Abstract
This paper examines whether official aid, Aid, and foreign direct investment, FDI, defined here as shares of recipients' gross domestic product, are substitutes, complements or neither. We hypothesise that there is no direct relationship between the two flows.
We explain how we address endogeneity and heterogeneity issues through a number of econometric methods. Applying standard panel estimators on data for around 180 countries from 1971 to 2007, Aid and FDI seem to be substitutes even after controlling for gross domestic product per capita, GDPc.
However, this correlation is not significant once we allow for parameter heterogeneity and common correlated effects. When we allow for endogeneity we find that there is no causal relationship between Aid and FDI, and that GDPc does impact on Aid, but not FDI.
We conclude that there is no evidence of causal relationship between Aid and FDI.