The main role of foreign aid in stimulating economic growth is to supplement domestic sources of finance such as savings, thus increasing the amount of investment and capital stock. As Morrissey (2001) points out, there are a number of mechanisms through which aid can contribute to economic growth, including (a) aid increases investment, in physical and human capital; (b) aid increases the capacity to import capital goods or technology; (c) aid does not have indirect effects that reduce investment or savings rates; and aid is associated with technology transfer that increases the productivity of capital and promotes endogenous technical change.
(1) The effect of direct foreign investment and aid has been to increase economic inequality within countries. (2) Flows of direct foreign investment and aid have had a short-term effect of increasing the relative rate of economic growth of countries. (3) Stocks of direct foreign investment and aid have had the cumulative, long-term effect of decreasing the relative rate of economic growth of countries. (4) This relationship has been conditional on the level of development of countries. The stocks of foreign investment and aid have had negative effects in both richer and poorer developing countries, but the effect is much stronger within the richer than the poorer ones. (5) These relationships hold independently of geographical area.