Foreign aid--blessing or curse: evidence from Pakistan.
Khan, Muhammad Arshad ; Ahmed, Ayaz
The role of foreign aid in promoting economic growth is a debatable issue and remains unsettled at both theoretical and empirical levels.
Pakistan has received a substantial amount of foreign aid since its
Independence in 1947 but little improvement has been observed in its
socio-economic development. This study considers the question as to
whether foreign aid is a blessing or a curse for Pakistan. The empirical
analysis is based on the ARDL cointegration approach. We examine the
aid-growth link at the aggregate and disaggregate levels for the period
1972-2006. The results show negative and insignificant effects of
foreign aid on the growth at the aggregate as well at the disaggregate
level. The findings further suggest that domestic investment, export
growth, and inflows of foreign direct investment are important
contributors in enhancing economic growth in Pakistan.
JEL classification: C13, C22, F23, F35, O11
Keywords: Foreign Aid, Economic Growth, FDI, Cointegration
1. INTRODUCTION
Foreign aid is an important source of income in developing
countries and carries potential to play a key role in promoting economic
growth. (1) The traditional literature on economic growth emphasises the
positive role of foreign aid in the process of economic development.
Foreign aid inflow influences the process of growth by reducing the
saving-investment gap, increasing productivity and transferring the
modern technology. However, in the neoclassical growth framework the
benefits of foreign capital inflows are of temporary nature. Like many
other developing countries, Pakistan has heavily relied on foreign
borrowings to finance its economic development. This strategy increased
its dependency on external resources. Pakistan has received around
US$73.14 billion in the form of foreign aid from 1960 to 2002 [Anwar and
Michaelowa (2006)], but the benefits of this aid flows have not
stretched to the whole society, which means that foreign aid has failed
to improve the economic conditions in Pakistan. The literacy rate is
still around 50 percent and other social indicators, such as employment,
health and education etc., also do not present an encouraging picture.
Saving rates have remained low, and the trade gap has widened [Husain
(1999)]. Foreign aid has not been utilised for development of the
economy; rather aid has served the vested interests of influential
people. During 1990s, the foreign loans at commercial rate of interest
have exacerbated the foreign debt problem of the country. The overall
situation depicted above cast doubts about the effectiveness of foreign
aid as a tool for economic growth.
The impact of foreign aid on economic development has always been a
controversial issue. (2) In 1950s, 1960s and 1970s rich countries used
foreign aid to fill the gaps in resources, encouraging domestic
investment and industrial development under the belief that foreign aid
could help developing countries to accelerate the "takeoff'
into self-sustained growth by generating new domestic investment [Rostow
(1960) and Waterson (1965)]. Many economists assert that foreign capital
inflow is necessary and sufficient condition for economic growth in
developing countries. They claim that there exist a positive correlation between foreign aid and economic growth because it complements domestic
resources and also supplements domestic savings to bridge
saving-investment gap and provides additional financial resources which
helps to achieve the short-term growth targets. Besides, it is also held
that, foreign aid assists to close the foreign exchange gap, provide
excess to modern technology and managerial skills and allow easier
excess to world markets [see for example, Chenery and Strout (1966);
Papanek (1973); Gulati (1975); Roemer (1989); Islam (1992) and Thirlwall
(1999); among others]. Mosley (1980) observes a positive relationship
between foreign aid and economic growth for UK aided countries and
negative for French and Scandinavian aided countries. However, he
concludes that aid could not improve the economic conditions in
Bangladesh, India and countries like Korea, Malawi and Kenya.
Another strand of literature asserts that external capital exert
significant negative effect on the economic growth of the recipient
countries. According to this view, foreign aid is fully consumed and
substitutes rather than complements domestic resources. It is argued
that foreign aid is used to import inappropriate technology, distorts
domestic income distribution and encourages a bigger, inefficient and
corrupt government in developing countries Foreign aid is also thought
to displace domestic savings, which in turn retards investment and
economic growth [Griffin and Enos (1970); Weisskoff (1972)]. Boone
(1996) finds that aid has no effect on investment and growth--his
estimates show that the marginal propensity to consume from foreign aid
is insignificant and marginal propensity to investment was zero.
Easterly (2001) finds no empirical relationship between foreign aid and
economic growth and between aid and investment. He concludes that aid
has not delivered the expected results and may create the wrong economic
incentives. Many studies confirm negative correlation between foreign
aid and economic growth. Negative correlation between aid and growth is
the outcome of factors such as economic policies, government
intervention, business cycle and instability of foreign aid flows in the
recipient countries [Levy (1984)]. Singh (1985) concludes that state
intervention in the economy generate negative impact on economic growth
and makes the aid-growth relationship statistically insignificant.
Burnside and Dollar (2000) find that the relationship between foreign
aid and economic growth may depend on whether the recipient countries
have been pursuing sound economic policies. Gounder (2001) and Lloyd, et
al. (2001) find that foreign aid contributes to long-term growth in
private consumption and policy reforms enhance the effectiveness of
economic growth. Mavrotas (2002) finds that policies impact aid
effectiveness in case of India. Lensink and Morrissey (2000) analyse the
impact of aid uncertainty on economic growth in developing countries.
