Abstract

Most developing countries work to attract foreign aid because it is expected to promote economic development in the recipient country. This study examines how foreign aid affects savings in Nigeria, applying the two-step Engle-Granger procedure within a co-integration framework. It uses time series data on several macroeconomic variables for the period 1970–2009, drawn from various issues of the Central Bank of Nigeria (CBN) statistical bulletin. The results show that foreign aid (ODA) has a positive effect on gross national savings (GNS) in the long run and a negative effect in the short run. In contrast, foreign direct investment (FDI) has a negative long-run effect on national savings and a positive short-run effect. Gross domestic product (GDP) and the interest rate affect national savings positively in both the long run and the short run. The error correction mechanism (ECM) term is negative and significant, which confirms a long-run relationship between foreign aid and savings in Nigeria. In light of these findings, the study recommends that the institutions and policies that support aid be considerably strengthened so that aid has a greater impact. It further recommends that government set up a civil society fund on aid effectiveness, results and accountability, to support the review and independent accountability role of national civil society organizations in monitoring aid for results.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Development economics contains two opposing views on the macroeconomic effect of foreign aid on savings. The traditional pro-aid view, which emerged early in the theoretical literature, holds that aid complements domestic resources, relieves foreign exchange constraints, transfers modern knowledge and managerial skills, and opens access to foreign markets, all of which support economic growth. Recent evidence has given this position fresh support. Arndt, Jones and Tarp (2015), focusing on the long-run cumulative effects of aid in developing countries, found that over four decades aid stimulated growth, promoted structural change, improved social indicators and reduced poverty. The radical anti-aid view, by contrast, rests on empirical observation and argues that aid displaces domestic savings, deepens income inequality, funds the transfer of unsuitable technology, finances ineffective projects, and generally helps to sustain larger, more corrupt and less efficient governments in recipient countries. Gross (2021) observes that the channels linking aid to productivity, to domestic savings and to the real exchange rate can all work against growth, which is why a well-functioning aid-investment channel matters. The same study finds that aid raises investment where institutional quality is good, and that sub-Saharan African countries benefit in particular.

From the end of the Second World War until fairly recently, Official Development Assistance (ODA) from developed countries was the main source of external finance for developing countries. Its principal purposes were to reduce poverty, provide emergency relief, support peacekeeping and expand infrastructure. Recent changes in the global economic and political environment, notably the collapse of the Soviet Union and the surge in private capital flows to developing countries, have affected ODA in ways that lead some observers to question whether aid is still viable. According to the World Bank, aid to developing countries fell by about one-third in real terms during the 1990s, possibly because donors had concluded that it no longer achieved its intended objectives. The question has regained urgency in the most recent data. The OECD (2026) reports that ODA from members of its Development Assistance Committee fell by 23.1 percent in real terms in 2025, to USD 174.3 billion or 0.26 percent of their combined gross national income, which is the largest annual contraction on record. These figures are preliminary, but they show that the debate over the role of aid has not been settled.

One of the development challenges facing Nigeria is how to reduce the high level of poverty among its population. At the heart of that challenge is how the country can sustainably feed its people, who numbered over 140 million at the time of this study. Observers nevertheless disagree about how effective foreign aid is in speeding up the process. A prominent argument for aid is that it helps reduce poverty, and the importance of poverty and hunger reduction is underlined by its position as the first of the eight Millennium Development Goals (MDGs). To help developing countries meet the MDGs by 2015, the international community called for aid to be raised to 0.7 percent of the gross national product (GNP) of industrialized countries, from a level then close to 0.24 percent. That call was accompanied by warnings that a very large increase in aid flows, roughly three times the existing level, could create difficulties for the poorest recipients, and that donors would need to consider carefully how to allocate aid among countries and among complementary poverty-reduction programmes if it was to be used efficiently. The gap between the target and actual provision has persisted, since the OECD (2026) puts the 2025 ratio at only 0.26 percent.

Aid is given for many reasons, but the main argument in its favour is that it will raise the rate of economic growth in recipient countries. Expectations of aid-induced growth have often been unrealistic, largely because aid tends to flow into consumption rather than productive activity, which crowds out domestic savings and investment. Bekele (2020) illustrates the risk for Ethiopia, finding that in the long run total aid crowded out domestic savings because the negative effect of multilateral grants outweighed the positive effects of other aid types, and he urges government to pay closer attention to how such grants are finally used. Calls for more aid to Nigeria have intensified in recent years. Developed countries, international organizations and other philanthropists have renewed their appeals for a massive injection of development aid, and experts who favour more aid argue that it would materially benefit the people of the recipient country.

