Aid Volatility, Human Capital, and Growth

We study the effect of aid volatility on education outcomes and economic growth, in a model that focuses on a low-income economy where acquiring skills benefits from public subsidies partly financed through foreign aid. By creating uncertainty about the net return to education, a high degree of aid volatility mitigates agents’ incentives to invest in skills. If savings and growth depend on the composition of the labor force, aid volatility may have an adverse effect on the mean growth rates of investment and output. Panel data regressions for a group of aid-dependent countries provide robust evidence of a negative relationship between the volatility of education aid and schooling outcomes.