They find that the impact of foreign aid on economic growth depends on
the aid levels and the stability of aid flows. Pallage and Robe (2001)
explain empirical regularities in the foreign aid flows to developing
countries. They reveal that aid flow is a major source of income in the
majority of recipient countries and aid flow is highly volatile and
overwhelmingly pro-cyclical. This means that even if foreign aid helps
foster economic growth, serious problems would nevertheless stem from
the fact that aid disbursement pattern intensify volatility of
developing countries' disposable income which affects growth
negatively. Hansen and Tarp (2001) conclude that aid increases growth
via capital accumulation and it does not depend on good policy. They
note that growth regressions are sensitive to choice of control
variables and choice of estimators and that much more theoretical work
is needed before drawing policy insights. Pack and Pack (1994) asserts
that foreign aid is fungible. They claimed that because of the
fungibility of foreign aid, the increase in government income in the
form of aid will be crowded-out.
On the other hand, Cassen (1994) argues that the relationship
between aid and growth is rather weak, and it can be either positive or
negative, depending on the country's absorption capacity of aid,
economic and political structure and the time period chosen. Studies
based on time series data conclude that foreign aid has been an
important determinant of economic growth. Feyzioglu, et al. (1998)
concludes that sectoral concessional loans are highly fungible.
An alternate strand of literature points out that foreign economic
assistance displaces processes of institutional maturation that is
essential to promote economic development. Thus, foreign aid promotes
aid-dependency [Friedman (1958) and Bauer (1971)]. Foreign assistance
represents a side payment to elites in recipient countries, design to
buy compliance in maintaining the economic and political dominance of
the industrialised countries [Frank (1966)]. Brautigam and Knack (2004)
point out that poor quality institutions, weak rule of law, absence of
accountability, controls over information and high level of corruption
have distorted the benefits of foreign aid in most African countries.
Similarly, Wolfensohn the president of World Bank in 2002 observed that
"we have learned that corruption; bad policies and weak governance
will make aid ineffective". However, selective foreign aid has
helped to improve per capita income and lower infant mortality rate in
under-developed nations [Easterly (2003)]. Selective foreign aid means
that donor nations put some conditionalities in the form of low
inflation and budget deficit, non-interference with market prices,
privatisation and openness to international trade [Easterly (2003)].
Svensson (1999) concludes that foreign aid has a positive long-term
impact in democratic countries, but in countries with authoritarian
regimes, aid has often dissipated into unproductive activities. Ranis
and Mahmood (1992) claims that foreign aid retard a country's
ability to adhere to responsible economic policies.
The bulk of theoretical and empirical literature has so far
produced inconsistent and elusive results regarding the relationship
between foreign aid and economic growth. Empirical findings are also
mixed with respect to the impact of foreign aid in Pakistan. For
instance, Chishti and Hasan (1992) conclude that 28 percent of the
domestic borrowings go towards financing the public sector
non-development expenditures. Their results also indicate that foreign
aid in the form of grants has a modest impact on public investment while
loans do not seem to have a significant impact on public investment.
Shabbir and Mahmood (1992) conclude that net foreign capital inflows,
disbursement of grants and external loans have a positive impact on
economic growth of Pakistan. Ali (1993) points out that there is no
significant relationship between inflow of foreign aid and economic
growth. Khan and Rahim (1993) conclude that foreign aid has negative
relationship with domestic savings and it has no significant impact on
economic growth. Iqbal (1997) is of the view that foreign capital that
flows into the public sector has strong positive impact on social and
non- development expenditures and has little effect on development
spending. He further suggests that foreign loans and aid are largely
consumed rather than invested productively and foreign assistance cause
a strong shift of public domestic resources from development projects to
nondevelopment expenditures. Khan (1997) has also pointed out that aid
has a robust negative impact on economic growth. Similarly, Ishfaq and
Ahmed (2005) conclude that foreign aid has not contributed favourably to
GDP growth rate of Pakistan. This ineffectiveness of aid is attributed
to diversion of aid funds to non-productive activities and inefficiency
in resource allocation especially in the public sector. Husain (1999)
argues that foreign aid exerts positive impact on growth if the
macroeconomic policies ,are correct, microeconomic incentives are not
distorted and the supporting institutions are in place. In the absence
of these preconditions foreign aid helps to postpone the tough decisions
required for prudent economic management. Under these circumstances,
foreign aid is curse rather than blessing and should be avoided.
These conflicting views have motivated us to reinvestigate the role
of foreign aid in determining economic growth. This paper seeks to
answer the question whether foreign aid is blessing or curse for
Pakistan? Specifically we hypothesise that Pakistan should concentrate
on those external resources that are stable, sustainable and are largely
within the policy control of the authorities, rather than continue to
depend on those resources which are more volatile, less stable and
controlled by the external policymakers. We formulate an empirical model
to test this hypothesis for Pakistan over the period 1972-2006. The
estimation is carried out using autoregressive distributed lag (ARDL)
cointegration technique. This study differs significantly from earlier
studies for Pakistan in three respects. First, we analyse the impact of
foreign aid on economic growth at aggregate as well as disaggregate
level by extending neo-classical production function. Second, the study
determines the relative importance of alternative external financing resources such as exports growth and foreign direct investment. Third,
the study uses most recent econometric techniques for estimation and
covers the period from 1972 to 2006 and, finally the study extends the
body of literature on aid-growth linkages.
The remainder of the study is organised as follows: Section 2
overviews the inflows of foreign capital in developing countries. The
brief review of foreign aid inflows in Pakistan is given in this
section. Section 3 discusses the model, methodology and data.