The role that Western assistance can play in relieving Africa's extreme poverty, Nigeria included, depends on the theory one adopts to explain why Africa is poor. Economists have proposed several models of poverty, each with different implications for aid. They include the big push models, project interventions in education, health and infrastructure, models of policy and growth, and models linking aid, institutions and development. Drawing on these and other theories, many researchers have studied empirically how aid inflows affect growth and savings. Most of this work has used panel or cross-country data, as in the sample of 91 to 115 countries analysed by Gross (2021). The main thrust of the present study is different, as it examines the connection through a time series analysis of a single country, Nigeria.

Nigeria is a mono-product economy that depends excessively on the oil sector, and this dependence has been linked to a shortage of investment capital. A country whose main source of foreign exchange is oil will continually lack investment capital, because oil revenue is exposed to the instability of international markets and must therefore fluctuate sharply. Shuaibu and El-Yaqub (2024) similarly describe the vulnerability of Nigeria's public finances to oil price movements. This situation has produced a savings gap and a foreign exchange gap, which together leave a wide divide between actual domestic investment funds and the investment required to speed up economic growth. Foreign capital has accordingly been seen as a way of bridging the divide. Kolawole (2013) explains the logic of the two-gap framework: investment above domestic savings defines a savings gap, and import requirements above export earnings define a foreign exchange gap, with aid directed to countries that face a balance-of-payments constraint. For a country like Nigeria, which has an investment gap and wants to reach a desired growth rate, foreign aid deserves serious consideration, since it brings in funds from the rest of the world to fill that gap.

1.2 Statement of the Problem

Foreign aid has been a defining feature of the relationship between industrial and developing countries since the 1960s, and it has been a major source of external finance for most countries in Africa and Asia since they gained independence.

From a development perspective, aid was conceived in the post-Second World War setting, within a particular development paradigm in which poor countries were seen as trapped in a low-income equilibrium, unable to generate enough savings for capital formation and rapid growth. Foreign aid was expected to lift such economies out of that trap, on the general belief that capital from developed countries was needed to produce the growth that would make economic take-off possible. This is the core of the two-gap model, which Kolawole (2013) applies to the Nigerian case. The dominant form of aid has changed considerably, moving from project finance in the 1960s to adjustment support in the 1980s, but its economic importance to recipients has remained substantial.

The United Nations Conference on Trade and Development (UNCTAD) stressed the importance of aid to Sub-Saharan Africa (SSA) by arguing that an increase in official flows of USD 20 billion could start a virtuous circle of rising national savings and investment and faster growth in the region, and that doubling aid to give African economies a big push could end their dependence within a decade. Donors and aid users then made a commitment at the World Summit for Social Development (WSSD) in Copenhagen to reduce the number of people living in extreme absolute poverty by 2015. According to the World Bank, achieving this would require African economies to grow at 7 percent a year, supported by productive investment equal to about 30 percent of African GDP annually. Given the region's low savings rates and limited short-term prospects of attracting private capital, the Bank estimated that this would imply roughly a 20 percent increase in the African aid budget, provided the additional resources were fully invested. Developed countries were urged to raise aid flows to 0.7 percent of GNP as soon as possible.

Recent discussion of aid effectiveness has centred on Africa, because it has received the largest amount of aid per head of any world region. Nigeria, however, has received less aid per head than other Sub-Saharan countries. Earlier estimates for 1990–96 put average net real ODA for African countries at USD 52 per person, against only USD 2.20 for Nigeria. As a share of GNP, net ODA to SSA averaged 14 percent, while for Nigeria it was below 1 percent. Even so, aid remains significant for Nigeria, especially for agriculture, a major recipient. Of a total net ODA of USD 350 million in 1990, about 25 percent went to the agricultural sector.

Despite the Copenhagen commitment, aid flows to Nigeria and to other developing countries have been declining. This is the pattern commonly described as aid fatigue, and the OECD (2026) data on the 2025 fall in ODA show that it has not abated. Meanwhile, Africa continues to suffer from heavy indebtedness, high unemployment and absolute poverty. Foreign aid has continued to play an important role in developing countries, especially in Sub-Saharan Africa, yet after half a century of directing resources to the developing world, little development has taken place. Weak institutions, corruption, inefficiency and bureaucratic failure in recipient countries are often cited as the reasons, a view consistent with the finding of Gross (2021) that aid supports investment mainly where institutions are of good quality.

A wide gap also exists between savings and investment in most less developed countries, Nigeria included. Without savings there can be no investment, and Oyedepo and Okor (2024) find that, in the short run, domestic savings significantly increase investment in Nigeria. In the Keynesian view, savings and investment are equal ex post, since the excess of aggregate income over consumption cannot differ from the addition to the capital stock, otherwise called gross domestic investment or capital formation. Savings is therefore a residual, and the decisions to consume and to invest together determine the volume of national income accumulated in a period, which is referred to as gross national savings.

