Can foreign aid influence the level of industrialization in African countries?

Capital inflows, such as foreign aid, can serve as a means to enhance infrastructure development in developing countries. This suggests that foreign aid might have an impact on the level of industrialization in African nations. While existing studies indicate that foreign aid can affect the competitiveness of the manufacturing sector by appreciating the real exchange rate, the veracity of this claim relies on empirical evidence. This paper explores the influence of aid on manufacturing value added using time-series data spanning from 1990 to 2018 for 27 African countries. Employing a panel vector autoregression technique and generating associated impulse response functions, the study scrutinizes the interactions between foreign aid and manufacturing. The analysis is conducted on both the full dataset and subsamples disaggregated based on the income levels of countries. The results indicate that foreign aid acts as a stimulus for manufacturing, primarily through a sustained depreciation of the real exchange rate. This finding holds true for both the overall dataset and the subset of low-income countries. The study attributes this phenomenon to the strategic utilization of aid to enhance infrastructure, leading to a reduction in the price of non-tradables relative to tradables. Consequently, this enhances the profitability and output capacity of the manufacturing sector in African countries. In essence, the results suggest that foreign aid plays a role in influencing or stimulating industrialization in African countries. The study concludes with a discussion on the implications of these findings for industrial policy in African nations.This paper determines the extent to which foreign aid influences the level of industrialization in African countries. By using time-series data spanning from 1990 to 2018 for 27 African countries, a panel vector autoregression technique and generating associated impulse response functions, the study scrutinizes the interactions between foreign aid and the level of industrialization in African countries. The analysis is conducted on both the full dataset and subsamples disaggregated based on the income levels of countries. Our results negate the general perception that foreign aid inflows harm industrialization in developing countries, which can affect the competitiveness and profitability of manufacturing and lead to deindustrialization. However, this perception has been one-sided because foreign aid can also be used to boost infrastructure in developing countries. The paper helps to unearth the dominant effect of foreign aid in this context and samples African countries because they are generally less developed and industrialized and stand to benefit from foreign aid.