Aiding economic freedom: Exploring the role of political institutions

Abstract

Can foreign aid promote economic freedom? The existing literature does not provide a conclusive answer. Using a panel of 108 countries from 1971 to 2010, we provide insight to this discussion by examining aid's impact on economic freedom conditional on the quality of political institutions. We find some evidence suggesting that aid can improve economic freedom when given to democracies, but it may decrease it in autocracies. Also, aid given to entrenched regimes may reduce economic freedom. We illustrate that the results are sensitive to model selection, choice of controls, time period sample, and measurement of aid. Our results have important policy implications. Most countries that ‘need’ aid do not have healthy political institutions. As such, aid is less likely to have a positive impact on economic freedom, partially explaining the contradictory findings in the literature. This also highlights the difficulty of finding a top-down solution to institutional improvements.

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