FIFTY years ago the first United Nations Conference on Trade and Development launched a debate about how much money rich countries should give to poor ones to reduce poverty and bolster growth. In the end, the UN settled on a figure of 0.7% of national income—a target subsequently reaffirmed by endless international powwows. Although few countries have met it, aid spending in real terms has nonetheless increased steadily ever since, to $134.8 billion in 2013 (see left-hand chart). Yet economists are still arguing about how much the aid helps—if it helps at all.

Aid comes in many forms, from food and tents handed out to refugees to cash that plugs holes in poor countries’ budgets. Donors tend to stretch the definition, to make themselves look more generous. But the goal, in most cases, is to lift a poor country’s productive capacity through investment in things like roads, schools and maternal health.

What the UN sees as a potent weapon against poverty, others consider money down a rat hole. Critics reckon aid hurts its recipients by fostering dependency, propping up oppressive or incompetent regimes and pushing up the value of poor countries’ currencies, thereby undermining the competitiveness of their exports. If aid helped, they say, the poorest countries would have been getting steadily richer for decades, which they have not (see right-hand chart). Those who favour giving aid argue that it could indeed lift people out of poverty, but rich countries simply do not give enough. It is like sending fire engines to combat a wildfire: it only works if you send a lot of them.

Assessing the impact of aid on economic growth is complicated by the fact that the causality is not always clear. A positive relationship between the two could simply mean that rich countries reward poor ones for implementing policies that would have helped their economies whether or not they had brought in money. Conversely, a negative relationship may just mean that more aid flows to the countries with the most sluggish growth. In neither instance would aid actually be driving growth.

To get around this problem, economists have long hunted for a factor that affects the amount of aid disbursed but is not otherwise correlated with growth—an “instrumental variable”, in the jargon. Finding one is harder than it seems. Many proposed candidates—such as the size of a poor country’s population or even the colonial empire to which it used to belong—have been found by subsequent studies to have an independent connection to economic performance after all.

A recent paper by Sebastian Galiani and Ben Zou of the University of Maryland and Stephen Knack and Colin Xu of the World Bank proposes a new instrumental variable. After developing countries escape abject poverty, as defined by the International Development Association, an arm of the World Bank, donors usually cut their handouts to focus on poorer places instead. The IDA’s threshold is a certain level of average income per person—$1,205 this year—a definition that takes no account of how fast income is rising. So if reaching the cut-off takes a toll on growth, the drop in aid is the likely culprit.

That is indeed what the authors find. By looking at the sums received by 35 countries before and after passing the threshold, they estimate that for every 1% of national income a country receives in aid, annual growth in real income per person rises by about a third of a percentage point in the short term.

Aiding and vetting

To be sure, most of the countries in question were at a similar level of development; the sample did not include the very poorest, because their incomes are still below the threshold. Moreover, there are drawbacks to studies involving lots of countries, since they combine so many kinds of aid delivered in wildly varying conditions. But other studies have yielded similar findings.

In a paper published in 2011 Markus Brückner, then of the University of Adelaide, estimates the impact of aid on 47 countries between 1960 and 2000. Donors tend to give less to faster-growing countries, he says, which can produce a negative correlation between growth and aid. By looking at periods when severe weather and dramatic shifts in commodity prices had big impacts on growth, Mr Brückner identified variations in foreign aid that were not driven by changes in income per person. He found that a 1% rise in foreign aid lifted growth in income per person by about 0.1 percentage points.

Osborne Jackson of Northeastern University in Massachusetts looked at instances of donors boosting aid across the board when one of the countries they are assisting suffers a natural disaster (thus, the windfall in countries spared the disaster is not linked to economic growth). He concluded that aid increases household consumption, which spurs growth in the short term, but not in the long run. A study by the World Institute for Development Economics Research has reviewed all peer-reviewed papers on aid and growth published since 2008. It concludes that the evidence that aid boosts growth is itself growing rapidly.

Whether that extra growth constitutes good value for money is another question. Unfortunately, there have been few studies of the cost-effectiveness of aid. A forthcoming analysis by Chris Doucouliagos of Deakin University and Martin Paldam of Aarhus University of 141 studies published between 1970 and 2011 finds that the average estimated effect of aid on growth is positive and statistically significant, but so small that it may not be terribly meaningful. Advocates of freer trade or more liberal immigration regimes contend that the economic benefits of such measures for poor countries far outweigh those of aid. Supporters of the 0.7% target can take comfort in the growing evidence that aid boosts growth; but they have more work to do to demonstrate that it boosts it by more, and at lower cost, than the alternatives.

Studies cited in this article:

“The Effect of Aid on Growth: Evidence from a Quasi-Experiment”, by Sebastian Galiani, Stephen Knack, Colin Xu and Ben Zou, SSRN working paper, June 2014

“On the Simultaneity Problem in the Aid and Growth Debate”, by Markus Brückner, Journal of Applied Econometrics, January/February 2013

“Natural Disasters, Foreign Aid and Economic Growth”, by Osborne Jackson, SSRN working paper, February 2014

“Aid, Growth and Employment”, UNU-WIDER position paper, May 2014