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Corresponding Author:
John Thornton, Norwich Business School, University of East Anglia, Norwich, UK; and Office of Technical Assistance, US Department of the Treasury, Washington DC, USA

Coauthors:
Yener Altunbaş, The Business School, Bangor University, UK
Chrysovalantis Vasilakis, The Business School, Bangor University, UK and IRES, Université Catholique de Louvain, Belgium

More Foreign Aid, Less Financial Development

Volume 76 - Issue 4, November 2023
(pp. 495-528)
JEL classification: C23; F35; G20
Keywords: Foreign Aid; Financial Development; Instrumental Variables

Abstract

We examine whether foreign aid substitutes domestic finance. A simple theoretical model is presented to show that foreign aid might raise private consumption but reduce private borrowing, which could be consistent with undermining financial development. The results of empirical tests of the foreign aid–financial development relationship reported employing cross-sectional and panel data sets of 96 developing countries for the period 1971-2015. The results indicate that foreign aid inflows have a negative and highly significant impact on financial development in aid-recipient countries. The results are not affected by model specification, different control variables, variation in country sample, or estimation technique. To our knowledge, this is the first paper to test the foreign aid–financial development linkage.

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Institute for International Economics of the Genoa Chamber of Commerce

Institute for International Economics
of the Genoa Chamber of Commerce