Ever since the notion of human development was introduced, it has been a key concept and a practical problem requiring global effort in addressing and solving it. With COVID-19 and its repercussions, issues regarding human development have become more important. According to the World Health Organization (WHO), over 100 million positive corona virus cases have been confirmed, and over 2.2 million people have died.¹ It is gradually becoming the worst pandemic in history, negatively affecting millions of people worldwide. Not only does this situation require the allocation of foreign aid to alleviate the situation and improve human development, but scholars should urgently seek to enhance its effectiveness.

While the term human development holds slightly different meanings among people, the general consensus is that it means more than just gross domestic product (GDP) growth (Human Development Report 2020). Factors such as educational opportunities and long, healthy lives have become equally important. In light of this, the Human Development Index (HDI) was developed as an alternative metric in 1990, and it has been included in every Human Development Report ever since. Although HDI itself is not a perfect measurement, it provides a general idea of a country’s human development, which made it the most widely used well-being index around the world. HDI made it possible for policymakers and practitioners to discuss human development in a broader spectrum.

Several mechanisms are believed to improve human development; however, in this study, we consider two of the most important ones: official development assistance (ODA) and foreign direct investment (FDI). While both mechanisms concern the transfer of money from more developed countries to developing countries, their characteristics are distinct. The former is, in principle, given to recipients without any compensation, and the latter is more of an investment, which requires returns from the recipients. Although scholars have paid much attention to the impact of ODA and/or FDI on human development, these relations have not been studied systematically using HDI, theoretically nor empirically. In this study, we attempt to narrow this gap by assessing the effect of FDI on human development. Moreover, we investigate the moderating effect of ODA on the relationship between FDI and human development.

Using the HDI panel dataset, our empirical results show that a high level of FDI seems to improve human development. This result is consistent with existing studies that show a positive relationship between FDI and human development, emphasizing that investing in the industry can improve human development. Further, the moderating effect of ODA on the relationship between FDI and human development is confirmed. The results show that ODA might weaken the relationship between FDI and human development. This study reveals the positive impact of FDI on human development, but raises the question of ODA effectiveness to improve human development.

This paper has five sections, including this section. The second section develops the hypotheses, based on the existing literature, and explores the relationship between human development, FDI, and ODA. The third section describes our methodology and data, and the fourth section presents the empirical results. The final section concludes and presents the study’s implications and limitations.

Relationship between FDI and Human Development

Existing studies suggest divergent views on FDI impact on the development of recipient countries. Some studies point out the possible negative effect of FDI on the recipient country (Moran 2011), as FDI capitalizes on market imperfections and leverages pecuniary (or vertical) and non-pecuniary (or technological) externalities (or spillovers) (Eden 2009). Carkovic and Levine (2005) criticize previous macroeconomic studies that propose a positive link between FDI and growth by pointing out a few statistical problems that distort the result. Hence, FDI inflow does not have an independent influence on economic growth.

However, the positive impact of FDI on economic growth has earned conventional wisdom status (Mencinger 2003). Zhang (2001) states that the positive linkage between FDI and economic growth is conditional on the host country’s specific characteristics, such as its liberalized trade regime, favorable human capital conditions, and macroeconomic stability. Hansen and Rand (2006) show that a strong relationship exists between FDI and GDP growth and that FDI has a significant impact on GDP in the long run, regardless of the development level of the recipient country. Wu and Hsu (2008) state that FDI alone has an ambiguous effect on economic growth; however, FDI plays an important role when the host countries’ conditions are met in terms of initial GDP and human capital. Empirical evidence indicates that the widespread belief within policy circles that FDI promotes the productivity of host countries and, therefore, contributes to economic development is only true if the host countries have well-developed financial markets (Alfaro et al. 2010).

Reiter and Steensma (2010) point out that FDI is positively related to improvement in human development, and this relationship is even more significant when FDI policy is adjusted in the right manner and when corruption is low. Though the magnitude of respective significance, time frame, and location of the research vary, some studies confirm the positive influence of FDI on components of human development, measured by HDI (Sharma and Gani 2004; Gökmenoğlu et al. 2018).

FDI might affect job opportunity, infrastructure improvement, and economic growth in the long term, resulting in macro-level changes. It has a positive effect on the overall welfare of a country (Anand and Sen 2000; Lehnert et al. 2013; Sharma and Gani 2004). For instance, FDI by transnational corporations helps create job opportunities. Karlsson et al. (2007) find empirical support for the positive effect of FDI on job creation in foreign firms. In addition, a positive indirect effect in domestic firms is also witnessed and is presumed to have been caused by spillover effects.

