The Effect of Foreign Funding on Economic Development - Research Paper Example

Quantitative Analysis Paper of THE EFFECT OF FOREIGN FUNDING ON ECONOMIC DEVELOPMENT THE EFFECT OF FOREIGN FUNDING ON ECONOMIC DEVELOPMENT Student Name Institution Name Abstract The enormous expenses on external financial aids by the developed countries and global financial organization, together with the poor outcome of the funding, brings to question the efficiency and effectiveness of the funds in developing nations. This study mainly focuses on the impact of the financial aids from developed countries on the economic development of the low or medium income developed countries. It measures the impact (effect) of these foreign aids on the economic growth indicators including the level of employment, GDP (gross domestic product), and the level of inflation in the countries. The results show that indeed foreign financial support such as grants and donations positively impacts on the level of economy in the beneficiary countries. The impacts are extremely modest. Nevertheless, many other factors not covered in this study, influence the economy, including the geographical location and political forces. With lack of political stability, the foreign aids turn into risks against economic growth, rather than a boosting factor. Key Words: Foreign Funding, Economic Development, Inflation Table of Contents 1. Introduction 2. Literature Review / Theory 3. Hypothesis 4. Methods / Measures 5. Results 6. Conclusions 1. Introduction For close to the last 50 years, foreign financial aid has gradually become an influential poverty reduction strategy for the developing countries. During the same timeframe, many global financial institutions, including the International Monetary Funds, World Bank and the UN have become very popular in controlling world economic matters. Even so, it appears like in the last 65 years, the developing nations in the world suffer great economic depression. This raises questions on the rationality of the foreign aid as well as its effectiveness in promoting economic development among the beneficiary countries. Studies on this issue attempts to empirically link the foreign funding and the economic development indicators. In spite of this, researches do not quite agree on the whether the foreign funding is effective on the growth of the developing economies. Foreign funding comes to the beneficiary countries in form of humanitarian intervention against natural disasters, military aid, economic grants and donations. This study, however, defines foreign financial aid as the official funding for increasing the economic growth level, with about 25% of it being a grant component. Many economists often criticize the aspect of development aid; arguing that it is an unrealistic strategy in the fight against international poverty. Notwithstanding the arguments, many studies show a positive link between foreign financial assistance and the level of economic development. This is especially true in the countries in the existence of economic policies concerning international trade, economic inflation rates and macroeconomic factors. This analysis serves the purpose of exploring the contributions of foreign financial aid the actual GDP rates. The difference between this study and the existing literature is that it uses a geometric gap model to account for the progressive impact of the foreign financing inflows in the later years after it was first introduced to the economy. 2. Literature Review and THEORY Two conflicting arguments arise on this subject. Foreman (2013) argues that the aspect of foreign financing positively contributes to the rise in the level of economic growth, with additional effect in nations with more stable policies on economy and trade. The second argument is that foreign financial assistance to the developing world promotes corruption and lack of financial accountability. In a number of prominent research work, there is a revelation that foreign financial support facilitates the economic development as long as they are implemented under the guidance of fiscal economic policies (Moyo, 2010). The economic policies include the maintenance of minor budgetary shortfalls, exercising necessary control on the rate of annual inflation, the adoption of global trade. The studies by Riddell (2008), an economist, reveal that the extent to which the financial assistance affects the GDP is determined by other factors including geographical locations. Moyo (2010) further illustrated that the financial aid is dependent on the reducing levels of marginal returns. This shows that developing countries simply need funding for the budgeted economic developmental budget, and any threshold of foreign financial assistance exceeding the development funding can be a risk to the economic development. The research works by Alan & Linnea (2009) show negative connection between foreign aid and economic growth level, in spite of foreign financial aid