Do Official Development Aid and Foreign Direct Investment Promote Good Governance in Africa?

In Africa, good governance has been preached as a panacea to reverse economic plight, to attract inflow of capital, and, in some cases, to reverse capital outflows. The flow of capital, however, has unexpected side effects on host economies¡¯ governance, among other things. Given the highly anticipated economic impacts, it is also becoming clear that the increased inflow of Foreign Direct Investment (FDI) and Official Development Aid (ODA) impact governance institutions of a host country. But the direction of the impact is not obvious. Knack and Rehman (2007) as well as Brautigam and Knack (2004) report a negative association between foreign aid and governance indicators, whereas Goldsmith (2001) indicates positive relationship between the two variables in Sub-Saharan Africa. Using data on governance indicators, FDI and ODA, the present study explores further whether FDI and ODA promoted good governance in Africa during 1975 – 2002 and attempts to explain these conflicting results. The results of the study confirm that ODA has had positive and significant effects on governance. In contrast, for the case of FDI, although contemporaneous effects could not be detected, significant effects from such investment come only a year or two after FDI firms commit themselves to start actual operation in a host country.