Interpretation of empirical findings is given in Section 4, while
concluding remarks along with policy implications are given in the final
section.
2. FOREIGN CAPITAL INFLOWS TO DEVELOPING COUNTRIES: AN OVERVIEW
Foreign aid and foreign private investment are the two main sources
of capital inflows in developing countries. Foreign aid could be
categorised into grants and relatively low interest rate loans, while
the foreign private investment can be categorised into foreign portfolio
investment (FPI) and foreign direct investment (FDI). The pattern and
trend of such foreign inflows into developing countries have
significantly changed during the past three decades. Grants-type aid to
developing countries increased from US$ 1.9 billion in 1970 to US$ 52.6
billion in 2005. This increase is, however, modest when compared with
the expansion in FDI and FPI (Table 1).
FDI flows increased from US$ 2.2 billion in 1970 to US$ 237.5 in
2005. Similarly, FPI which was US$ 2.8 billion in 1990 reached to US$
61.4 billion in 2005, while aid in the form of grants increased from
US$1.9 billion in 1970 to US$ 52.6 billion in 2005.
Foreign aid has been an important source of capital inflows for
developing countries during 1960s, 1970s and 1980s. After the end of
cold war, the strategic importance of foreign aid has declined in 1990s,
although the number of donor agencies has increased from 7 to 50 from
1960 to 1990. There is no doubt that foreign aid helps to promote
economic growth and infrastructure of recipient countries, particularly,
at the time of natural disasters. However, the literature suggests that
the impact of foreign aid on economic development is rather limited
because foreign aid is usually directed towards military and political
fields instead of socio-economic fields [Le and Ataullah (2002)]. On the
other hand, the conditionalities imposed by the donor agencies may
constrain the autonomous policies the recipient countries may like to
pursue. Many empirical studies suggest that foreign aid has not
contributed profoundly to the economic growth and development of
recipient countries and it has tendency towards increasing inequalities
among different groups [Rana and Dowling (1990) and Griffin (1991)].
Moreover, foreign aid hurts rather than helps the poor. It goes to their
rulers whose spending policies are determined by their own personal and
political interests, among which the position of the poor has very low
priority [Lappe', et al. (1980) and Bauer (1981)]. Similarly,
Hayter and Watson (1985) notes that the governments of the rich
countries claims that they are providing 'aid' to help the
Third World to escape from the underdevelopment and poverty but much of
this aid fails to alleviate poverty.
In contrast, the British Department for International Development
(2000) argues that development assistance could contribute to poverty
reduction in countries pursuing sound macroeconomic policies. Canadian
International Development Agency (2002) cites World Bank
researchers' compelling evidence that good governance and sound
policy environment are the most important determinants of aid
effectiveness.
Moreover, the increasing tendency towards providing loans instead
of grants and tying aid had left many Third World countries in debt
burden cycle. Given the unequal effects of foreign aid and limited
control over the quantity of aid received, policymakers in LDCs are
increasingly looking for alternate sources of foreign capital including
foreign direct investment and portfolio investment.
2.1. History of Foreign Aid in Pakistan
Foreign aid began to flow into Pakistan soon after the
independence. During 1950s the flows of aid was very small. But in 1960s
and 1970s, foreign aid remained an important source of capital for
Pakistan. Pakistan was one of the largest aid recipient countries in
Asia during this period, (see Table 2). For example, Pakistan got
foreign aid around 6.6 percent of the GNP in 1960. The increase in aid
was concomitant with the increase in the level of private investment,
which rose from 42.55 percent of total investment in 1959-60 to 53.3
percent of the total investment in 1969-70 [Malik, et al. (1994)].
During this period, huge investment in the physical infrastructure,
power, and irrigation related projects was made with the help of foreign
aid which helped to lay down economic foundation of the country. Mega
projects such as Terbala and Mangla dams were constructed during this
period. The inflows of aid picked up momentum in the early 1970s and
remained around 4.2 percent of the GNP. In 1974-75, the inflow of
foreign aid to Pakistan reached US$ 1.00 billion mark, and the
proportion of aid to GNP by then had touched 5.5 percent. Because of the
huge inflow of foreign aid, the government launched public investment
programmes such as roads, electric power, increasing social services,
and projects like Indus Super Highway and Pakistan Steel Mills.
The increase in aid witnessed in the mid-1970s did not continue for
the coming years. Gross disbursements of aid fell in 1977-78 and 1978-79
as the United States curtailed aid to Pakistan because of its nuclear
policy [Malik, et al. (1994)]. However, during 1980s Pakistan again
received a large amount of foreign aid (4.6 percent of GNP) because of
its front-line role in the America-Soviet Union conflict over
Afghanistan. The foreign inflows reached to US$2.0 billion mark per
annum by the mid-1980s which enhanced the credit worthiness of Pakistan
[Le and Ataullah (2002); Husain (1999)]. Pakistan and United States
signed a six year agreement in 1985 according to which United States was
to provide US$ 4.02 billion in terms of loans and grants over six-year
period beginning September 1987. Of US$ 4.02 billions, 57 percent amount
was allocated as economic aid and the remaining in the form of military
aid. After signing this agreement, the gross disbursement of aid
increased to US$1.8 billion in 1987-88. The composition of aid over the
years has changed from grants and grants-type assistance to loans on
difficult terms.
