An Empirical Analysis of the Relation between Foreign Aid and Foreign Direct Investment: A Case Study on CLMV Countries

Abstract

Since 1950s, internatonal donors have placed large sums in grants and loans in developing countries through Offical Development Assistance (ODA). Due to development of Sustainable Development Goals (SDGs) in late 2015, international society once again noticed the importance of international aid for eradication of poverty and any inequalities. It already has been proven that foreign aid or development assistance facilitates economic growth in developing nations. Moreover, Foreign Direct Investment (FDI) has longer been implemented in developing nations long before 1950s and has been considered as one of the important source for economic growth of the developing nations. These two subjects have attracted a number of interests in the literature on development finance, and as mentioned above, it is proven that both do have a significant impact on economic growth of developing countries. From the early 2000s, there were some scholars focusing on the relationship between ODA and FDI, however the results have been ambiguous or unclear

many of the studies find different answers on whether the foreign aid has the power to promote the foreign investment in the recipient countries. This study aims to examine whether foreign aid or ODA promotes FDI especially in CLMV countries. In particular, the study will test the hypothesis that bilateral aid is an effective means to increase FDI flows to host countries in aggregated and disaggregated sense. In this context, the study employs panel tobit estimation techniques on the panel data covering 18 donor countries providing aid in CLMV region over the period from 2000 to 2014. As a result, the study find that ODA has a statistically significant positive effect on FDI to host countries, in this case, in CLMV region. Individually, ODA allocated in Vietnam has a positive correlations to its FDI inflows. It was possible to believe that foreign aid in CLMV countries, especially in Vietnam, promotes FDI inflows therefore it assists the economic growth of the host country. In addition, aid for social infrastructure in CLMV region had a positive impact on FDI inflows of the countries. However, humanitarian aid and aid for multisector has crowding out effect on FDI inflows in Myanmar and Vietnam.