Aid, Governance and Private Foreign Investment: Some Puzzling Findings for the 1990s*


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     Earlier versions of this article were presented at the Universities of St. Gallen, Konstanz, Marburg and Hamburg; the annual conferences of the Money, Macro and Finance Study Group (2003), the German Economic Association (2003), the European Economic Association (2003) and the European Public Choice Society (2004) and at the Swiss National Bank. We thank these audiences for many insightful comments. We are also indebted to the managing editor and two anonymous referees for many helpful suggestions.


Does official aid pave the road for private foreign investment or does it suffocate private initiative by diverting resources towards unproductive activities? We explore this question using panel data covering a large number of developing and emerging economies during the 1990s. Controlling for countries’ institutional environment, we find that, evaluated at the mean, the marginal effect of aid on private foreign investment is close to zero. Surprisingly, however, the effect is strictly positive for countries in which private agents face a substantial regulatory burden. This result is robust across a wide range of specifications, samples and estimation methods.