Australian Journal of Business and Management Research Vol.3 No.04 [09-18] | July-2013 ISSN: 1839 - 0846 9 Foreign Aid and Poverty level in West African Countries: New evidence using a heterogeneous panel analysis Olofin Olabode Philip (Corresponding Author) Obafemi Awolowo University, Ile-Ife, Nigeria opolofin@oauife.edu.ng ABSTRACT This paper re-examines the effects of different types of foreign aid on poverty level in 8 West African countries between 1975 and 2010 by employing both the first and second generation econometrics methods of panel unit root test, cointegration test and empirical estimators with heterogeneous slopes. Our results suggest that total foreign aid and food aid impact positively on poverty, while technical aid reduces poverty. Apart from total foreign aid, none of the results was statistically significant. The results show negative relationship among poverty, life expectancy, foreign direct investment, per capita GDP and financial depth, but they were not statistically significant. This suggests that their impacts on poverty in West Africa were minimal. Keywords: Foreign aid; Poverty; Non-stationary panels; Parameter heterogeneity; Cross sectional dependence, West African countries. BACKGROUND In spite of the large of amount of foreign aid disbursed to developing countries as a whole and West African Countries in particular, the belief that foreign aid provides the take off ground for financial constrained economy and the consensus reached at Monterrey in March 2002 that donor community will increase aid flow to encourage the achievement of the Millennium Goals, studies have revealed that increasing foreign aid as a tool for promoting economic growth as well as reducing poverty is still empty of empirical generality. With increase in foreign aid, favorable environment and growing working population, threat of hunger and poverty alongside increased unemployment persist in West Africa. Ten of the twenty countries considered to possess the world’s lowest human development indicators are found in West Africa (UN, 2008). This shows that the issue of foreign aid as a panacea for reducing poverty remains a subject of debate in West African Countries. While some researchers argued that foreign aid can spur growth and thereby reduce poverty (see Arndt et al. 2010, 2011; Chowdhury and Das, 2011; Miller and Torr, 2003; Addison,Mavrotas and McGillivray, 2005; Sachs et al., 2004), some have argued that there is possibility of not spending foreign aid inflow on productive sectors, instead it can be wasted on frivolous spending (i.e. aid fungibility) as well as encourage corruption (Freidman, 1958;. Bauer, 1971, 1991; Boone, 1994, 1996; Radelet, Clemens, and Bhavnani 2005; Hodler, 2007; Economides et al., 2008) and therefore, it can undermine incentives for both private and government savings, sustain bad governments in power, helping to perpetuate poor economic policies and delay proper reforms, discourage private investment, motivating currency appreciation, and in consequence could lead to non- competitiveness in the production of non-tradable goods (i.e. Dutch diseases). A common feature of these studies is that they have based their analysis on using the first generation of panel unit root test, cointegration test and empirical estimators which assumed that panel members were cross sectionally independent as suggested by Im et al, (2003); Maddala and Wu, (1999); Pedroni, (1999, 2004). Example is Chowdhury and Das (2011). The second generation such as Bai and Ng, 2004; Bai, Kao and Ng, 2009; Pesaran 2006, 2007) have explicitly expressed great concern on the correlation across groups of the panels. Despite this disagreement, relatively few studies have applied and compared these methods in their analysis. Exceptions to this are the work of Herzer and Nunnenkam, (2012) that examined the effects of foreign aid on income inequality for 21 recipient countries over the period 1970-1995. However; this study failed to examine the effects of aid components on poverty. On this note, this study explores the advantages of first and second generation econometric methods to reexamine the effects of foreign aid on poverty level in West African Countries. The remainder of this paper is organized as follows. Section 2 examines the literature review, section 3 discusses and specifies our model, section 4 discusses the method, sources of data and measurement of variables. Section 5 discusses the results, while section 6 presents concluding remarks.