Saving Sudan Yet Starving Uganda? A Spatial Analysis of Foreign Aid and Economic Growth

Abstract

This paper studies the spatial effects of foreign aid in Sub-Saharan Africa. The motivation for the analysis builds on the case of Sudan and Uganda in which aid to Sudan has caused inflation in Uganda. By raising prices for food and other consumption goods, the theory argues that aid constrains the growth of the economies that border the aid recipient as it limits the development of non-agricultural sectors. The evidence used to test this argument includes a time-series cross-section econometric analysis for all contiguous Sub-Saharan African countries. A fixed-effects estimator and an instrumental-variables analysis indicate that a one standard-deviation increase in foreign aid to a country’s neighbors reduces growth in the bordering country by 1.6 percentage points. Further tests support the intervening part of the argument that aid is associated with inflation. Several important policy implications are discussed in the conclusion.

Keywords: foreign aid, economic growth, inflation