Foreign Aid, Political Instability, and Economic Growth

Relying on a simple endogenous growth model, this paper highlights a political instability effect as a potential explanation for why foreign aid is frequently ineffective with respect to economic performance. In the present framework, the role of the state is to fund institutions allowing for ongoing technology adoption and hence long-run growth. However, providing a self-interested government with additional resources to fill a possible ”financing gap” may not result in better institutions. More money in the hands of the regime fuels conflict over the distribution of the funds - and decreases the incumbent regime’s time horizon in office. With a shorter time horizon, it is less attractive to finance good institutions whose returns mainly accrue in the future. Panel data evidence points indeed to a sizable causal effect of foreign aid on political instability in the 1980s and 1990s.Foreign aid; Economic growth; Political Instability; Institutions