Research Brief
Aid and Economic Growth

Phillip Michael Kargbo's UNU-WIDER working paper, 'Impact of Foreign Aid on Economic Growth in Sierra Leone: Empirical Analysis' examines the impact of foreign aid on growth in Sierra Leone using a variety of econometric approaches. The paper finds that in the period 1970-2007 aid has a significant contribution in promoting economic growth in the country. It also shows that the effect of aid on economic growth during the period of war is either weak or non-existent and that aid during the pre-war period was marginally more effective than aid during the post-war period. These latter results suggest that the impact of aid may change with time.

The Impact of Aid on Economic Growth in Sierra Leone

Sierra Leone is a country characterized by high levels of aid dependence and unimpressive economic performance, as well as by long term political instability and armed conflict. Development aid has historically been a high proportion of Sierra Leone’s gross domestic product and surged after the civil conflict that took place between 1991 and 2002. Annual aid disbursed to Sierra Leone between 1970 and 2007 stands at an average of 14.2% of GDP, a figure much higher than the regional average of 3.7% for Africa as a whole. Despite this level of support Sierra Leone's economic performance has remained wanting in terms of both growth and poverty reduction.
 
In his working paper Kargbo uses a variety of econometric approaches to assess the effect aid had on economic growth in Sierra Leone in the period from 1970 to 2007. The paper presents three main findings.
 
Aid had a significant positive effect on economic growth over the period as a whole. The effect of aid on growth during Sierra Leone's eleven year civil conflict, 1991-2002, is either weak or non-existent.
Aid had a greater positive impact on growth prior to the conflict than it has had in the post-war period. These findings are to a large extent consistent with a great portion of the macro level aid-growth literature. Indeed the UNU-WIDER paper “Aid Effectiveness: Opening the Black Box” by Channing Arndt, Sam Jones and Finn Tarp finds that a similar positive link between aid and growth is present on a more general, cross-country, level. However some case studies, for example, of Bangladesh, Cameroon, Papua New Guinea and Pakistan, have not teased out a similar statistically significant link between aid and growth. If the results of the paper are to help further our understanding of the relationship between aid and economic growth it is important to discuss why this may be the case

The general positive impact of aid on economic growth

Kargbo finds that aid had a significant positive effect on economic growth in Sierra Leone in the period 1970-2007.The author suggests three reasons why this relationship may be present in Sierra Leone but not found in the other case studies mentioned above.
 
First the differing motivations that lead to donors granting aid may well determine how effective that aid is in promoting growth. As one of the poorest countries in the world Sierra Leone is likely to receive aid targeted towards generating economic growth and reducing poverty. While donors may wish to see aid promoting democracy it is likely that this is not their central goal in Sierra Leone where as it may be in some of the other cases mentioned above. Kargbo posits that aid targeted at economic growth is likely to be more successful in generating it than aid targeted at other areas.
 
Second aid is likely to have a positive impact on economic growth in countries, like Sierra Leone, which require capital in order to fund the foreign imports essential for growing their economy. Sierra Leone is a non-industrialized country and thus needs to import machinery for the few domestic factories and industries that do exist, mining equipment to support its large mineral-producing sector, and tradeable commodities for the domestic market. Giving this high level of imports, and the likelihood that exports will be much lower, a foreign-exchange gap is inevitable. Inflows of foreign assistance help to fill this gap and thus promote economic growth.
 
Finally while there is history of corruption in Sierra Leone it may be that this is not widespread enough to ensure that aid becomes an ineffective factor vis-a-vis growth. Furthermore, past and present political regimes in Sierra Leone have been associated with informal donors such as China and Libya. This informal aid could be used by politicians for their own purposes without affecting the development effectiveness of official aid. While there is some evidence of official aid being misused by the bureaucracy aid corruption by politicians may largely affect non-official aid.
 
The paper suggests that if the purpose of the donor aid to Sierra Leone is to promote growth then its findings should be an inspiration to donors to continue giving aid. However, although the findings show that the impact of aid on growth is positive and significant, the magnitude of this effect is not that high. Consequently other factors such as private investment and the quality of institutions need to be strengthened in order to allow for an enhanced growth effort in the country.

Aid and growth during the civil conflict: 1991-2002

The author's results suggest that if aid had any impact on economic growth during Sierra Leone's eleven year civil conflict it was distinctly unimpressive. Kargbo makes the reasonable suggestion that this should not be particularly surprising. Civil conflicts inevitably destabilize and damage the political and economic institutions that are necessary if aid is to be put to effective use. This is not to say that donors should not grant any aid during civil conflicts. Instead aid given under such conditions should be viewed as a measure targeting short-term economic stability rather than long term economic growth.

Aid and Growth in the post-war period: 2002-07

The paper gives three reasons for singling out the post-war period to find out if aid remains positively significant on economic growth during this period. First since the end of the 11-year civil conflict Sierra Leone has had substantial inflows of foreign aid from a diverse range of donors sympathetic to the destruction of human resources, and social and physical infrastructure in the country. Second, there has been considerable strengthening of the countries policies and institutions. Third there have been reports and attacks on the government as well as the donor community for their misuse of foreign aid flows after the civil conflict.
 
The fact that the results show that aid had a positive impact on growth during the post-war era is perhaps unsurprising given the substantial influx of aid to Sierra Leone during this period and the reform of its institutions to standards surpassing their pre-war levels. The interesting question then is why aid was less effective in promoting growth in the post-war period than in the pre-war period. The paper suggests two possible reasons for this finding.
 
First the economic growth experienced during the post-war growth may have been substantially influenced by factors other than foreign aid. Growth during the pre-war period was mostly associated with the agricultural sector which can be largely aid funded. In the post-war period growth seems to have inspired by increases in the services sector which receive little aid funding. Second the adverse effects associated with damaged institutions during the civil conflict may have carried over into the post-war period. There is evidence of democratic reforms in the post-war period however these effects may take some time to develop.
 
Kargbo concludes that his results should provide donors with encouragement to continue their effort to provide aid to capital-starved nations. However he cautions that donors should perhaps be more hesitant with respect to the amount of development aid they disburse to countries during conflicts.