FDI, which includes capital and technology, as well as management expertise, improves the economic growth of the recipient country (Sharma and Gani 2004). For instance, Chamarbagwala et al. (2000) show that foreign capital investment has contributed to improving the average manufacturing productivity of recipient countries in Asia. This is because FDI invests heavily in human capital, which is difficult for governments in least developed countries to do. This positive FDI effect increases when local firms have the capacity to absorb and compete with new firms (Lehnert et al. 2013).

Moreover, according to a study by Hsiao and Shen (2003), in the short run, FDI inflow causes a 1% increase in GDP growth, and in the long run, a 7% increase in GDP growth. This result shows the possible edge that FDI has on economic development in the long run, and is confirmed in later work. Njangang et al. (2018) found empirical support for a positive and significant long-run relationship between FDI and 36 African countries; simultaneously, foreign aid and migrant remittances did not show any significant results.

FDI also improves the infrastructures in recipient countries, which is fundamental for production and productivity. Infrastructures, such as roads, telecommunications, and water supply, increase as FDI inflow increases (Wang 2019). In addition, the capacity of the firm to absorb FDI is likely to be influenced by the host country’s “knowledge infrastructure.” Intellectual property protection, regulation, and utilizing knowledge spillovers are examples of knowledge infrastructure (Lehnert et al. 2013).

Conventional wisdom can be questioned because most of the empirical results that support the positive impact of FDI on development have one or more conditions, which could be translated as a lack of robustness. However, considering that even studies that cast doubt on FDI effectiveness posit that FDI may have a significant positive impact on development under certain conditions (Carkovic and Levine 2005; Moran 2011), the relationship between FDI and human development, in general, is considered positive.

After all, it would be unwise for a state to block the inflow at any cost because, in most cases, the positive impact of FDI inflow, such as creating employment opportunities and transferring technology, are greater than its downsides (Vissak and Roolaht 2005). More importantly, the fact that FDI inflows continuously increase in magnitude, even surpassing ODA, indicates that FDI influences the host countries’ economic ability to promote development (Benmamoun and Lehnert 2013; Lehnert et al. 2013). Considering that most of the empirical evidence favors the positive aspect of FDI, we hypothesize the following:

H1: FDI has a positive impact on human development.

Moderating Effect of ODA on the Relationship between FDI and Human Development

Because ODA and FDI flow into recipient countries simultaneously in most cases, it is important to understand whether ODA has a positive or negative effect (or no effect for that matter) on the relationship between FDI and human development. While some studies do not explicitly use the term, or investigate, the “moderating effect” of ODA, they suggest that ODA strengthens the relationship between FDI and human development.

Selaya and Sunesen (2012) focus on the relationship between foreign aid and FDI. They conclude that an increase in foreign aid, which is invested in complementary inputs, draws in FDI, while aid invested in physical capital crowds it out. This indicates that the composition of aid is important for FDI efficiency, providing an insight into the possible synergy that exists between ODA and FDI in the host countries. Moe (2008) investigates the relationships between different types of ODA² and human and educational development³ in eight Southeast Asian countries. In summary, the results suggest that sustainable economic growth and FDI, coupled with ODA, have a positive impact on human and educational development. Similarly, Blaise (2005) argues that Japan’s ODA was successful in promoting FDI inflow in delivering the funds needed for development assistance programs, in the case of the People’s Republic of China. In support of this view, Rotarou and Ueta (2009) find that ODA is only beneficial to a country’s economic growth because other factors, such as the implementation of relevant policies and increase in FDI, were also present.

However, ODA also weakens the relationship between FDI and human development. Arguably, aid has a positive long-run growth impact on a recipient country’s economy, when the recipient country is somewhat democratic. This is because the institutionalized check on governmental power prevents the utilization of aid for non-productive goals (Svensson 1999). Moreover, sound and relevant economic policies are also very important for aid to work. When invested, aid is effective for growth, and this is likely to only occur based on the extent of good fiscal, monetary, and trade policies in developing countries (Burnside and Dollar 2000). Good policies prevent aid from being dissipated in unproductive government expenditures.

These results suggest that ODA has the potential to strengthen the relationship between FDI and human development. However, we need to consider the following facts: Most recipient countries are not consolidated democracies and, therefore, lack the required institutionalized check on governmental power to prevent ODA from being wasted. Moreover, recipient countries, in general, lack good governance to meet all the pre-conditions that the literature mentioned above suggest, such as good fiscal, monetary, and trade policies, for ODA to work effectively. Further, Knack (2001) proposes that aid dependence is likely to undermine the recipient country’s quality of governance by weakening accountability and causing conflicts and corruption, implying that not only does aid not necessarily help the recipient country’s economy, but it can also be a curse in a broader spectrum. For example, public corruption may distort public policy and undermine operational efficiency, thus negatively affecting income distribution and poverty situation (Chen et al. 2010).

