ASSESSING THE IMPACT FOREIGN AID ON ECONOMIC GROWTH

Abstract

Despite several countries relying on foreign aid, there is a paradox as to whether aid benefits each country in the same way or differently, raising critical questions about its overall effectiveness in promoting sustainable development. This study examines the effect of foreign aid on economic growth in Tanzania, one of Sub-Saharan Africa’s largest recipients of aid. The study aimed to address three specific objectives: to explore the long term impact between foreign aid and economic growth, analyze the short-term impact of aid on economic performance, and evaluate the causal impact between aid inflows and economic growth. In this case the study employed quantitative approach to determine the effect of foreign aids in Tanzania economic growth and determine the relevance of Endogenous growth theory and Two Gap Model in Tanzania context. The study employed time-series data from 1990 to 2023 and used the Vector Error Correction Model (VECM) alongside Granger causality tests in estimating the effects. The findings reveal a negative long-term impact of foreign aid on Tanzania’s economic growth, suggesting that aid dependency may be undermining efforts toward sustainable development. In the short term, aid showed a positive but statistically insignificant impact on growth, indicating that while aid provides temporary relief, it does not significantly drive short-term economic expansion. The Granger causality test revealed unidirectional causality from economic growth to foreign aid, suggesting that donor countries increase aid in response to Tanzania's economic performance, rather than aid serving as a driver of growth. Based on these findings, the study recommends that the Tanzanian government focus on reducing aid dependency by enhancing domestic resource mobilization and improving governance to ensure aid is used productively. Additionally, aid should be more strategically allocated to productive sectors like infrastructure to amplify its immediate economic benefits