Aid and Capital Investment - Effects of sector allocated aid on firm-level investment in the Least Developed Countries

Abstract: This paper explores the impact of foreign aid on firm investment in physical capital using a dataset of 10 783 firms in 21 of the least developed countries. Using data from the World Bank Enterprise Surveys combined with sector allocated Official Development Assistance obtained from OECD CRS, no significant effect of aid was found. Fixed effects for country, sector and year did not change this result, nor did country clustered standard errors. The result is robust to various checks and the benchmark logit model passed both the linktest and the Hosmer-Lemeshow test for model specification and goodness-of-fit. Possible indirect effects of aid were investigated and aid was found to neither affect institutional quality nor infrastructure. The failure to find indirect effects of aid on firm capital investment by positively or negatively affecting investment climate through institutions and infrastructure supports the result of the benchmark regression, that aid does not have a significant effect on firm capital investment.