Chapter 16 Aid and Growth in Kenya: A Time Series Approach

There is now a large, if rather contentious and inconclusive, cross-country empirical literature on the effectiveness of aid in contributing to economic growth. Surprisingly, perhaps, there are very few country studies of aid effectiveness, and none of which we are aware that adopt a time series econometric approach to analyzing the impact of aid on growth. This chapter is an attempt to fill that gap, through a study of Kenya over the period 1964–2002. The core hypothesis underlying our approach is that aid does not have a direct effect on growth, but can have indirect effects through mediating channels. Given the requirements of time series techniques, we focus on two channels for the aid-growth relationship, one through effects on government fiscal relationship (as aid finances public spending) and another through effects on investment (as aid finances public investment). The analysis is no more than indicative but suggests a number of reasons why aid has not been effective in Kenya: reliance on aid loans to finance unanticipated budget deficits, low productivity of public investment and adverse effects of government behavior on private investment. Addressing these deficiencies is necessary if Kenya is to be enabled to utilize aid to improve its poor economic performance.