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Philip Denkabe, a Ph.D. Candidate in Economics at New York University, will present a paper delving into the relationships and effects of foreign aid to economic growth, when examined within the context of macroeconomic policy.
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 undertaking 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. I construct a simple growth model in a bid to analyse the empirical results. Findings suggest the existence of a threshold value of aid, defined by macroeconomic policy, below which aid tends to have a positive affect 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 have different effects on economic growth. As compared to a relatively ‘good’ policy environment, a relatively ‘bad’ policy environment experiences diminishing returns to aid relatively more quickly. This could be attributed to the inability to effectively absorb aid.
Aid, Policy and Growth: A Threshold Hypothesis (PDF)