In Nigeria, as elsewhere in Sub-Saharan Africa, the mobilization of savings and deposits has long hindered economic growth and development. Savings and investment remain very low because of high inflation and continual devaluation of the local currency, which restricts credit to the economy. Oyedepo and Okor (2024) likewise report that inflation significantly reduces domestic investment in Nigeria. Because financial resources are vital to economic development, their mobilization raises capital formation. Capital formation, or gross domestic investment (GDI), requires either the release of domestic goods and services for investment in real assets, or the import of resources from abroad, or, as is usually the case, a combination of both.

Over the period under study, average per capita income in the region was reported to have fallen since 1970 despite high aid flows. This prompted donor agencies and experts to revisit the earlier debate on the effectiveness of foreign aid. The macroeconomic impact of foreign aid on domestic savings in developing economies therefore remains inconclusive and merits further study. The research questions are accordingly as follows:

1. What is the short-run and long-run impact of foreign aid on domestic savings in Nigeria?
2. What is the impact of other macroeconomic variables, namely gross domestic product (GDP), interest rate and foreign direct investment (FDI), on national savings in Nigeria?

1.3 Objectives of the Study

The broad objective of this study is to determine the macroeconomic impact of foreign aid on domestic savings. Specifically, the study intends to:

1. Find the short-run and long-run impact of foreign aid on domestic savings in Nigeria.
2. Determine the impact of gross domestic product (GDP), interest rate and foreign direct investment (FDI) on domestic savings in Nigeria.

1.4 Hypotheses

The following null hypotheses were formulated to guide the study:

1. Foreign aid does not have a significant short-run and long-run impact on domestic savings in Nigeria.
2. Gross domestic product (GDP), interest rate and foreign direct investment (FDI) do not have a significant impact on domestic savings in Nigeria.

1.5 Significance of the Study

It is often argued that aid works best in a good policy environment, so that a poor country with sound policies should receive more aid. Gross (2021) supports this reasoning, since the study finds that aid raises investment in countries with good institutional quality. A well-designed aid package can strengthen institutions and governance by supplying knowledge and by transferring technology and skills. It is often recommended that the components of aid be decentralized within recipient countries, because monetary aid is necessary but technical and idea-based aid is more important. In Nigeria, therefore, where a good policy environment is present, aid has the potential to mobilize savings for investment projects, and it can also support reform through the training of policy makers and the transfer of technology.

The results of this study are expected to encourage government and policy makers to revisit the economic objectives of foreign aid and to set up an implementation committee to ensure that aid resources are used effectively. They should also encourage government to analyse critically the costs and benefits of any aid package, so that donor motives do not undermine the economic purposes for which aid is sought.

Other things being equal, the results should further encourage government and policy makers to adopt policies and measures that increase both domestic and foreign savings as a foundation for capital accumulation. The study is also expected to point to measures that will ensure that accumulated capital is fully used in the production process, thereby raising the level of output.

1.6 Scope and Delimitation of the Study

This study is limited to investigating the impact of foreign aid on domestic savings in Nigeria. It is therefore based on the Nigerian economy and covers the sample period 1970–2009. The choice of this period was guided by the availability of data and by the need for a precise time series analysis.

References

Arndt, C., Jones, S., & Tarp, F. (2015). Assessing foreign aid's long-run contribution to growth and development. World Development, 69, 6–18. https://doi.org/10.1016/j.worlddev.2013.12.016

Bekele, Y. (2020). The impact of disaggregated foreign aid on domestic saving in Ethiopia. Ethiopian Journal of Business and Economics, 10(1). https://doi.org/10.4314/ejeb.v10i1.5

Gross, E. (2021). Aid effectiveness: When aid spurs investment. Applied Economic Analysis, 29(87), 189–207. https://doi.org/10.1108/AEA-08-2020-0110

Kolawole, B. O. (2013). Foreign assistance and economic growth in Nigeria: The two-gap model framework. American International Journal of Contemporary Research, 3(10). https://www.aijcrnet.com/journals/Vol_3_No_10_October_2013/19.pdf

Organisation for Economic Co-operation and Development. (2026). Preliminary official development assistance levels in 2025. OECD Publishing. https://one.oecd.org/document/DCD(2026)8/en/pdf

Oyedepo, E. O., & Okor, O. J. (2024). Determinants of domestic investment: Evidence from Nigeria. African Journal of Economic Review, 12(1). https://doi.org/10.22004/ag.econ.340557

Shuaibu, M., & El-Yaqub, A. B. (2024). A closer look at the nexus between oil price and non-oil revenue in Nigeria. Iranian Economic Review, 28(2), 369–390. https://doi.org/10.22059/IER.2022.88412