Analysis of the impact of foreign aid on economic growth in COMESA.

Abstract

The Common Market for East and Southern Africa (COMESA) was officially established in 1994. Its primary objective was to help its member states attain sustainable economic growth and development through regional integration and trade. In this regard, the region’s specific goals encompassed: (a) comparable and balanced development of human capital, production and market structures in its respective member countries. (b) harmonization of the individual economic and trade policies among its member countries in line with its collective regional growth and development goals. Among the tools for the realisation of these goals, is a coherent and consistent development financing plan for the essential investments across its sectors. Accordingly, focusing on the region’s core objective of economic growth, this study empirically investigated how foreign aid, as one of the region’s vital development financing resource has influenced economic growth in the respective COMESA countries. Contrary to the existing literature, this thesis adopted a comprehensive approach that encompassed aggregate and sectoral implications of aid receipts in the region without undermining the role of the factors affecting its utilization as mostly discussed in the literature. From the political economy perspective, recent debates on Africa’s inclusive and sustainable growth have focused on structural transformation as a critical priority in transforming its development platform. Based on these debates, the thesis focused on two crucial sectors for comprehensive econometric assessments of direct and indirect effects of sectoral aid on growth. For direct effects of aid on growth, the work chose the agricultural sector, which continues to sustainably support the region’s structural transformation process through the provision of at least 50% of the raw materials to the industrial sector. The agricultural sector also supports livelihoods of at least 60% of the region’s population. For indirect effects, the thesis selected economic infrastructure as a critical enabler of effective backward and forward linkages between the agricultural sector and the industrial/ service sectors. This comprehensive assessment was therefore accomplished firstly by assessing the extent to which the received aid volumes in the respective COMESA countries consistently closed their overall and specific sectoral development financing gaps. Trends analysis of aid and economic growth performance showed that foreign aid is the dominant source of foreign capital, accounting for an average of 60 percent of the development financing gaps annually in COMESA countries. Although better growth performances were expected among aid recipients, erratic growth rates below the 7% minimum stipulated in the Sustainable Development Goals are widespread across the countries. Aid volatility and misalignment of

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the aid allocations across (within) sectors and among countries compromise the potency of aid in the region. Incidences of foreign aid receipts over and above the estimated external development financing gaps are partially due to the large share of humanitarian assistance in some countries. However, they also imply a lack of systematic assessment of the region’s development financing needs, particularly in countries whose public investments were fully covered by domestic resources yet these countries received foreign aid. Furthermore, sectoral prioritization in favour of non-growth enhancing consumption, mostly in the social sectors, may be redundant as far as growth is concerned. In this regard, the thesis recommends a joint donor-recipient country financing needs and COMESA-wide capacities assessments for effective targeting to improve growth outcomes of aid. This approach to development financing will be more effective if accompanied by policies that focus on strengthening domestic institutions and increasing domestic resource mobilization. Secondly, contending for comparable impacts of aid across the countries in the region for the attainment of unified regional growth and development goals, Chapter 5 assessed how the received aid affected growth in the respective countries using the Pooled Mean Group (PMG) estimator. The thesis found that although aid had a significant positive impact on growth in the short run, its long-term effect was negative. The results show that the long-term impact of grants on growth is positive and significant, while the net effect of loans on growth was negative and significant. In line with the visible adverse effects of corruption on aid utilization in the short run in most countries, the results show that corruption has a net negative impact on the utilization of loans and grant. Accordingly, the short-run effects of loans and grants varied significantly among the countries in the region, potentially reflecting which component of aid is mostly affected by their respective weak institutions. Overall, the results show thart the potency of total foreign aid is equally compromised by corruption in the long term . Furthermore, Chapter 5 found that domestic savings have a positive effect on growth both in the short and long run. Therefore, the chapter postulates better outcomes from aid if COMESA effectively addresses corruption in all its member countries. This should be complemented with policies and strategies that focus on effectively increasing domestic revenue (savings) to further enhance their growth outcomes complemented with foreign aid. Lastly, rationalisation of the region’s exports to enhance their competitiveness remains imperative if the exports are to productively contribute to its regional growth goals.

