AID-GROWTH NEXUS: EMPIRICAL EVIDENCE FROM CARIBBEAN STATES

1. AID-GROWTH NEXUS: EMPIRICAL EVIDENCE FROM CARIBBEAN STATES Abiodun O. Folawewo

2. Outline of Presentation • Introduction • Objectives of the study • Aid-Growth literature: theory and empirics • Analytical framework and data • Empirical results • Conclusion

3. Introduction • The importance of finance as a significant engine of economic growth is embedded in the role of savings in growth • Domestic savings are grossly in adequate in many developing countries, hence, the reliance on foreign sources of development finance • Foreign aid is a major source of development finance; it comes in the form of ODA, ODF, grant, and other forms of transfers.

4. Introduction (contd.) • There are some benefits associated with the flow of aid, likewise there are some disadvantages of aid to any recipient country • The impact of aid on growth depends on existing macroeconomic environment in the recipient country • Caribbean states have enjoyed relative good inflows of foreign aid as a result of their peculiar nature • The extent to which aid has impacted on economic growth remains largely unclear

5. Aim of the study • The main of the study is to analyse the relationships among foreign aid, macroeconomic policies, and economic growth within the Caribbean region

6. Aid-Growth literature • Theory • The aid growth debate has its origin in the classical growth model – rate of growth is determined by annual saving ratio (Harrod-Domar model) • Foreign aid and domestic saving are complements. • Foreign aid increases total saving, but also increases consumption. Thus, aid and domestic saving ratio are negatively correlated, while aid and total investment are positively correlated. • Aid will only lead to improved rate of growth if domestic saving does not fall by the amount of aid.

7. Aid-Growth literature (contd.) • Empirical evidence • While growth rate in some recipient countries has improved, aid has had little or no impact on rate of growth on many recipient countries (Dacy, 1975; Boone, 1995, 1996; Burnside and Dolar, 2000). • Aid effectiveness could be affected by macroeconomic policies (Sachs and Warner, 1995; Burnside and Dollar, 2000; Collier and Dollar, 2002; Luthria and Dhar, 2005. • Measuring the extent to which policies could affect aid effectiveness is subject to methodological approach, in terms of the construction of policy index (Dalgaard and Hansen, 2001; Denkabe, 2004, Easterly et al, 2004; Dalgaard et al, 2004; Antipin and Mavrotas, 2006) • Institutional factors also play a crucial in the aid-growth nexus (World Bank, 1998; Svensson, 2003; Ram, 2004; Antipin and Mavrotas, 2006)

8. Analytical framework and data • The analytical framework for investigating the relationship between aid and growth is based on a production function in which aid enters as input • Expressing the production function in growth rate per capita, and assuming that individual country growth rate depends on its initial level of income following Burnside and Dollar (2000), we have • Also, since the flow of aid is endogenously determined by prevailing policies and some other factors, thus aid can be expressed as

9. Analytical framework and data (contd.) • Data • Data for the study is sourced from IFS and ranges over the period of 1980 to 2005. The data covers six Caribbean states – Belize, Dominican Republic, Guyana, Haiti, St. Kits and Nevis, and St. Vincent and Grenada.

10. Empirical results • The estimation of the growth equation using all the measures of policy shows that Aid/GDP has both positive and negative relationships with growth subject estimation techniques.

11. Empirical results (contd.) • The estimation of the growth equation using the policy index indicates the policy variable has a positive and significant relationship with growth rate of GDP per capita, while the value of Aid/GDP reduces.

12. Conclusion • The study have produced some interesting preliminary implications about the interactions among aid, policy and growth in the Caribbean states. Some of these implications are: • there is a positive, but insignificant relationship between aid and growth. • policy index and the interaction term of ratio of aid to GDP and policy have positive effect on economic growth. However, while the policy index has a significant impact on growth, the interaction term of ratio of aid to GDP and policy does not have important effect. • size effect of aid on growth and the pattern of effect, that is, either positive or negative, are to large extent dependent on the existing macroeconomic policies.