Natural Disasters, Foreign Aid and Economic Development
Valeriu Tomescu
Advisor: Mihail Miletkov
University of New Hampshire, Department of Accounting and Finance
Motivation
Capital inflows from foreign aid have been theorized to increase the economic
growth of recipient countries. However, the empirical evidence for any such
Empirical Model
Results
Growth Equation
These questions are estimated using variants of the following equations:
positive relation has been very mixed. Critics of foreign aid claim that it has no
effect on growth and may even weaken it. Proponents of aid claim that, on
𝑔𝑖𝑡 = 𝛼𝑖 + 𝑎𝑖𝑡 𝛽𝑎 + 𝑑𝑖𝑡 𝛽𝑑 + 𝑎𝑖𝑡 𝑑𝑖𝑡 𝜃𝑎𝑑 + 𝒑𝒊𝒕 𝜷𝒑 + 𝒛𝒊𝒕 𝜷𝒛 +
average, it has been an effective tool. A more recent school of thought claims that
aid can be effective or ineffective, depending upon a country’s specific
𝑔
𝜀𝑖𝑡
OLS
Lasso
Intercept
-1.35
-1.35
-1.44
Inflation
-0.03***
-0.025***
-0.023***
-0.027***
Surplus/deficit
0.23***
0.231***
0.176***
0.261***
-0.12***
-0.124***
-0.109***
-0.124***
0.014***
0.014***
0.012**
0.014***
FDI
0.09***
0.098**
0.103***
0.139***
M2/GDP
-0.016**
-0.016**
-0.015***
-0.021***
Pop (log)
0.48***
0.478***
0.464***
0.495***
AID/GDP
0.05*
0.049*
0.054**
0.018
Disaster
-0.62*
-0.624**
-0.492
Disaster*AID/GDP
0.13***
0.128***
0.137***
N
641
641
641
186
Adj. R2
0.19
-
0.33
0.27
BIC
3632.9
3632.8
3620.1
2410.9
RMSE
3.91
3.90
Government Consumption
Trade Openness
𝑎𝑖𝑡 =
𝑎
𝛼𝑖
+ 𝑔𝑖𝑡 𝛽𝑔 + 𝑑𝑖𝑡 𝛽𝑑 + 𝒑𝒊𝒕 𝜷𝒑 + 𝒛𝒊𝒕 𝜷𝒛 +
𝑎
𝜀𝑖𝑡
circumstances (Burnside and Dollar, 2000). The present research contributes to this
discussion by examining the effect of aid on growth in countries experiencing
Where i index countries, t index time, 𝑔𝑖𝑡 the real GDP growth, 𝑎𝑖𝑡 aid
natural disasters.
Estimation Method
receipts relative to GDP, 𝒑𝒊𝒕 a P x 1 vector of policies that affect growth,
𝒛𝒊𝒕 a Z x 1 vector of other covariates that might affect growth and the
allocation of aid, 𝑑𝑖𝑡 a natural disaster indicator variable,
𝑔
ε𝑖𝑡
and ε𝑎𝑖𝑡 as
mean zero scalars.
𝒑𝒊𝒕 includes inflation, budget surplus, government consumption and
trade openness, while 𝒛𝒊𝒕 includes foreign direct investment, the level of
broad money (M2) and the total population.
FE
-2.55
-0.652***
1.51
Aid Equation
Estimation Method
OLS
Intercept
16.41***
Inflation
- 0.008
GDP Growth
0.178***
FE
16.54***
- 0.009
0.143**
Surplus/Deficit
- 0.128**
- 0.137**
Gov. Consumption
- 0.063
- 0.065
M2/GDP
- 0.079***
- 0.079***
Pop (log)
- 0.541***
- 0.535***
Disaster
1.022*
1.044*
to create an overall measure of economic policy rather than four
N
641
641
Adj. R2
0.14
0.12
RMSE
6.01
6.04
BIC
4169
4211
𝑔𝑖𝑡 = 𝛼𝑖 + 𝑎𝑖𝑡 𝛽𝑎 + 𝑑𝑖𝑡 𝛽𝑑 + 𝑎𝑖𝑡 𝑑𝑖𝑡 𝜃𝑎𝑑 + 𝑝𝑖𝑡 β𝑝 + 𝑎𝑖𝑡 𝑝𝑖𝑡 θ𝑎𝑝 + 𝒛𝒊𝒕 𝜷𝒛 +
𝑔
𝜀𝑖𝑡
0.156***
3.58
To test the third hypothesis, principal component analysis will be used
separate variables. The following equation will be estimated:
WLS
Residuals Distribution and Tests
Test
Statistic AC
White’s test 74.1
Ljung–Box
38.8
0.21
D-W
1.61
0.19
Hypotheses
•
If a country is experiencing a natural disaster, foreign aid inflows are less likely
to be mismanaged, and therefore, can have a more positive effect on growth.
•
•
Countries that suffer from natural disasters, or countries with “good policies”
p-value
0.0294
0.0001
0.0001
There is no obvious pattern in the errors plot,
while their distribution is fairly normal.
The VIFs are around 2 revealing there is little
evidence of multicollinearity. White’s test reveals
possible error heteroscedasticity; as a solution,
Lasso and WLS regressions are used. Both
Durbin-Watson and Ljung-Box show there is slight
autocorrelation at the first lag. Potential solutions
will include estimating GMM regressions or
the inclusion of a lagged term for the dependent
variable.
References
are likely to experience an increase in foreign aid allocations.
Boone, P. (1996). Politics and the effectiveness of foreign aid. European economic review, 40(2), 289-329.
Following Burnside and Dollar (2000), the finding that countries with “good
Burnside, C. and Dollar, D. (2000). Aid, policies and growth. American Economic Review, (90): 847-868.
policies” experience higher growth is tested.
Easterly, W. (2003). Can foreign aid buy growth?. The journal of economic perspectives, 17(3), 23-48.
James, G., Witten, D., Hastie, T., & Tibshirani, R. (2013). An introduction to statistical learning (Vol. 112). New York