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Thirdly, Chapter 6 analysed the impact of agricultural foreign aid on agricultural productivity and growth in a Panel Vector Autoregressive (PVAR) framework. The chapter finds a significant unidirectional causality from agricultural growth to foreign aid and thus confirming the theoretical dispositions of the developmental role of foreign aid. However, instead of complementing domestic resources in this regard, the results showed that foreign aid in the sector substitutes government financing, which effectively reduces its effectiveness. A mismatch in government resources and aid allocations to a sub-sector erodes the synergy that should typically exist between donor aid and government expenditure in a sector. This mismatch implies that a policy shift towards Result-Based (Aid on Delivery) approaches in aid disbursements will be critical to eliminating fungible resources. Misalignment of aid allocations with the respective sub-sectoral relative importance in the sectoral development goals was further found to undermine the potency of aid in the sector. Accordingly, the thesis contends for a better understanding of the role various sub-sectors play to the overall growth of the agriculture sector. This understanding will be crucial for equitable resource allocation and enhanced aid effectiveness. Moreover, the higher impact of domestic resources compared to foreign aid calls for policies to increase domestic resource mobilization and a broader focus on reducing aid. Lastly, the thesis assessed the contribution of foreign aid to the region’s infrastructure development in Chapter 7. Using the Blundell-Bond (BB) system Generalised Methods of Moments, the paper found that foreign aid has a net negative effect on infrastructure development mainly because of corruption which increases the cost of its loans. Although the results shows that corruption does not affect net utilization of grants, the regional effect of grants on infrastructure development negative. Notably, grants have been steadily declining since 2009 (Figure 3). Overall, the chapter shows the potential that loans have in turning around the infrastructure deficit in the region, particularly if corruption is effectively addressed in all the COMESA countries. Thus, the chapter concludes that unless COMESA countries effectively addresses corruption, it cannot adequately close its infrastructure gaps and cannot enhance its growth with foreign aid. With the highlighted positive and significant impact of domestic resources on infrastructure development in its core model, the chapter further recommends the exploring of other avenues of revenue for closing the infrastructure gaps. This examination will be beneficial in fast-tracking infrastructure development and enhance economic growth in the region.

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Overall, notwithstanding the comparable short-run positive effects of aid on growth across the countries in the region, the research failed to conclude that foreign aid positively contributes to the region’s long- term sustainable growth and development objective. While it marginally enhances productivity and growth of its core growth sector, foreign aid in the region has failed to bring about the desired changes in the growth-enhancing support sectors (economic infrastructure and social sectors). High levels of corruption in some of its member countries, which potentially lead to unnecessary increases in the overall financial costs of its loans, undermines the potency of foreign aid. Similarly, the substitution effect of aid on domestic resources further compromise the performance of foreign aid in the region. In this regard, “aid on delivery” (result based) approaches remain the best policy option to effectively eliminate fungible resources in all countries in the region. Furthermore, poor alignment of aid to the respective development financing gaps both across (within) sectors and countries is vital in accounting for aid inefficiency in enhancing the region’s growth. On the one hand, there is evidence of the lack of systematic assessment on the part of the region’s development partners (donors) to properly align aid to the region’s development financing gaps as reflected by episodes of aid over and above existing development financing gaps. While the large component of humanitarian aid in some of the countries in the region comprehensively explains this mismatch, it does not provide enough explanation about other countries in the region, including those whose investments were fully covered by domestic resources in the presence of aid receipts. On the other hand, poor sectoral prioritization of the received aid across the countries in favour of non-growth enhancing consumption, mostly in the social sectors, is redundant for the attainment of its growthenhancing objectives. In this regard, a thorough understanding of the region’s development financing needs and capacities to ensure the right targeting and effective utilization of both foreign aid and domestic resources remains imperative. Enhancing domestic resource mobilization will further be beneficial in reducing aid dependency in the region.