Foreign aid, economic growth, and institutional quality : evidence from government effectiveness in African countries

Abstract

This research examines the relationship between foreign aid and economic growth in 37 African countries from 2000 to 2022, emphasizing the moderating role of institutional quality specifically government effectiveness. While existing literature presents mixed results on the impact of official development assistance (ODA), this research introduces institutional quality as a key factor influencing aid outcomes. Using panel data, the study applies pooled OLS, fixed effects (FE), and random effects (RE) models to assess aid effectiveness. A novel aspect of the study is the interaction term between ODA and government effectiveness, allowing for an evaluation of whether stronger institutions enhance aid’s impact on growth. The research also explores regional differences by categorizing countries based on colonial history into British, French, and others to understand historical influences on institutional capacity. Findings show that while OLS and RE models suggest a positive effect of aid on growth, the FE model reveals an insignificant or negative relationship. However, when institutional quality is accounted for, aid becomes effective under better governance conditions, supporting the conditional aid effectiveness hypothesis. The study concludes that foreign aid promotes growth only when coupled with strong institutions, highlighting the importance of governance reforms for maximizing aid impact in Africa.