Ethnic fractionalisation and aid effectiveness

We test the hypothesis that the effect of foreign aid on economic growth is positive in ethnically homogenous countries, but decreasing in ethnic fractionalisation. Using panel data covering 114 aid-recipient countries over the period 1962 to 2001, and employing two-stage least squares and GMM estimation techniques, we find a strong support for this hypothesis. Our estimates suggest that foreign aid promotes growth in ethnically homogenous countries, while being ineffective or even harmful in many Sub-Saharan African countries and some ethnically fractionalised countries elsewhere.