actually growing as indicated by the GDP. Riddell (2008) revealed that the high amounts of foreign financial aid erode the rigid organizational quality, which facilitates corruption. Other non-economic factors that effectively mitigate the impact of foreign financial assistance include establishment of stable foreign political policies. This study uses a data set indicating the years of financial aid distribution and the corresponding values of the three independent factors. Foreman (2013) established that political instability in many developing countries is because of leaders using the financial aid to sponsor criminal activities such as genocide and attempted coups. These events occur in the absence of economics policies or when the factions in power conducts sustained economic policies that directly target rival ethnic, political and religious groups leading to deaths of innocent people. On the other hand, the research works by Riddell (2008) cited countries in the developing world whose rapid economic growths can only be traced back to support from foreign aid. Arguably, the question of whether financial aids are effective or ineffective depends on how the funds are spent and the structure of governance and policies in place (Foreman, 2013). 3. RESEARCH PROBLEM The study problem in this research is to establish the relationship between the foreign financial support given to the developing countries and the resultant financial growths in those countries. The study is based on a number of questions as stated below: 3.1. Study Question The entire research is driven by two study questions below: Is there any connection between the foreign financial aid and the GDP? Is there any connection between the foreign financial aid and the level of Employment? Is there any connection between the foreign financial aid and the Economic rate of inflation? These two fundamental questions lead to the development of hypotheses as stated in the subsequent section shown below. 3.2. Hypothesis From the study questions, the hypotheses of the study are stated as: There a positive relationship between the foreign financial aid and the GDP There a positive relationship between the foreign financial aid and the level of Employment There a negative relationship between the foreign financial aid and the Economic rate of inflation Even though many scholars have argued on the lack of sustainability of this idea, not enough studies have been carried out to establish the effectiveness of financial aid. It can be concluded that the resources are misappropriated by the political parties for personal benefits as opposed to the interest of the countries. A periodic report by Foreman (2013), mentions the positive link between the foreign financial aid and the economic growth of the landlocked nations, indicating that these countries are disadvantaged for the reason of foreign aid as well. Their geographical location warrants their dire need for foreign financial intervention, for it to fill the gap in international trade, which they face, as opposed to their counterparts with vast access to the international trade opportunities. 4. Methods and Measures 4.1. Data The focus of this study is directed to the low development and the medium development nations under the definition of the UNDP. The selection of these countries was done in the light of the idea that they were not among the likely beneficiaries of the foreign financial aid. The high development countries were selected in the hope that they were likely to donate the foreign financial resources. The GDP was selected as the basis for classifying the countries since apart from the income, the GDP index accounts for the economic strength of the countries. Other indicators of economic growth were the annual inflation rates and the rates of employment. The source of data for this study was the IMF economic report for the first quarter of 2015. This data provides a more robust understanding of the nations’ stage of economic development as well as a complete study on the citizens’ quality of life. The data carries 520 records of different financial aids (FOR) granted at different times and the corresponding Gross Domestic product (GDP), Employment rate (EMP) and the rate of inflation (INF) at different times. The data is restricted for a range of years between 2009 and 2014, giving 520 observations, which is a sufficient data set for this study. The independent variable in this study is the foreign Aid (FOR), while the dependent variables in the study are the INF, EMP and GDP. The time variable (YR) is not applicable in any instance of the analysis. The data for domestic utility, government expenses, exports and imports only reflected in the GDP. The major indicator of economic growth by virtue of its weight is the GDP, with the INF and EMP being the minor determining variables. 