Impact of Foreign Aid on Economic Growth in Sierra Leone

Empirical Analysis

Philip Michael Kargbo*

January 2012

This paper examines the impact of foreign aid on economic growth in Sierra Leone, a country where an empirical econometric study on aid effectiveness is yet to exist. Using a triangulation of approaches involving the ARDL bounds test approach and the Johansen maximum likelihood approach to cointegration for the period 1970-2007, we find that foreign aid has a significant contribution in promoting economic growth in the country. This finding is found to be robust across approaches and specifications. Whilst aid may have been associated with improvement in economic growth in the country, its impact during the period of war is found to be either weak or non-existent. Further, aid during the pre-war period is found to be marginally more effective than aid during the post-war period. The latter results suggest that the impact of aid may change with time.

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Operational Plan 2011-2015

DFID Sierra Leone

Sierra Leone remains one of the poorest countries in the world and is unlikely to meet any of the Millennium Development Goals before 2015, has a GDP per capita of only $254, (compared to the sub-Saharan average of $679) and continues to languish near the bottom of the United Nation’s Human Development Index. It is a fragile state in a fragile region, still under UN Security Council supervision and has a UN peace building mission as a successor to the peace-keeping operation, which ended in 2007. However, there is cause for optimism, Sierra Leone has over the last three years made a significant commitment to reduce maternal and child mortality, increase the opportunities for external investment and improve its revenue base. The UK remains one of Sierra Leone’s most significant development partners and DFID will be a key partner for the Government of Sierra Leone as it tries to accelerate the pace of development in the coming four years. DFID will continue to work to its relative strengths in Sierra Leone which are in governance, human development and wealth creation.

Sierra Leone currently remains heavily dependant on donors’ aid which currently accounts for 19% of the country’s Gross National Income (GNI) and an even higher percentage of the national budget. The Government of Sierra Leone know that they have to both make the most of existing development assistance and also ensure they are developing new, more sustainable sources of income, in particular revenues from minerals (including the potential for hydrocarbons) and agriculture. A key part of the UK’s development strategy is to reduce the dependency of the Government’s national budget on donor funds by generating a broader domestic revenue base and increasing foreign investment. Sierra Leone has one of the lowest revenue bases in Sub-Saharan Africa, currently standing at 12% GNI, compared to Liberia (in excess of 20%). It is also hard for entrepreneurs to obtain the finance they need to build their businesses and so create wealth and jobs.

The Government’s Poverty Reduction Strategy (2009-12), called The Agenda for Change, is a clearly laid out set of national priorities for development; Infrastructure; Energy; Agriculture; and Human Development. DFID’s objectives in Sierra Leone, as one of its main donors, directly support the Human Development and Energy themes while our Governance and Security and Wealth Creation work helps to sustain the environment within which development progress can take place. This represents a clear division of labour with the other three main donors, the World Bank, the European Union (EU) and the African Development Bank, who lead on infrastructure, energy and agriculture. DFID and these three multilateral donors provide 80% of total development assistance to Sierra Leone. The UK is a major stakeholder in all three of these multilateral organisations and DFID works closely with them to ensure their priorities are aligned to the Government of Sierra Leone’s priorities and they are maximising the effectiveness of their aid. This is consistent with DFID’s Multilateral Aid Review, which we are using as the basis for decisions on our engagement with donor partners.

DFID’s work is a major part of the UK Government’s engagement in Sierra Leone and the DFID objectives are fully aligned to the overall UK objective of reducing the potential for future conflict, reducing poverty, increasing prosperity and promoting democracy.

Sierra Leone is in the Mano River Union (with Ivory Coast, Guinea and Liberia). This is a fragile region which has suffered regularly from serious violence, political instability, military coups, infiltration by narcotics traffickers and extreme poverty. Today, although challenges still remain, Sierra Leone provides an example for peaceful, post conflict development for others to follow. However, until the whole Mano River Union is at peace and trade opportunities expand, Sierra Leone’s full development potential will be limited.

Opportunities for enhanced regional integration exist but are limited by current sub-regional instability; the EU is establishing road links to Guinea and Liberia which will enhance trade opportunities, in the future Sierra Leone hopes to contribute to and benefit from the West Africa Power Pool. Trade opportunities also exist in the markets of the Economic Community Of West African States (ECOWAS), especially in Nigeria and these should be developed further.

To view the paper, click here.