In 1990, the United States announced that it would not enter into
any more aid agreement with Pakistan and would wind up its aid related
projects at the end of 1993. This shift in US policy led to considerable
adverse change in aid receipts to Pakistan. The major reasons for
changes in United States contributions were the passage of the Pressler
Amendment and the Brown Amendment in the aid authorisation bills by the
United States Senate in 1985 and 1995 respectively. Because of the
Pressler Amendment US aid disbursement to Pakistan which was US$ 452
million in 1989, fell in early 1990s to touch rock bottom at only US$
5.4 million in 1998 [Anwar and Michaelowa (2006)]. In 199394, aid from
consortium and non-consortium sources declined considerably. In 1998,
when Pakistan conducted nuclear tests, further international
aid-sanctions, particularly by the US government, were imposed on
Pakistan. As a consequence, during 1998-2001, both bilateral and
multilateral aid declined significantly.
However, after the 9/11 things changed dramatically. When Pakistan
joined the 'War against Terrorism', the volume of aid
increased by 7 times and reached US$ 776.5 million. The US launched
another US$ 3 billion five-year economic assistant package for Pakistan
in June 2003. Other donor countries also sanctioned aid and rescheduled
Pakistan's external debts. This situation reflects how the flow of
foreign aid to Pakistan has always been subject to conditionalities, and
vulnerable to geopolitical and strategic interests of the donors
particularly, Unites States. Figure 1 clearly depicts the picture of the
composition and structure of foreign aid received by Pakistan during the
period 19562005.
Figures 1 indicates that from 1956-57 to 2004-05, the share of
project aid averaged 60 percent of the total aid, followed by the share
of balance of payments support, which is 15 percent. The shares of
non-food and food aid have been 10 percent and 12 percent respectively.
The share of foreign aid for relief was only 3 percent during the
period.
The project/non-project aid and food/non-food aid are very
important components of the total foreign aid because project aid
directly adds to the productive capacity of the aid recipient country.
Contrarily, large proportion of non-project aid adds to the debt burden
of aid receiving country. Figure 2 shows the trend of project and non-
project aid inflows to Pakistan since 1990-91. The project aid depicts a
declining trend during the period 1990-91 to 2005-06, whereas from
2002-03 non-project aid again had been following an increasing trend.
Resultantly, total aid increased from US$ 1270 in 1996-97 to US$ 2316
million in 2005-06.
[FIGURE 2 OMITTED]
The sectoral distribution of foreign private loans, for the period
1990-2005 is shown in Table 3 and Figure 3. The share of, textiles
sector in total foreign private loans is almost 15 percent, Petroleum
refining 14 percent, Pakistan International Air Line (PIA) 26 percent
and transport 23 percent.
During the 1960s, 1970s and 1980s, Pakistan was among the largest
aid recipient countries. But the benefits of this aid could not stretch
to the whole society. The aim of Pakistan's five-year Plans for the
period 1965-85 was elimination of dependence on foreign assistance [Le
and Ataullah (2002)]. But there had been a significant increase in
foreign economic assistance since then. This increase in foreign aid
could not help in the socio-economic uplift. For example, during the
1960s and 1970s when Pakistan was the largest aid receiving country
among Asian countries, the average percentage of population living under
the poverty line declined marginally from 43 percent to 39 percent.
Social services and human sector development have remained neglected and
the social indicators have worsened, leaving Pakistan at par with some
of the poorest African countries. Pakistan ranks 120th in the human
development index constructed by UNDP [Husain (1999)]. Physical
infrastructure such as irrigation, electricity, roads and highways,
telecommunications, railways, and other capital assets have been poorly
maintained and have neither been replaced, nor expanded to keep up with
the growing demand [Husain (1999)]. Empirical studies suggest that aid
has not exerted any significant effect on economic growth. Khan (1997)
finds negative causal effect of aid on economic growth, while Ishfaq and
Ahmed (2005) conclude that economic growth of Pakistan has remained
independent of foreign aid.
The huge inflows of foreign aid to Pakistan could not be utilised
for the development purposes. Rather, aid has served the vested interest of a small influential group of the society and the political elite in
the government circle and has delayed the day of reckoning. An increase
in foreign aid in the form of loans during the 1990s has exacerbated the
foreign debt problem in the country.
3. MODEL, METHODOLOGY AND DATA
The rationale that foreign aid increases economic growth is based
on Chenery and Strout's Dual Gap Model. Chenery and Strout (1966)
claimed that foreign aid promotes economic growth by contributing to
domestic savings as well as foreign exchange availability and helping to
close the saving-investment and export-import gaps. In two-gap model,
investment is the cornerstone of growth and requires imported capital
goods [Ali and Isse (2005)]. However, developing countries generally
face two fundamental financial gaps. The first gap is between the
investment and domestic savings, while the second gap is between imports
and foreign exchange earnings [Easterly (2003)] The developing countries
cannot overcome the shortage of savings and foreign exchange earning on
their own due to their limited resources however, foreign aid and other
financial flows can fill these gaps and contribute to achieving target
growth rates. In two-gap model the contribution of foreign aid is to
finance investment including imports of capital goods. Exports growth is
also important as it generates foreign exchange to finance imports.
