Foreign Aid, Investment and Economic Growth in Kenya: a Time Series Approach

Most of the literature on determinants of economic growth in developing countries is basedon cross-country analysis and thus only yields some patterns that hold on average. The aim of this paper is to identify aspects of the determinants of growth in Kenya, in particular if aid played a role. The empirical specifications used in cross-country work do not translate easily into country studies: many of the variables are not available annually or tend to change very slowly over time, and it is not feasible to include all potential determinants. Thus, we focus on one element of growth and use a multivariate approach on time series data for Kenya over the period 1964 – 2002 to investigate the growth effects of foreign aid, investment and a measure of international trade. Our econometric results reveal two long run relations representing the reduced form growth equation and the behavioural function of private investment. We find that shares of private and public investment, and imports in GDP have strong beneficial effects on per capita income in Kenya. However, aid in the form of net external loans is found to have a significant negative impact on long run growth. Private investment relates to government investment and imports negatively, but positively to foreign aid. The implication for policy is that in order for Kenya to foster and sustain growth, closer attention should be given to factors that promote private investment.