The Next Step in African Development: Aid, Investment, or Another Round of Debt?

Abstract

Amidst intense debt relief, and alongside dramatically improved governance, investment and growth increased substantially across Africa during the past decade. This paper interprets the timing of the Heavily Indebted Poor Countries (HIPC) Initiative, launched by the IMF and World Bank in the late 1990s, as a natural experiment to see whether these positive trends were specific to Africa, or specific to HIPC countries, as well as whether debt relief itself manifests deeper structural shifts in economic governance. As many HIPC countries are presently raising their external public debt levels, we question whether these loans would be a “good kind of debt” that leads to investment and development or the beginning of a new debt cycle potentially leading to another round of debt relief programs. Data on external debt and capital development for 46 countries of sub-Saharan Africa and six other HIPC countries outside of Africa is used to evaluate structural breaks and parameter stability in a longitudinal panel analysis. Incorporating an identification strategy that isolates the debt relief initiatives from endogenous improvements to economic governance, we find that they had a statistically significant impact on foreign investment flows to Africa. The data suggests that even alongside new escalating debt levels, investment will likely be the next step in African development.