Foreign aid, institutional quality and economic growth: Evidence from the developing world

This paper examines the effect of sectoral foreign aid and institutional quality on the economic growth of 74 developing countries from Africa, Asia and South America, and covers the period 1980-2016. We consider bilateral aid flows into three sectors, namely education, health and agriculture, and find that among the three types of aid, education aid is more effective for aid-receiving countries. The effect is conditional on the current level of institutional quality and varies substantially across regions. While education aid is more effective in South America, health aid is more effective in Asia and agricultural aid is more effective in Africa. As the level of institutional quality improves, the gap between the marginal effect of education, health and agricultural aids widen. Our findings have strong policy implication for donor countries and international aid organisations, which shows that it is more desirable to shift aid flows towards the education sector as the level of institutional quality improves.