How does this relate to the moderating effect of ODA? As mentioned in the FDI literature section, FDI is positively related to improvement in human development. This relationship is even more significant when the FDI policy is adjusted in the right manner and when corruption is low (Reiter and Steensma 2010). This means that good governance and low corruption are also important factors for FDI inflow and their impact on human development. Thus, if ODA undermines the governance of a country and causes corruption, it more likely weakens the positive relationship between FDI and human development because it means that ODA hinders the inflow and performance of FDI. We also need to consider the general history of ODA ineffectiveness. Despite the steady flow of development aid to developing countries, only a few countries in East Asia have experienced improvement in their poverty situation, while many other poor countries have neither experienced positive nor even negative effects on their real per capita income (Ovaska 2003). The negative effect of ODA is likely to undermine the ground on which FDI best performs. To summarize, there are conflicting views on the impact of ODA on the relationship between FDI and human development. Therefore, we propose the following hypotheses:

H2-1: ODA strengthens the relationship between FDI and Human Development.

H2-2: ODA weakens the relationship between FDI and Human Development.

This study is designed to investigate the relationship between FDI and human development. Moreover, we attempt to understand the possible moderating effect of ODA on the relationship between FDI and human development. Hence, the conceptual model below is created to visually understand this process. In this study, we do not try to uncover the direct impact of ODA on human development. Instead, we examine how ODA intervenes to either strengthen or weaken the ties between FDI and human development. As this moderating effect model has been used in many studies in the political science domain (Lim et al. 2020; Yoon and Moon 2019), we propose that this model will provide explanations regarding the moderating effect of ODA in this study as well.

Dependent Variables and Methods

To reflect the situation in countries, regarding human development, we adopt the HDI from UNDP as a dependent variable. Human development is a “broad concept, aiming at enlarging people’s choices and freedoms.”⁴ Even though HDI itself is not a perfect measurement to account for all human development dimensions, no other measurement better captures human development elements that are necessary to reflect more developing countries in the world.

Therefore, we decided to use HDI as the best available human development measurement; it is a widely used index for this measurement and a composite index that reflects three key human development dimensions: long and healthy life, knowledge, and a decent standard of life. These dimensions are reflected by the indicators of life expectancy at birth, expected years of schooling, mean years of schooling, and gross national income per capita (PPP \$). While HDI varies from 0 to 1 in the original dataset, we multiply it by 100 with a variation from 0 to 100.

As this index covers most countries for the period of 1990–2018, we have a panel dataset for the empirical analysis. For countries, we attempted to include all recipients during this period. Since we used the recipient list from the Organization for Economic Cooperation and Development (OECD), we included all historical recipients, such as Israel, the Republic of Korea, Qatar, among others. The countries’ data were dropped after they stopped receiving ODA from donors.⁵ We included all historical recipients, starting with 155 recipients, and excluded territories; we ended up having 130 recipients. Moreover, we ran another empirical model with 122 current recipients. In both cases, territories and small recipients were dropped because the other variables had missing variables.

To reflect the characteristics of the panel dataset, we considered using either fixed-effects or random-effects models. Since the dataset includes almost all developing countries, and does not intentionally exclude some, it might be desirable to adopt fixed-effects models over random-effect models (Greene 2018). The Hausman test also supports the use of fixed effects models (Greene 2018).

Independent and Control Variables

For the main independent variables, we included the logged amount of FDI inflow and the logged amount of the recipients’ ODA. The FDI inflow is from the World Development Indicators (WDI), and the amount of ODA is from the OECD. As the amount of both FDI inflow and ODA were dispersed, we logged them to prevent statistical distortion.⁶ In addition to these main independent variables, we included several control variables that might affect human development. These control variables reflect the political, economic, and social aspects of the recipients. For the political aspects of recipients, we included the level of democracy and the corruption index. The logged GDP and logged GDP per capita were included to reflect economic conditions. The social aspects of the recipients are measured using the logged population and the urban population rate.

Human development is closely related to domestic political regimes, for example, democracy (Gerring et al. 2012; Liotti et al. 2018). The stronger and older the recipients’ democracy is, the better human development can be. The dataset was from the V-dem dataset.⁷ The corruption index from the V-dem dataset was also included to measure how corrupt the recipients’ political systems are; as it varies from 0 (least corrupt) to 1 (most corrupt) and measures the level of corruption in the recipients’ political systems. The index is calculated by taking the average of the public sector, executive, legislative, and judicial corruption indices.