4.2. Model Specification The assumption is that the inflows of foreign financial support will continuously impact on the level of economic development for many years after being introduction, but the rate of growth will decrease. For effective coverage of this rationale, we use tow methods of data analysis, the regression analysis and linear correlation analysis. The regression uses the general form model form shown below: (1) In the model, Y is the representative of the GDP, λ represents the Foreign Aid value (FOR), Z represents the inflation rate (INF) and X represents the employment Rate. The greatest weight is given to the FOR variable. In mathematical terms, the model is restated as: (2) This is a simpler form of the same model with Y as the dependent variable. Y is seen to have Ԑ as the error component in Equation (1). 4.3. Expected Results From the hypotheses, the expectation in this analysis is to find a positive relationship connecting foreign financial aid (FOR) and the level of economic development, either the (GDP) or the EMP. The relationship is expected to be a negative in relation to the inflation rate because growth takes place with low level of inflation in the economy of the countries. 5. Results and Analysis 5.1. Regression Analysis The results of the regression analysis are presented from Table 1 to Table 4 below: . reg GDP FOR Source | SS df MS Number of obs = 520 -------------+------------------------------ F (1, 518) = 0.45 Model | 79.0958768 1 79.0958768 Prob > F = 0.5018 Residual | 90694.4886 518 175.085885 R-squared = 0.0009 -------------+------------------------------ Adj R-squared = -0.0011 Total | 90773.5845 519 174.900933 Root MSE = 13.232 ------------------------------------------------------------------------------ GDP | Coef. Std. Err. t P>|t| [95% Conf. Interval] -------------+---------------------------------------------------------------- FOR | .0000296 .0000441 0.67 0.502 -.000057 .0001162 _cons | 24.70163 1.658779 14.89 0.000 21.44287 27.96039 ------------------------------------------------------------------------------ Tab1e 1: Regression Between GDP and Foreign Aid As seen in the result, the coefficient of regression analysis is +0.0000296. This is a positive coefficient of asociation, but it is very low in its significance. The P value of this test is 0.52, which is greater than 0.5. This indicates a high level of significance of the GDP variable under the 95% confidence level. With this, the the alternative hypothesis is adopted as true while the null hypothesis is rejected. . reg INF FOR Source | SS df MS Number of obs = 519 -------------+------------------------------ F( 1, 517) = 0.31 Model | 27.4544407 1 27.4544407 Prob > F = 0.5762 Residual | 45367.5223 517 87.7514938 R-squared = 0.0006 -------------+------------------------------ Adj R-squared = -0.0013 Total | 45394.9767 518 87.6350902 Root MSE = 9.3676 ------------------------------------------------------------------------------ INF | Coef. Std. Err. t P>|t| [95% Conf. Interval] -------------+---------------------------------------------------------------- FOR | .0000175 .0000312 0.56 0.576 -.0000438 .0000788 _cons | 4.737374 1.174948 4.03 0.000 2.429115 7.045634 ------------------------------------------------------------------------------ Table 2: Regression Between Inflation Rate and Foreign Aid As seen in the result, the coefficient of regression analysis is +0.0000175. This is a positive coefficient of asociation, but it is very low in its significance. The P value of this test is 0.56, which is greater than 0.5. This indicates a high level of significance of the inflation rate variable INF under the 95% confidence level. With this, the the alternative hypothesis is rejected as failed while the null hypothesis is accepted. . reg EMP FOR Source | SS df MS Number of obs = 520 -------------+------------------------------ F( 1, 518) = 0.25 Model | 13.0948275 1 13.0948275 Prob > F = 0.6145 Residual | 26706.0106 518 51.556005 R-squared = 0.0005 -------------+------------------------------ Adj R-squared =-0.0014 Total | 26719.1054 519 51.4818987 Root MSE = 7.1803 ------------------------------------------------------------------------------ EMP | Coef. Std. Err. t P>|t| [95% Conf. Interval] -------------+---------------------------------------------------------------- FOR | .0000121 .0000239 0.50 0.614 -.0000349 .000059 _cons | 18.7012 .9001243 20.78 0.000 16.93285 20.46954 ------------------------------------------------------------------------------ Table 3: Regression Between Employment and Foreign Aid As seen in the result, the coefficient of regression analysis is +0.0000121. This is a positive coefficient of asociation, but it is very low in its significance. The P value of this test is 0.50, which is the same as 0.5. This indicates a high level of significance of the level of employment (EMP) under the 95% confidence level. With this, the the alternative hypothesis is adopted as true while the null hypothesis is rejected. . reg GDP FOR INF EMP Source | SS df MS Number of obs = 519 -------------+------------------------------ F (3, 