The Effects of Aid and Foreign Direct Investment on Total Factor Productivity: Empirical Evidence from Bangladesh

Abstract

This paper investigates the effects of official development assistance (ODA) and foreign direct investment (FDI) on total factor productivity (TFP) in Bangladesh. Using data ranging from the period 1985-2019, an autoregressive distributed lag (ARDL) bound testing approach to cointegration is employed. Robust statistical results show that ODA has a long-run as well as a short-run positive effect on the TFP. On the other hand, FDI appears to hurt the TFP in the long- run as well as in the short-run. These findings have two important implications: funds obtained as aid from foreign donors may have been utilized in the proper development avenues, which improve overall productivity, and FDI invested in the relatively less productive sectors in the country by foreign businesses may weaken TFP. Additionally, the Toda-Yamamoto Granger causality test identifies bidirectional causality between TFP and ODA, and a unidirectional causality running from FDI to TFP. Based on the findings, this paper calls for urgent attention to upgrading the skills of the labor force in Bangladesh so that a substantial share of the FDI is drawn to the sectors which may generate strong spillovers and eventually enhance the TFP.