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The effectiveness of aid on savings and investment in Sub-Saharan Africa: do volatility and institutional quality matter?

ABSTRACT The effectiveness of aid is somewhat subject to its volatility. This study investigates the impact of aid volatility, especially on savings and investment, with a particular focus on the role of institutional quality in 45 Sub-Saharan African (SSA) countries over the period from 1990 to 2013. We used the Generalized Method of Moments (GMM) technique combined with a measure of volatility, namely an averaged data method involving six 4-year sub-periods. Our results suggest that while aid is positively associated with savings and investment, its volatility is harmful to savings and investment. However, when higher quality institutions exist, the volatility of aid has a less negative impact on savings and investment. The policy implications are diverse; first, donors and SSA aid-dependent countries need to take into account the diversity of shocks to which aid can respond in mitigating its unpredictability. Secondly, SSA countries should be encouraged to establish the conditions for better quality institutions to mitigate the negative effects of the volatility of aid on macroeconomic aggregates such as savings and investment.