Can foreign aid influence the level of industrialization in African countries?

Abstract

AbstractCapital inflows, such as foreign aid, can serve as a means to enhance infrastructure development in developing countries. This suggests that foreign aid might have an impact on the level of industrialization in African nations. While existing studies indicate that foreign aid can affect the competitiveness of the manufacturing sector by appreciating the real exchange rate, the veracity of this claim relies on empirical evidence. This paper explores the influence of aid on manufacturing value added using time-series data spanning from 1990 to 2018 for 27 African countries. Employing a panel vector autoregression technique and generating associated impulse response functions, the study scrutinizes the interactions between foreign aid and manufacturing. The analysis is conducted on both the full dataset and subsamples disaggregated based on the income levels of countries. The results indicate that foreign aid acts as a stimulus for manufacturing, primarily through a sustained depreciation of the real exchange rate. This finding holds true for both the overall dataset and the subset of low-income countries. The study attributes this phenomenon to the strategic utilization of aid to enhance infrastructure, leading to a reduction in the price of non-tradables relative to tradables. Consequently, this enhances the profitability and output capacity of the manufacturing sector in African countries. In essence, the results suggest that foreign aid plays a role in influencing or stimulating industrialization in African countries. The study concludes with a discussion on the implications of these findings for industrial policy in African nations.

Keywords

• Foreign aid
• manufacturing
• industrialisation
• Africa
• C23
• E60