The recipient countries’ governance can be an important factor that influences the human development level. The corruption level influences human development conditions (Reiter and Steensma 2010; Keser and Gökmen 2018). If recipient countries are corrupt, inflow FDI can barely influence the human development level (Reiter and Steensma 2010). While inflow FDI is supposed to promote the economic development of recipient countries, its influence might disappear owing to corruption in a corrupt society (Habib and Zurawicki 2002; Al-Sadig 2009; Reiter and Steensma 2010).

Other socioeconomic characteristics of the recipients need to be considered. Therefore, we include the logged GDP, logged GDP per capita, logged population, and urban population rate from the WDI. All independent variables are lagged by one year to address possible endogeneity issues.

To test the moderating effect of ODA, the moderated regression analysis (MRA) is adopted, following Sharma et al. (1981). Based on the MRA, we need to have the following three equations: In the first equation, we test the effect of the main independent variable (ln(FDI)) on the dependent variable (HDI). The ODA variable is introduced in the second equation. To understand the moderating effects, the third equation includes the interaction between FDI and ODA.

(1) HDIt = ln(FDI)t-1 + Democracyt-1 +Corruption Indext-1 + ln(GDP)t-1 + ln(GDP per capita)t-1 + ln(Population)t-1 + Urban population ratet-1

(2) HDIt = ln(FDI)t-1 + ln(ODA)t-1 + Democracyt-1 +Corruption Indext-1 + ln(GDP)t-1 + ln(GDP per capita)t-1 + ln(Population)t-1 + Urban population ratet-1

(3) HDIt = ln(FDI)t-1 + ln(ODA)t-1 + ln(FDI)t-1*ln(ODA)t-1 + Democracyt-1 +Corruption Indext-1 + ln(GDP)t-1 + ln(GDP per capita)t-1 + ln(Population)t-1 + Urban population ratet-1

The Effects of FDI on Human Development

Before exploring the moderating effects of ODA on the relationship between FDI and human development, we need to reveal the effects of FDI on human development. In Table 1, Models 1–3 are tested, using all historical recipients, and Models 4–6 using the current recipients. Models 1 and 4 in Table 1 show that FDI strongly influences human development. In both models, the relationship between FDI and human development is statistically significant at the 5% significance level. This result is aligned with existing studies that show a positive relationship between FDI and human development, emphasizing the fact that macro-level investment in the industry can improve human development. Fatah et al. (2012) demonstrate that FDI has a positive impact on economic growth in Asia and Latin America. For example, the positive effect of FDI on economic growth is consistent and statistically significant for both China and Indonesia at the 1% and 5% significance levels, respectively. They argue that the positive effect of FDI in these Asian countries is due to their macroeconomic stability, improvement in human capital and education, export-promotion strategies, and policies that favor export-oriented FDI.

Other statistically significant control variables are the corruption index, logged GDP, logged GDP per capita, logged population, and urban population rate. These variables are closely related to human development. Unexpectedly, the levels of democracy did not show any statistical significance in the two models. Interestingly, the corruption index shows a statistically positive impact on human development. We believe that the positive aspect of corruption seems to function for better human development conditions when we only consider the recipients. For example, in line with the “greasing-the-wheels” hypothesis, many studies suggest that corruption could be a growth-enhancing factor for some countries (Méon and Weill 2016; Mallik and Saha 2010).

Models 2 and 5 in Table 1 confirm two important findings. First, the consistent effects of FDI on human development are confirmed with the variable of ODA. Aligned with the findings from Models 1 and 4, FDI has a statistically significant impact on the improvement of human development. Second, we confirm that ODA can function as a moderating variable. Considering these two findings, we observe the moderating effects of ODA on the relationship between FDI and human development.

The Moderating Effects of ODA on the Relationship between FDI and Human Development

From Models 3 and 6, in Table 1, the effect of FDI on human development is still positive and statistically significant at the 5% level. However, the moderating effects of ODA on the relationship between FDI and human development show a negative coefficient at the 1% and 5% significance levels in Models 3 and 6, respectively. This implies that while FDI has a positive effect on human development, its significance decreases as more ODA is provided to recipients. In other words, the average effect of FDI on human development in recipients is positive when recipients do not receive ODA. However, the effect of FDI on human development in recipients decreases as more ODA is provided.