Following Husain (1992) we divide external resources in to two
categories. First, the resources which have stable, sustainable and
positive effect on economic growth and are within the policy control of
the domestic authorities. These include export of goods and services (X)
and foreign direct investment (FDI). Second, foreign aid, external
borrowings and workers remittances are found to be volatile, less stable
and under the control of external policymakers and their contributions
to economic growth are questionable. The external environment influence
exports demand and FDI supply, but despite short-term fluctuations these
resources remains stable and are relatively more influenced by the
domestic policy variables. Hence, preference may be given to these
resources rather than foreign aid, worker remittances and external
borrowings to finance long-term development [Husain (1992)].
Based on the above arguments we formulate the link between economic
growth and foreign aid following pure production function theory. Assume
that real gross domestic product (GDP) of Pakistan is:
Y = F(q) ... ... ... ... ... ... ... ... (1)
Where Y is the real GDP, F is the transformation rule associating Y
and q, q is the vector of explanatory inputs. Assuming a multiplicative
aid-trade-augmented production function and that {capital (K), labour
(L), foreign aid (A) and exports (X)} [member of] q, Equation (1)
becomes [Amavilah (1998)]:
Y = [THETA][K.sup.[alpha]][L.sup.[beta]][A.sup.[delta]][X.sup.[gamma]][e.sup.[mu]] ... ... ... ... ... ... (2)
Where u is the normally distributed random error term. The
inclusion of exports in the conventional production function may be
justified on two grounds. First, exports allow countries to specialise
in the production of such commodities in which they have comparative
advantage. Export sector is assumed to be more competitive and efficient
than other sectors. Exports growth facilitates the exploitation of scale
economies, allows for increased capacity utilisation and encourages
efficiency through specialisation in accordance with the principles of
comparative advantage. Second, the export sector is assumed to generate
positive externalities, such as relaxing foreign exchange constraints
and the introduction of technology and knowledge. It is also assumed
that with the given level of capital and labour, the larger the size of
the export sector, the larger the gross value of production [Rana and
DoMing (1990)]. Edwards (1998) points out that exports affect economic
growth positively through increases in total factor productivity. The
inclusion of foreign aid in the conventional production function c.an
also be found in Tyler (1981), Feder (1982), Gounder (2001), Amavilah
(1998) and Burke, et al. (2006) among others.
Following Burke, et al. (2006) and Ahmed and Hamdani (2003) we
break total capital stock (K) into domestic capital ([K.sub.d]) and
foreign capital ([K.sub.f]) i.e., K = [K.sub.d] + [K.sub.f]). Now
Equation (2) becomes:
Y = [THETA][K.sup.[alpha].sub.d][K.sup.[phi].sub.f]
[L.sup.[beta]][A.sup.[delta]][X.sup.[gamma]][e.sup.[mu]] ... ... ... ...
... ... (3)
The log-linear form of Equation (3) is given by:
LnY = Ln[THETA] + [alpha]Ln[K.sub.d] + [theta]Ln[K.sub.f] +
[beta]LnL + [delta]LnA + [lambda]LnX + [mu] ... ... (4)
Since the data for domestic capital stock and foreign capital stock
are not available, therefore we use domestic investment as a share of
GDP (INVY), foreign investment to GDP (FDIY) as proxy for the domestic
capital and foreign capital. Furthermore, we use foreign aid as a share
of GDP (AIDY) to control for the effect of price changes over time.
Edwards and Tabellini (1990) and Fosu (2001) points out that political
instability is expected to exert negative impacts on growth. To account
for political instability we included a dummy variable (D) taking value
one for the period 1979-1985 and 1999-2002 and zero otherwise. Equation
(4) now takes the following form: (3)
[Y.sub.t] = [[eta].sub.0] + [[eta].sub.1][INVY.sub.t] +
[[eta].sub.2][FDIY.sub.t] + [[eta].sub.3][AIDY.sub.t] +
[[eta].sub.4][L.sub.t] + [[eta].sub.5][X.sub.t] + [[eta].sub.6][D.sub.t]
+ [[mu].sub.t] ... (5a)
Equation (5a) represents the neoclassical growth model expanded to
include exports and non-export sectors and is similar to that of Gounder
(2001) and Burke, et al. (2006). The production function includes share
of total investment to GDP (INVY) to measures its impact on economic
growth because investment is one of the principal determinants of growth
[Lensink and Morrissey (2000)]. Thus, investment is included in the
model to capture its affects on growth through the level of efficiency.
Exports and FDI variables are also included in the model to measure the
degree of trade and financial openness. It can be argued that trade and
financial openness is expected to improve resource allocation and
accelerate economic growth. (4)
To examine the impact of various forms of foreign aid on economic
growth, the model incorporates project aid (PAIDY) and non-project aid
(NAIDY) in the following specification form:
[Y.sub.t] = [[beta].sub.0] + [[beta].sub.1][INVY.sub.t] +
[[beta].sub.2][PAIDY.sub.t] + [[beta].sub.3][NAIDY.sub.t] +
[[beta].sub.4][FDIY.sub.t] + [[beta].sub.5][L.sub.t] +
[[beta].sub.6][X.sub.t] + [[beta].sub.7][D.sub.t] + [v.sub.t] (5b)
Where Y is the real GDP, INVY the domestic investment as proportion
of GDP, PAIDY the project aid as a share of GDP, NAIDY the non-project
aid as share of GDP, FDIY the net foreign direct investment as share of
GDP, L the labour force, X the real value of exports and [v.sub.t] the
error term. All the variables are expressed in logarithmic form.
