Priming the Pump: Does Aid Pave the Way for Investment?

Recent advances in the coverage and precision of development data have opened exciting new avenues for analyzing the political economy behind the allocation and effectiveness of foreign aid. While a number of recent papers have looked at the social, environmental or welfare implications of aid, this paper instead focuses on how aid impacts an intermediate outcome in the development process, foreign direct investment (FDI). Combining geo-referenced data on foreign aid with a similarly coded dataset of FDI project locations, the paper uses a quasi-experimental, spatial-temporal, identification strategy to evaluate if the location of foreign aid projects presages later FDI. Drawing on the literature on the political economy of aid, the paper develops theoretical expectations about a given donor’s aid and FDI projects from that state before finding that local aid increases the chance of a location attracting FDI by up to 40 percent. While aid and FDI from bilateral donors goes hand-in-hand, both Chinese and EU aid also attracts FDI from
other sources.

Funding: The author thanks the European Union’s Horizon 2020 research and innovation programme under grant agreement number 693609 (GLOBUS) for generous funding support for this project.