2070. The Search for the Key: Aid, Investment, and Policies in Africa

David Dollar and William Easterly
(March 1999)

Aid does not necessarily finance investment, and investment does not necessarily promote growth. But the combination of private investment, good policies, and foreign aid is quite powerful. When societies themselves take the lead in putting growth-enhancing policies in place, foreign aid can play a powerful supporting role, bringing ideas, technical assistance, and money.

Dollar and Easterly's study of aid, investment, and policies in Africa leads them to four principal conclusions:

• The traditional links between aid, investment, and growth are not robust. Aid does not necessarily finance investment and investment does not necessarily promote growth.
• Differences in economic policies can explain much of the difference in growth performance. Poor quality of public services, closed trade regimes, financial repression, and macroeconomic mismanagement explain Africa's poor record.
• Foreign aid cannot easily promote lasting policy reform in countries where there is no strong domestic movement in that direction. Country ownership of reform is more important than donor conditionality.
• These three conclusions imply that societies themselves must take the lead in putting growth-enhancing policies in place. When this happens, foreign aid can play a powerful supporting role, bringing ideas, technical assistance, and money. The combination of private investment, good policies, and foreign aid is quite powerful.

Where do we stand in the search for the key to growth in Africa? Because past "keys" to growth in Africa have failed, Dollar and Easterly are cautious about claims to a new key. But even if aid-cum-private-investment-cum-policy reform falls short of being the one and only key to growth, disbursing aid into good policy environments would be an improvement on current practices.

This paper—a product of Macroeconomics and Growth, Development Research Group—is part of a larger effort in the group to examine aid effectiveness. Copies of the paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Emily Khine, room MC3-347, telephone 202-473-7471, fax 202-522-3518, Internet address kkhine@worldbank.org. The authors may be contacted at ddollar@worldbank.org or weasterly@worldbank.org. (28 pages)

The full report is available in PDF format.