This study employs Autoregressive Distributed Lag (ARDL)
methodology advanced by Pesaran, et al. (2001). The main advantage of
this methodology is that it allows testing for the existence of
cointegration irrespective of whether the variables are I (0) or I (1).
This approach is more appropriate than the Johansen-Juselius
multivariate approach to cointegration when the sample size is small
[Pesaran, et al. (2001)]. The estimation procedure involves two steps.
First, long-run relationship between the variables under consideration
is tested by computing F-statistics. If the evidence of longrun
relationship is found then at the second stage the short-run and
long-run parameters are estimated using autoregressive distributed lag
(ARDL) method. The final equation is selected based on the acceptability
of various diagnostics.
The study is based on annual data covering the period 1972-2006.
The data are collected from different sources. GDP, foreign aid, project
aid, non-project aid (i.e., sum of non-food, food, balance of payments,
relief and earthquake rehabilitation assistance), ratio of foreign
direct investment to GDP, and exports are taken from the State Bank of
Pakistan (2005) and Pakistan Economic Survey (various issues). Data on
labour force is from Asian Development Bank--Key Indicators (various
issues). The data on consumer price index (CPI) is from International
Financial Statistics (IFS) CD-ROM (2007). All the flow variables (INV,
AID, FDI) are measured as a ratio of GDP to control for the effect of
price changes over time. (5)
4. EMPIRICAL RESULTS
The cointegration test based on the ARDL procedure is employed by
estimating Equation(s) (5a and 5b) for Pakistan using annual data over
the period 1972-2006. (6) The number of lags on the first-differenced
variables is selected using Akaike Information Criterion (AIC).
Initially, we set 3 lags for the VAR and tested down using
general-to-specific methodology. The final lag is selected when the
estimated equation(s) satisfy all the diagnostic checks including
CUSUMSQ test of stability. On the basis of this criterion, two lags were
selected to carry out ARDL cointegration test. The results of the
cointegration test are reported in Table 4.
It is apparent from Table 4 that for each type of aid the bound
cointegration test rejects the null of no cointegration because the
computed F-statistic is much greater than the upper bound of the
tabulated F-statistic. After finding the evidence of cointegration
between the variables specified in equation(s) (5a and 5b), we have
estimated the long-run and short-run relationships using Autoregressive
Distributed Lag (ARDL) approach. Table 5 reports the long-run and
short-run estimates for various types of aid-growth nexus. The estimated
ARDL equations pass all the diagnostic tests including the CUSUM and
CUSUMSQ tests of stability. (7) Overall, ARDL equations have a very high
adjusted [[bar.R].sup.2], F-statistics are significant and no estimation
problem exists as suggested by Lagrange Multiplier test (LM), functional
form (FF), normality (NO) and heteroscedasticity (Het) statistics. A
more detailed interpretation of results is given below:
(A) Real Output and Aggregate Foreign Aid
The estimation of the equation with total aid (Table 5 case A)
suggests that in the long-run foreign direct investment to GDP (FDIY),
total investment to GDP (INVY), labour force (L) and real value of
exports exert positive and significant impact on real GDP. The
coefficient of foreign aid to GDP (AIDY) is insignificant with negative
coefficient in the long-run as well as in the short-run. The negative
and insignificant impact of foreign aid on output suggests that economic
growth is independent of foreign aid in case of Pakistan. This raises
many serious questions regarding its justification. The reason could be
that in most developing countries including Pakistan foreign aid is
fungible and is diverted to public consumption [Feyzioglu, et al.
(1998)]. Another reason may be that foreign aid is channeled through the
public sector and is utilised to finance non-development expenditures.
Moreover, when foreign capital inflows into the public sector are
increased, some resources are diverted from development projects to
non-development projects. This diversion of resources may offset of
positive impact of foreign aid on growth. This result suggests that the
economic policies regarding aid utilisation are not appropriate or
perhaps aid inflows have distorted macroeconomic incentives in Pakistan.
The results show that foreign direct investment and exports,
domestic investment and labour force are the main determinants of real
output in the long-run. The coefficient of the dummy variable (D),
introduced to account for political instability, is negative and
significant both in the long-run and short-run indicating that political
instability adversely influenced economic growth. (8)
In short-run the coefficient of domestic investment is negative and
insignificant. Given the dominant share of public investment in total
investment, the inefficient and non-productive nature of public
investment might have contributed to the overall negative impact of
total investment on growth [Ghani and Din (2006)]. Moreover, political
instability may also affect investment growth through the decline in
total factor productivity [Gounder (2001)]. The over all contribution of
labour force ([DELTA]L) is negative and significant in the short-run.
This may be due to the higher share of non-productive labour in total
labour force. Another explanation for the negative coefficient on
[DELTA]L could be the presence of low quality and unskilled labour
force. Brain drain could be yet another reason of the negative effect of
labour force.
The inflows of foreign direct investment (FDI) and exports exert
positive and significant impact on economic growth in long-run as well
as short-run. This implies that instead of relying on foreign aid
preference be given to attract FDI and boost exports. Both the FDI and
exports are linked to capacity utilisation, research and development
(R&D), increased market access and technological spillover. These
benefits are expected to be more stable than the temporary benefits of
foreign aid. Since the magnitude of exports is relatively larger than
the magnitude of the FDI. Therefore, the authorities have paid much
attention on the export growth and than on creating conducive
environment for inflows of FDI. Finally, the adjustment coefficient
possesses expected negative sign and is highly significant. This
indicates that 41 percent of the previous period deviations are
eliminated in the current period.
