Re-Examining the Effects of Remittances, Foreign Direct Investment, and Foreign Aid on Economic Growth

There is considerable debate about the effects of remittances, foreign direct investment (FDI) and official development assistance (ODA) on economic growth in developing economies. These inflows represent the three main sources of foreign income in the developing economies after exports. Unlike income from exports, remittances, FDI and ODA are not generated by activities within the country.;To date the majority of studies in the literature have estimated the effects of these inflows in isolation, with a few studying two of them together. In this study, I estimated the effects of remittances, FDI and ODA on economic growth following the most recent methodology. I included all three inflows because the omission of one of these sources of funds can generate an omitted variable bias. I used a panel GMM model with a sample of 85 countries to analyze their effects on economic growth. I constructed my sample into non-overlapping five-year averages to control for fluctuations in the business cycle.;I found that remittances and FDI had a substantial positive impact on economic growth that was approximately equivalent compared to the negative impact of ODA. The positive contribution of remittances can be explained by increased investment in small business enterprises and increased spending on education, which both promote long run economic growth. The negative contribution of ODA can be explained by corruption and other misuses of these funds. Thus the role that institutional quality plays in recipient countries is important particularly in relation to ODA. I found that failure to include all three variables lead to serious bias in the estimation.;In addition to institutional quality as a mediating factor, debate remains concerning the role that financial development plays in the relationship between remittances and economic growth. I found that the contribution of remittances to economic growth was greater in countries with low levels of financial development. Remittances may help to ease financial constraints that lower the cost of capital and promote higher domestic investment in recipient countries. Thus remittances were more important in countries where domestic financial markets were not well developed.