, 0 < c. herefore, hs es allows for heerogeney n he panel. Mone Carlo expermens mplemened by Karlsson and Löhgren (000) also demonsrae ha he IPS es has beer power properes. If he daa generang process for he varables s characerzed by panel un roos, s crucal o es for conegraon n a panel perspecve. Performng panel un roo ess s mporan n order o avod spurous regresson when panel daa s used. Pedron (995, 997, 999) proposes among ohers he followng es sascs o es for panel conegraon:. Panel -Sasc (on-paramerc): Z, ~ σ / L ˆ, e Lˆ e ˆ, eˆ,, ( ) ˆ ˆλ, (8). Panel -Sasc (Paramerc): Z *, ~ s / * L ˆ * e L e * ˆ ˆ *, eˆ,,, ˆ, (9) 3. Group -Sasc (on-paramerc): / ~ Z, / / ˆ L ˆ eˆ eˆ,, ( ) σ e ˆ, ˆ λ, (0) 4. Group -Sasc (Paramerc): / ~ * Z, / / * ~ * * * s eˆ eˆ, eˆ,,, () where ˆ k s λ ˆ µ ˆ,, s s k + µ, () s+ sˆ ˆ µ,, ˆ σ sˆ + λ, (3) ˆ

6 76 ABDULASSER HAEMI-J AD MAUCHEHR IRADOUS ~ σ *, sˆ *, ˆ µ, (4) ˆ ˆ L σ and η s. (5) k Lˆ ˆ +, ˆ η ˆ, η, s k + s+ he esmaed error erms used o calculae he above expressons are obaned by runnng he followng regressons: e ˆ ˆ ˆ ˆ, γ e, + µ,, (6) K * ˆ ˆ ˆ ˆ ˆ, γ e, + γ, k e, k +. k e ˆ µ, (7) and YC b ln + ˆ η. (8) ln AID, s he frs dfference operaor. Pedron suggess some adjusmens for each of all es sascs (boh for panel un roo ess and panel conegraon ess) descrbed above ha produces sandard normal dsrbuons. In hs sudy, we repor he adjused values so ha n all cases he repored es values can be compared o he sandard normal dsrbuon. hs s he case for boh he conegraon and un roo ess ESIMAIO RESULS he esmaon resuls for hree ess of panel un roos are presened n able. All hree ess show ha each varable n he panel s negraed of he frs order; I(). Snce he varables are found o be negraed (non-saonary), s mporan o nvesgae wheher he varables esablsh any long-run seady sae (conegraon). Based on Pedron s ess for panel conegraon, presened n able, we fnd srong emprcal evdence for panel conegraon beween foregn ad and real GP per capa for all counres n he sample. All he four ess suppor he vew ha he varables conegrae n a panel perspecve. hree ess rejec he null hypohess of no conegraon a he % sgnfcance level whle he remanng es rejecs he null a he 5% sgnfcance 3 For more deals see Pedron (999).

7 FOREIG AID AD ECOOMIC GROWH 77 level. he adjused values for he ess are also repored n able. hese values can be drecly compared o he one sded sandard normal dsrbuon. able. H 0 : I(), H : I(0) es Resuls for Panel Un Roos H 0 : I(), H : I() LL LL IPS LL LL IPS lnyc lnyc -7.0 a a a ln AID ln AID a -9.8 a -.4 a oes:. LL and LL are he ess recommended by Levn and Ln (993). he frs es augmens he regresson unl auocorrelaon s removed. he second es akes no accoun he effec of poenal auocorrelaon when he parameers are esmaed.. IPS s he es nroduced by Im e al. (003). a ndcaes ha he null hypohess can be rejeced a % sgnfcance level. 3. he adjused es resuls are repored here so hey can be compared o he (0,) dsrbuon. oce ha each es s one sded (o he lef sde of he dsrbuon). able. Panel Conegraon es Resuls for real GP per Capa and Foregn Ad Based on Pedron ess es es es 3 es oes: oce ha es Panel -Sasc (on-paramerc), es Panel -Sasc (Paramerc), es 3 Group -Sasc (on-paramerc), and es 4 Group -Sasc (Paramerc) as descrbed n he man ex. Once agan usng Pedron s procedure, we presen he adjused values hear ha can be compared o he (0,). Snce he ess are one sded he % crcal value s -.96, he 5% value s -.64 and he 0% crcal value s -.8. Snce here s srong ndcaon of long-run equlbrum (conegraon) n he panel, we are n a poson o proceed and esmae he parameers of neres. o oban he counry-specfc elasces, we esmaed he panel sysem presened n Equaon () by makng use of he dummy leas squares mehod. he esmaed elasces are presened n able 3 ogeher wh her sandard errors, -sascs and he correspondng p-values. Each elascy appears o be of posve sgn and sascally sgnfcan a any sgnfcance levels. For mos counres n he sample, he counry-specfc elascy s close o one. hese elasces ndcae ha, oher hngs beng equal, he foregn ad receved from Sweden has a sgnfcan posve mpac on he real per capa GP n our sample counres. he las row n able 3 also presens he group (pooled) elascy of foregn ad. hs elascy appears o be sgnfcan a all convenonal sgnfcance levels. hs esmaed elascy mples ha a 0% ncrease n foregn ad resuls n a 9%