(B) Real Output, Project Aid and Non-project Aid
The results with project aid and non-project aid (Table 5 case B)
show that project aid exerts positive and non-project aid exerts
negative and significant impact on real output both in the long-run and
short-run. However, the magnitude of both the variables is very small
and negligible. This implies that project and non-project components of
foreign aid may not effectively promote economic growth. The possible
reason could be that the aid flows are in practiced translated into
government consumption. (9)
The other variables such as labour, FDI and exports play
significant role in enhancing real output in long-run as well as
short-run. However, the overall impact of labour force growth in the
short-run is negative and significant. The coefficient of total
investment share is insignificant in both the long-run and short-run.
Among exports and FDI, the relative impact of real exports is larger
than FDI in the long-run. These results confirm the hypothesis that
exports and FDI are the main external sources of growth rather than
foreign aid. The dummy variable, introduced to capture political
instability, is also negative and significant indicating the adverse
effect on output both in the long-run and short-run. The
error-correction term is negative and significant, indicates that about
34 percent of the previous period's deviations in real output is
eliminated in the current period to keep real GDP at steady state level.
(C) Real Output and Project Aid
Table 5 (case C) indicates that the relationship between project
aid and real output is negative and insignificant both in the long-run
and short-run. This implies that in Pakistan project aid is fungible.
The amounts of money granted for a particular project by the donors are
transferred to finance social and other non-development expenditures.
(10) Our result confirms the earlier findings by Iqbal (1997) that
foreign capital inflows have negative impact on development expenditure.
This strengthens the idea that some resources are transferred from
development projects to non-development expenditures when foreign aid is
increased. Hence, project aid exerts negative and insignificant impact
on domestic productivity. Our results also confirm the results obtained
by Chishti and Hasan (1992) that in case of Pakistan the project aid
money is fungible and this may have been channeled to finance government
consumption.
In long-run labour force, domestic investment, FDI and real exports
exert positive and significant impact on real output. In short-run the
external financial resources such as FDI and exports exerts positive and
significant impact on domestic productivity. Domestic investment is
insignificant while labour force exerts negative and significant impact
on growth. (11) The relative effect of exports is larger than that of
FDI. The findings imply that to reduce dependence on the foreign aid,
the government may concentrate on boosting the exports sector and create
enabling environment to attract foreign investment. The error-correction
term is again negative and highly significant. The coefficient on the
term indicates that around 41 percent of the past deviations are
eliminated in the current period.
(D) Real Output and Non-project Aid
Table 5 (case D) suggest that non-project aid is significant and
negatively related to real output in both the long-run and short-run.
This finding suggests that non-project aid failed to produce any
significant impact on economic growth. The size of the coefficient of
non-project aid is very small indicating negligible effect on growth in
the long-run and short-run. The reason could be the use of non-project
aid to finance government consumption; therefore it does not contribute
to growth. Other variables are significant and possess expected positive
coefficients in the long-run. In the short-run, FDI and exports are
positively correlated to growth, while domestic investment remains
insignificant and labour force influences growth negatively. A positive
coefficient of FDI and exports supports the argument that to reduce aid
dependency on export sector and FDI may need special attention. The
coefficient of dummy variable, introduced to account for political
instability, is negative and significant indicating negative impact of
political instability on growth in the long-run and short-run. The
error-correction term is -0.43 and statistically significant which
indicates that 43 percent of the past deviations are corrected in the
current period.
Overall, the impact of foreign aid at aggregate and disaggregate
level is negative and insignificant. These results support the
hypothesis that aid is fungible in case of Pakistan and growth is
independent of foreign aid. Our results confirms the view expressed by
Husain (2005) that net flows as percentage of gross national income have
gradually declined from 4.3 percent in 1970 to 1.5 percent in 2003 and
net transfers from 3.6 percent to 0.7 percent. The deduction from this
evidence is quite obvious--Pakistan's dependence on foreign aid is
so low and insignificant that it does not make much of a difference to
our national economy.
Generally, there may be several reasons that undermine the impact
of foreign aid on growth. For example, the projects funded by foreign
donors may impose conditions including purchase of equipment, services
and technical expertise from them. Consequently, a huge amount of money
is drained out in the form of salaries and other payments. Moreover,
foreign contractors are paid kickbacks on foreign added projects which
encourage and promote the culture of corruption, weaken state
institutions and increase the costs of projects. Alesina and Weder
(2002) points out that foreign aid overtime increases government
corruption. The evidence of this study is not much puzzling because many
studies conclude that foreign aid exerts negative impact on growth [for
example Gounder (2001); Burke, et al. (2006); Chishti and Hasan (1992);
Khan (1997) and Ishfaq and Ahmed (2005)]. The findings of the study
imply that foreign aid does not improve economic conditions. One reason
could be poor governance. Many studies point out that foreign aid is
extended for "strategic" reasons rather than real needs of a
country. (12) Besides, foreign aid is highly volatile and its flows
depend on the political ties between recipient and donor countries. So
if the impact of foreign aid on growth is ambiguous or unpredictable,
this should not be surprising.
