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## Literature Review about the Relationship between Foreign Aid and Economic Growth

October 2022A review of select studies finds that foreign aid can have a positive impact on economic growth, but it is worth reflecting on the factors that explain why this finding is not stated in more conclusive terms.

## Background

In Fiscal Year 2022, the Department of State and USAID disbursed approximately 11 billion USD in foreign assistance programs with the primary intent of increasing economic growth. With the aim of proving accountability to the American taxpayer, incompliance with the Evidence Act and guided by a Learning Agenda, the Department of State is assessing the impacts of these disbursements. The literature review featured here is a key step in that assessment. The 140-page literature review covers 30 studies, with an emphasis on attempts to estimate the economic impact of foreign aid on recipient communities. Other topics covered include the impact of foreign aid on corruption and conflict.

## Findings

The literature review captures important takeaways, including: 

              - Scholars have long debated the impacts of foreign aid. Even as these debates continue, there is evidence that foreign aid can have a positive impact on economic growth. 
              - The most impactful aid agencies in the world are transparent and limit overhead costs, while providing the kind of assistance that recipients need most. 
              - Historically, foreign aid has been allocated to countries irrespective of their levels of corruption. Still, even within countries burdened by corruption, foreign aid can have a positive impact.   

## Recommendations

Success in foreign aid is about impact and not about the amount of funds transferred.

Detecting the economic impacts of foreign aid poses methodological challenges.

Be patient. There’s no consensus as to the years it takes for foreign aid to achieve impact.

Anecdotes about foreign aid should be supported by systematic evidence.

Evaluate evidence critically; no one study can capture the full truth about foreign aid.

## Research Questions

                  - What does the empirical research from the past twenty years conclude regarding the impacts of foreign aid on economic growth and other development outcomes, such as corruption, conflict, and even health?

                  - What are the factors that obscure our understanding about the impacts of foreign aid?

                  - What are best practices in the provision of foreign aid?

                  - How do other countries and aid agencies practice foreign aid?

                  - What questions relating to foreign aid have academic researchers not yet fully answered?

The President’s Emergency Plan for AIDS Relief (PEPFAR) provides aid by supporting the systems and capabilities countries need to deliver effective, efficient, and sustainable health care, including for HIV/AIDS, even in times of great public health adversity.

## Approach, Methods, & Data

The literature review analyzes a total of 30 studies. The selected studies meet at least one of three criteria:

                  - Subject matter experts have highlighted the study;  

                  - The study is a recent publication that promises to inform the field of research; and  

                  - The study is relevant to priorities held by the Department of State.  

As a result of applying this selection criteria, four of the studies covered by the literature review may be thought of as classics. These are studies that were published between 2000 and 2005 and have a high citation count. To balance these with more recent publications, nine of the studies included were published in or after 2016.

The included studies can also be described as follows: there are 28 peer reviewed journal articles, a working paper, and a policy paper. Fifteen studies focus on the impact of foreign aid on economic growth, while the remaining 15 explore interconnected topics, such as the impact of foreign aid on corruption, conflict, and public health. For each selected study, the literature review provides a synopsis, contextual information, methodological details, and crystalized takeaways. 

## Detailed Findings

Has the allocation of wealthy countries’ funds with the purpose of promoting economic development in lower income countries had reliably positive effects? Because of methodological challenges, this key question eludes a simple answer. 

One challenge is donors often direct aid to countries with poor growth records. This critical factor in deciding foreign aid recipients may inherently hinder the desired outcome of economic growth. 

Other methodological challenges include insufficient data, disagreement about the time needed for foreign aid to achieve impact, and unresolved debates about what factors mediate the effects aid can have on recipient communities. This explains why all studies on foreign aid should be reviewed critically, and why no one study should be approached in isolation. 

Among the 30 studies covered by the literature review, 15 of them speak directly to the question of whether foreign aid has had a significant and positive impact on the economies of recipient countries. Of these studies, 11 conclude that foreign aid has had a positive impact on economic growth. The other four studies either question the evidence in favor of the aid-leads-to-growth argument, or they hold an ambivalent position on the issue. 

Therefore, there is evidence that foreign aid can have a positive impact on economic growth. There are also ways to increase the probability that foreign aid will prove impactful. These methods include reducing the ratio of overhead costs relative to aid disbursements and directing aid where the policy choices and quality of the institutions provide some assurance that the resources will be used responsibly. 

It is debated whether aid can positively impact countries facing various instabilities. There is some research showing that foreign aid can promote peace. In countries with armed conflict, for instance, much of the aid money is seemingly allocated to target unemployment – following the assumption that employed people are less likely to engage in violence. 

In contrast, based on data from Afghanistan, Iraq, and the Philippines, some researchers do not find evidence that lower levels of unemployment are associated with less insurgent violence. Therefore, it is worth keeping in mind that the truth is always approximated and that there is value in knowing where the uncertainty lies.

All told, the goal of this literature review is not to provide a definitive answer to the question about foreign aid and its impact on economic growth. Instead, the goal is to bridge the gap between academics and practitioners who are asking the same questions and who are similarly invested in wielding foreign aid as an instrument for good.  

In response to the destructive earthquakes in Turkiye and Syria, the U.S. will provide 85 billion dollars in lifesaving assistance. This image shows U.S. military members distributing humanitarian aid.

## Impact by the Numbers

                      - 10 studies originally planned for inclusion in the literature review
                      - 30 studies covered by the literature review
                      - 50% of studies included in the literature review that focus squarely on the connection between foreign aid and economic growth
                      - 3 steps in the peer review process – each study summary included in the literature review was edited by three individuals that were not the author of the summary

## Learning Summary

The literature review was designed as a meaningful learning opportunity to both expand and fine-tune the use of evidence in decision-making. The two activity leads were the Office of Foreign Assistance – Policy Directorate (F/P) and the Bureau of Energy Resources (ENR). The Bureau of Budget & Planning (BP), the Bureau for Development, Democracy, and Innovation (DDI) at USAID, the Bureau of Economic & Business Affairs (EB), Consular Affairs (CA), the Foreign Service Institute (FSI), and the Office of Foreign Assistance – Planning, Performance, and Systems (F/PPS) served as key contributors.

Those involved in the learning opportunity immersed themselves in the relevant academic literature and, together, concluded there is evidence that foreign aid can have a positive impact on economic growth. The group also identified some of the methodological limitations that weaken such a conclusion. One of the key methodological challenges is that foreign aid is often directed to low-income countries. This makes it difficult to clearly identify the economic impacts of aid. Another challenge to causal identification is the fact that there is little to no consensus as to how many years it takes for foreign aid to achieve impact. Therefore, the call is to continue to critically evaluate any new research about the impacts of foreign aid. The learning continues!

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