Foreign aid and economic growth in the developing countries - a  (Page 10/21)

Barro’s model has the following form:

whereis country i’s growth rate of GDP per capita between times t-T and t,is its level of per capita GDP at time t-T, andis a vector of other explanatory variables.

Compared to the traditional neoclassical models, this model allows for increasing returns to scale andpermanent effects of aid on growth. If the imported capital is of a higher level of technology than domestic capital, then aid canincrease the long-run growth rate.

My model takes the following form:

where β0 is the intercept, GROWTH is GDP per capita growth, INITIALGDP is the GDP per capita at the beginning ofthe study period, SAVING is gross domestic savings over GDP, FDI is foreign direct investment over GDP, ODA is official developmentassistance over GDP, SCHOOL is the number of secondary pupils over population, TRADE is percentage of trade to GDP, POPULATION is thepopulation growth rate and ε is the disturbance term. SAVING and FDI are proxies for physical capital accumulation while SCHOOL is aproxy for human capital. TRADE is expected to affect growth positively whereas POPULATION does so adversely. ODA (or foreignaid) can go either into physical capital formation if the aid is capital-intensive or into human capital investment if the aid isknowledge or technology intensive. As Burnside and Dollar (1997) indicate, aid is effective only if it is invested, not consumed. Iwould stress that aid is even more effective and viable if it is invested in human capital rather than in physical capital of therecipient countries.

Barro (1991) argues that economic growth is negatively related with initial GDP per capita holding humancapital constant, while it is positively related with human capital holding initial per capita GDP constant. This implies that thegrowth rate is expected to be negatively related with the initial level of income only if countries are similar in investment, humancapital accumulation and population growth rate. The growth rate of those countries, which have the same level of per capita GDP, tendsto differ depending upon the human capital accumulation. Empirically, evidence for convergence is found among the US states,the European regions, the Japanese prefectures and within OECD countries.

The savings rate positively affects growth and the population growth rate does so inversely. Savings raisescapital stock and helps to improve social and economic infrastructure. Theoretically, high population growth normallyentails economic, social and environmental problems. This implies that countries with higher savings rates grow faster and thosecountries with higher population growth rates tend to grow slower. However, as some people argued, population growth, and along withit the rise in the labor force, is considered to contribute positively to economic growth thanks to the lager pool of availableproductive labor and greater potential domestic market. Still, whether population growth affects economic growth positively ornegatively in labor-surplus developing countries remains a controversial issue (Todaro and Smith, 2003).