Foreign Aid Ethic Division

Whether foreign aid can stimulate economic growth is one of the most debated questions in economics. However, empirical studies don’t seem to give a clear answer to it, even if they control for specific categories of aid or for aid effectiveness dependence on policy and geographical environment (see, for example, Rajan and Subramanian [2005]). In this paper we investigate one of the possible causes of this ambiguity. Specifically, we analyze the relationship between growth effects of foreign aid and ethnic fractionalization in the recipient countries. Empirical studies indicate that ethnic diversity tends to be associated with low GDP growth rates (see Easterly and Levine [1997], Alesina et al. [2003], Alesina and La Ferrara [2005] for that point). One of the explanations of this fact is the “common pool’’ problem that separation of power between distinct groups may lead to. Foreign aid directed to highly fractionalized countries characterized by the existence of multiple powerful groups, that have access to a pool of common resources, might be not effective. We show both theoretically and empirically that unless a recipient country has built institutions that mitigate the influence that ethnic groups have in allocating resources (and foreign aid), international assistance may be prone to appropriation by distinct groups. As foreign aid disbursements are usually anticipated by recipient’s country groups, we also provide novel analysis how such anticipation affects group behavior and find that both anticipated and unanticipated aid components are prone to appropriation by multiple powerful groups.