This finding indicates that ODA can weaken the positive impact of FDI on human development. The existing aid literature emphasizes that ODA has a negative or no impact on human development (Doucouliagos and Paldam 2009; Williamson 2008). Even worse, ODA can sometimes deteriorate human development by causing corrupt political and economic systems (Knack 2001). Therefore, even though FDI can positively influence human development, its effect can be diminished because of the negative impact of ODA.

Improvement in human development requires development in many areas. Fundamental economic development is essential in the long term, and the welfare of people should be considered. While both FDI and ODA are supposed to promote economic development in developing countries, FDI generally seems more effective in terms of macro-level economic development than ODA (Bird and Choi 2020; Unceta et al. 2010). While ODA can increase the level of human development, as shown in empirical studies, it can diminish the significance of the positive effects of FDI on human development.

Robustness Check

To understand the effects of FDI on human development, we first show the relationship between FDI and human development in Figure 1, which shows a positive relationship between the average of the logged FDI and the average human development index. Outliers include Suriname, Saudi Arabia, and Libya, which receive minimal FDI but have a higher level of human development index. Moreover, many sub-Saharan African countries like Niger, Central African Republic, and Mozambique have lower human development levels; however, the FDI amount does not seem small, compared to other countries.

To better understand the moderating effect of ODA on the relationship between FDI and human development, the marginal effect of FDI on human development and the histogram of ODA are graphically shown in Figure 2. Model 6 in Table 1 is used to calculate the marginal effects of ODA. As shown in Figure 2, the positive effect of FDI on human development in recipients decreases as the amount of ODA increases. The effect becomes zero and negative. However, this negative effect does not necessarily mean that FDI can negatively affect human development because the effect remains positive in areas where ODA is observed the most. This figure implies that FDI has a positive impact on human development and its impact remains positive, even though its effects decrease as more ODA is provided.

Owing to the characteristics of the panel dataset used in the empirical studies, there might be issues of heteroskedasticity and autocorrelation (Greene 2018). After conducting the Wald Test (Baum 2006) and Wooldridge Test (Drukker 2003), using Model 6 in Table 1, we note that these issues need to be addressed. Therefore, we additionally adopt the generalized least squares (GLS) estimation to address heteroskedasticity and autocorrelation issues (Hansen 2007; Lim et al. 2020). Table 2 presents the empirical results of the GLS estimation. Model 1 is for all historical recipients, and Model 2 is for the current recipients. As shown in Table 2, the positive impact of FDI on human development becomes more significant with the 1% significance level, with GLS estimation. Moreover, the moderating effects of ODA on the relationship between FDI and human development have become more significant.

The Promotion of human development has always been an important matter for developing countries even before the crisis. But owing to COVID-19, human beings worldwide are dealing with more critical situations. While COVID-19 affects both developed and developing countries, the human development conditions in developing countries have been quite critical and will be more negatively affected by COVID-19. Monetary transfer among countries is not as limited as physical movements are. Even though some donors like the United Kingdom decided to cut their ODA budget, others maintain or even increase the amount of ODA. However, global FDI flow reduced by 42%, from \$1.5 trillion in 2019 to an estimated \$859 billion in 2020.⁸ Despite its recent decrease, FDI will increase in the future once the COVID-19 pandemic is managed. Both ODA and FDI from developed countries to developing countries can influence the situation in developing countries, especially people’s lives. While ODA and FDI have a distinct purpose, they can make a difference in developing countries to promote the well-being of the people and provide job opportunities, better infrastructure, and economic growth in the long run. In this study, we focus on the effect of FDI on human development as well as on how ODA can influence this relationship.

The results show that FDI can positively affect human development, and the moderating effects of ODA on the relationship between FDI and human development are confirmed. ODA seems to decrease the significance effects of FDI on human development. FDI improves the fundamental conditions of recipients by providing job opportunities, changing economic structures, and promoting economic growth. As such, we focused sufficient attention on both FDI and ODA.

While we attempt to prove our hypotheses with extended data and sophisticated methods, this study still has limitations that should be addressed in future research. First, we focus only on a macro-level analysis of the impact of FDI on human development. While it was our original intention, it would be much better if we could include micro-level analyses, especially development projects and/or private corporations’ investment examples in developing countries. As these micro-level projects and investments can show the mechanism of how FDI can improve human development, micro-level analyses could improve the quality of the paper. Second, we are aware that FDI and ODA may occur simultaneously and in the same place. Even though we develop a theoretical model of how FDI can improve human development and how ODA can moderate that relationship, this mechanism might not work properly in real life owing to the different time spans and spaces in which each FDI and ODA occurs. Despite potential discrepancies between FDI and ODA, their influence on the societies of developing countries can be tested, as we do in this study.