Policy, Aid and Growth: A Threshold Hypothesis

Philip Denkabe ()
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Philip Denkabe: Department of Economics, New York University

Journal of African Development, 2004, vol. 6, issue 1, 1-21

Abstract: This study examines the contribution of foreign aid to economic growth in the context of macroeconomic policy. Using certain macroeconomic indicators as policy variables I construct a dynamic growth equation which is estimated by way of Generalized Method of Moments. In generating the estimation, attention is focused on country-specific effects and the non-linearity in the contribution of aid to economic growth arising from the interaction between aid and macroeconomic policy. Findings suggest the existence of a threshold value of aid, defined by macroeconomic policy, below which aid tends to have a positive impact on economic growth and beyond which diminishing returns to aid may generate a non,-positive impact on growth. For two economies characterized by different macroeconomic policies, similar aid inflows will gave different effects on economic growth. As compared to a 'good' policy environment, a 'bad' policy environment experiences diminishing returns to aid relatively more quickly, due to the inability to effectively absorb aid.

Date: 2004
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