515) = 4.47 Model | 2305.38148 3 768.460494 Prob > F = 0.0041 Residual | 88467.6453 515 171.781835 R-squared = 0.0254 -------------+------------------------------ Adj R-squared = 0.0197 Total | 90773.0268 518 175.237503 Root MSE = 13.107 ------------------------------------------------------------------------------ GDP | Coef. Std. Err. t P>|t| [95% Conf. Interval] -------------+---------------------------------------------------------------- FOR | .0000277 .0000437 0.63 0.527 -.0000582 .0001135 INF | -.0705725 .0615461 -1.15 0.252 -.1914847 .0503397 EMP | .272198 .0803077 3.39 0.001 .1144271 .429969 _cons | 19.93932 2.251203 8.86 0.000 15.51665 24.36199 ------------------------------------------------------------------------------ Table 4: Combined Regression Between Foreign Aid and All Variables As seen in the result, the coefficient of regression analysis is +0.0000277 for FOR, -0.705725 for INF and 0.272198 for EMP. Incidentally, all the coefficients of association are as they were predicted. This indicates that all the expectations are satisfied, hence all the three hypotheses are accepted. The foreign financial support positively impacts on the economic growth indicators according to the regression. 5.2. Correlation Analysis The results for linear Correlation Analysis are shown in Table 5 below. . correlate GDP FOR INF EMP (obs=519) | GDP FOR INF EMP -------------+------------------------------------ GDP | 1.0000 FOR | 0.0295 1.0000 INF | -0.0521 0.0246 1.0000 EMP| 0.1491 0.0213 -0.0192 1.0000 Table 5: Correlation Analysis – All Variables As seen in Table 5 above, the correlation coefficient betweeen the FOR and the GDP is 0.0295, for FOR and INF is 0.0246, while for FOR and EMP is 0.0213. It indicates that the foreign funding of the developing countries has a positive impact on all the three variables, employment, inflation and the GDP. The first two hypotheses are adopted while the third hypothesis is rejected as failed. The summary of the variables are presented in Table 6 below. . summarize GDP FOR INF EMP Variable | Obs Mean Std. Dev. Min Max ------------- +-------------------------------------------------------------------------------- GDP | 520 25.7461 13.22501 0 98 FOR | 520 35262.6 13179.89 13201.04 71533.3 INF | 519 5.353015 9.361362 .01 118.43 EMP | 520 19.12618 7.175089 1.5 34.33 Table 6: Statistical Summary - All Variables 5.3. Time Series Analysis The time Series Analysis for the variables is presented from figure 1 to figure 4 below. Figure 1: Time Series Analysis – FOR The time series analysis shows a fluctuating pattern in the financial AID in the entire period. Figure 2: Time Series Analysis - INF It can be seen that the rate of inflation is increases in the first quarter of the period then falls to a constant level for the rest of the time. The net effect is a prediction of a negative association between the foreign AID and the rate of inflation. Figure 3: Time Series Analysis - GDP It can be seen that the rate of GDP is increases is constant in the first half of the period then increases continuously before falling in the last quarter to a constant level. The net effect is a prediction of a positive association between the foreign financial aid and the rate of growth in GDP. Figure 4: Time Series Analysis – EMF It can be seen that the rate of rate of employment is high in the greater part of the period with a few instances of reduction. The net effect is a prediction of a positive association between the foreign financial aid and the rate of growth in the level of employment. 1. Conclusions The main objective of this study was to confirm whether the foreign financial aid given to the developing countries indeed have an impact on the development of their economies. The model used in this analysis confirms the projection that the foreign aid has a positive impact on the growth and development of the economy in the developing world. In that regard, it not rational to decline the financial aid extended to the developing countries by the international organizations and the developed countries. This study however, cautions the developing countries to exercise economic policies to ensure that the financial aids do not degenerate into a source of malpractice. Instead, it advises them to apply rapid transformation principles. The developing countries have been in the center of social ills such as corruption and civil disruptions. Part of the transformation agenda ought to be a permanent elimination of poverty so that the developing countries can become self-reliant and avoid overdependence on foreign assistance. References Foreman, J. (2013). Aiding and Abetting: Foreign Aid Failures and the 0.7% Deception. Civitas. Moyo, D. (2010). Dead Aid: Why Aid is Not Working and How There is Another Way for Africa. Penguin. Riddell, R. C. (2008). Does Foreign Aid Work?. Oxford University Press. Alan H. & Linnea, J. (2009), ‘Beyond Aid’ for sustainable development London: Overseas Development Institute. Read More