8 78 ABDULASSER HAEMI-J AD MAUCHEHR IRADOUS ncrease n GP per capa n our sample counres as a group. 4 able 3. he Long-Run Foregn Ad Elasces Counry Elascy S.E -sascs P-value Boswana <0.000 Ehopa <0.000 Inda <0.000 Kenya <0.000 Srlanka <0.000 anzana <0.000 Pooled Daa <0.000 oes:. he elascy presened n column s he elascy of GP per capa n each counry wh respec o ad from Sweden, excep he las elascy whch shows group elascy.. I should be menoned ha he elasces (boh ndvdual and pooled) are esmaed by allowng for ndvdual effecs hrough dummy varables o ake no accoun he scale effec. 5. COCLUSIOS hs sudy makes use of he new developmens n he fled of panel conegraon analyss o nvesgae he long-run relaonshp beween foregn ad and real economc growh. he donor counry s Sweden and he recpens are Boswana, Ehopa, Inda, Kenya, Sr- Lanka, and anzana and he sample perod s Several ess for panel un roos and panel conegraon are conduced. he esmaon resuls show ha he varables are characerzed by one panel un roo. However, he ess for panel conegraon provde emprcal suppor ha he varables can be consdered as a conegraed panel sysem. he esmaed long-run elasces (boh ndvdual and group) ndcae ha he Swedsh foregn ad has a posve and sgnfcan mpac on economc acvy for all counres n he sample. For mos counres, he counry-specfc elascy of real ncome wh respec o foregn ad s close o one. A polcy mplcaon, whch may be drawn from he sudy, s ha foregn capal flows can have a favorable effec on real ncome by supplemenng domesc savngs. 4 I should be poned ou ha he elasces (boh ndvdual and pooled) are esmaed by allowng for ndvdual effecs va dummy varables o capure he scale effec. hese esmaes are no presened bu hey are avalable from he auhors upon reques.

9 FOREIG AID AD ECOOMIC GROWH 79 REFERECES Boone, P. (994), he mpac of foregn ad on savngs and growh, Cener for Economc Performance, Workng Paper 65, London. (996), Polcs and effecveness of ad, European Economc Revew 40, Burnsde, C., and D. Dollar (000), Ad, polces and growh, Amercan Economc Revew 90, Chenery, H.B., and A. Srou (966), Foregn asssance and economc developmen, Amercan Economc Revew 56, Easerly, W. (999), he Ghos of fnancng gap: esng he growh model used n nernaonal fnancal nsuons, Journal of Developmen Economcs 60, Grffn, K.B. (970), Foregn capal, domesc savngs and economc developmen, Oxford Unversy Insue of Economcs and Sascs 3, 99-. Grffn, K.B., and J.L. Enos (970), Foregn asssance: Objecves and consequences, Economc Developmen and Culural Change 8, Gula, U. (975), Effec of capal mpors on savngs and growh n less developed counres, Economc Inqury 3, Gupa, K. (975), Foregn capal nflows, dependency burden and savngs raes n developng counres: A smulaneous equaon model, Kyklos 8, Haem-J, A., and M. Irandous (004), Is prcng o marke behavor a long-run phenomenon? A non-saonary panel analyss, Emprca 3(), Im, K.L., M.H. Pesaran, and Y. Shn (003), esng for un roos n heerogeneous panels, Journal of Economercs 5, Islam, A. (99), Foregn ad and economc growh: An economerc sudy of Bangladesh, Appled Economcs 4, Karlsson, S., and M. Löhgren (000), On he power and nerpreaon of panel un roo ess, Economcs Leers 66, Lensnk, R., and O. Morrssey (000), Ad sably as a measure of uncerany and he posve mpac of ad on growh, Journal of Developmen Sudes 36, Levn, A., and C.F. Ln (993), Un roo ess n panel daa: ew resuls, Deparmen of Economcs, Unversy of Calforna a San Dego, Dscusson Paper o Levn, A., C.F. Ln, and C.J. Chu (00), Un roo ess n panel daa: Asympoc and fne-sample properes, Journal of Economercs 08, -4. Levy, V. (988), Ad and growh n he Sub-Saharan Afrca: he recen experence, European Economc Revew 3, Over, M. (975), An example of he smulaneous equaons problem: A noe on foregn asssance: Objecves and consequences, Economc Developmen and Culural Change 4, Pallage, S., and M.A. Robe (00), Foregn ad and he busness cycles, Revew of Inernaonal Economcs 9, Papanek, G.F. (973), Ad, foregn prvae nvesmen, savngs and growh n less

10 80 ABDULASSER HAEMI-J AD MAUCHEHR IRADOUS developed counres, Journal of Polcal Economy 8, Pedron, P. (995), Panel conegraon, asympoc and fne sample properes of pooled me-seres ess, wh an applcaon o he PPP hypohess, Indana Unversy, Workng Paper n Economcs, o , June. (997), Panel conegraon, asympoc and fne sample properes of pooled me-seres ess, wh an applcaon o he PPP hypohess: ew resuls, Indana Unversy, Workng Paper n Economcs, ovember. (999), Crcal values for conegrang ess n heerogeneous panels wh mulple regressors, Oxford Bullen of Economcs and Sascs 6(S), Shller, R., and P. Perron (985), esng he random walk hypohess: Power versus frequency of observaons, Economcs Leers 8, -8. Sngh, R.D. (985), Sae nervenon, foregn economc ad, savngs and growh n LDCs: Some recen evdence, Kyklos 38, 6-3. Wesskoff,.E. (97a), An economerc es of alernave consrans on economc growh of underdeveloped counres, Revew of Economcs and Sascs 54, (97b), he mpac of foregn capal flow on domesc savngs n underdeveloped counres, Journal of Inernaonal Economcs, Malng Address: Abdulnasser Haem-J: Deparmen of Economcs, Unversy of Skövde, P.O. Box 408, SE-54 8, Skövde, Sweden. el: , Fax: +46 (0) E-mal: [email protected]. Manuchehr Irandous: Deparmen of Economcs, Unversy of Örebro, SE-70 8, Örebro, Sweden. el: , Fax: E-mal: [email protected]. Manuscrp receved Aprl, 004; fnal revson receved Ocober, 004.