Foreign direct investment and exports exerts positive and
significant impact on growth. The positive and significant impact of
exports on real output supports the argument that export sector is an
engine of growth. Though FDI also exerts positive and significant impact
on real output, however, the magnitude of exports is larger than that of
FDI. These results demands for the expansion of export sector and
encouragement of FDI inflows to reduce aid dependency. Finally, we
conclude that domestic investment, labour, exports and FDI are important
and significant contributors to economic growth as compared to foreign
aid. These results are consistent with the earlier findings by Husain
and Jun (1992) that exports performance contributed more in economic
growth than aid.
This does not mean that foreign aid has no contribution in the
economic development of Pakistan. During the 1950s, 1960s and 1970s
foreign aid helped in laying down the physical infrastructure, which is
pre-requisite for future economic development. Aid-financed investment
in water, power and transport strengthened the infrastructure base. The
construction of Terbela and Mangla dams, other irrigation-related
projects, Steel Mills and Indus Super Highway are examples of the
contribution of aid. Since 1990s, aid has helped in carrying out
economic reforms. Moreover, during Afghan War and 2005 earthquake,
non-project aid helped to overcome food shortages and balance of
payments deficits.
Despite some positive contributions of aid, there are some negative
aspects which are more serious. Public sector imbalances have worsened
and non-wage component of recurrent expenditure is squeezing. Saving and
investment rates remained low and the trade gap has widened. Official
aid has declined their importance to rectify the economic conditions,
while foreign investment and foreign assets of Pakistanis provide a much
longer volume in the 1990s [Husain (1999)]. Khilji and Zampelli (1991)
pointed out that US-aid is highly fungible and large proportion of aid
has been diverted to meet defense expenditures. Similarly, large sums of
aid were wasted in inefficient projects and controls over the
international trade affected adversely the overall economic environment.
Consequently, aid has become less productive and has put the country
into a vicious circle of dependency. Inelastic revenue structure, large
size of non-development expenditures, reduction in public investment,
infrastructure deficiencies, and lack of social services are the main
gifts of aid. To enhance aid effectiveness there is need to break the
vicious circle of dependency and rehabilitate the economy through
prudent macro-management policies.
To make aid more effective, Pakistan may rethink its macroeconomic
policies, strengthen related institutions, improve governance and reduce
corruption. At present economic growth in Pakistan is independent of
foreign aid. For the economy, foreign aid is curse rather than blessing
because reliance on aid further increases dependency. Hence further
solicitation of foreign aid should be avoided and the authorities may
focus on the encouragement of domestic investment, FDI and exports
sector which are less volatile than foreign aid.
5. CONCLUSION AND POLICY IMPLICATIONS
Foreign aid effectiveness is a very critical and unsettled issue at
the theoretical and empirical level. Pakistan has received about US$
73.14 billions from 1960 to 2002, but its social indicators still seem
to be very poor. Most of the foreign aid components diverted from
development to non-development expenditures, have produced hardly any
significant impact on economic growth. Based on theoretical literature
we specify aid-exports-augmented neo-classical production function to
examine aid-growth link. The model is estimated using ARDL approach to
cointegration over the period 1972-2006 for Pakistan.
Result suggests that foreign aid neither at aggregate nor at
disaggregate level influenced economic growth in Pakistan. These
findings confirm the earlier findings by Gounder (2001), Burke, et al.
(2006), Movrotas (2002), Chishti and Hasan (1992), Khan (1997) and
Ishfaq and Ahmed (2005). The finding implies that foreign aid is not a
blessing. Further the demerits of foreign aid that include but are not
limited to; harsh covenants from donors that times even call for
compromising the autonomy of the Nation, corruption within the
government, fiscal imprudence and poor institutions turn foreign aid
into a curse. Therefore, we can say that foreign aid is not a blessing
but a curse for Pakistan.
Other variables such as, domestic investment, foreign direct
investment and exports exerts positive and significant impact on
economic growth at the aggregate and disaggregate level. These results
confirm the earlier findings of Husain and Jun (1992). The results imply
that domestic investment, labour force, exports and FDI inflows have
made an important contribution to economic growth in Pakistan.
The most important policy implication derived from the results is
that to reduce dependency to foreign aid and to improve the growth
prospects in the country the authorities may provide enabling
environment for domestic investment, expand export-oriented industries
and encourage FDI inflows. Furthermore, Pakistan may focus on those
external financing resources that are much stable, sustainable and have
positive impacts on growth rather than depending on the volatile and
unstable sources. Given the general characteristics of exports and FDI
one can expect that these are more stable external resources relative to
foreign aid. The two variables, i.e., exports and FDI have not only
exerted positive impact on growth but also generate spillover effects.
Hence, there is need to focus on these sectors.
Authors' Note: We would like to thank Dr Eatzaz Ahmed,
Professor of Economics, Quaid-i-Azam University, islamabad, and Dr
Muhammad Idrees Khawaja of the Pakistan Institute of Development
Economics, Islamabad, for their valuable comments and suggestions on an
earlier draft of this paper. Thanks are also due to Mr Muhammad Aziz
Khan, Librarian, PIDE, for providing relevant background literature. We
are also grateful to two anonymous referees of this journal for their
helpful comments and suggestions.
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(1) Foreign aid may be defined as the transfers of all governmental
resources from one country to another country. In other words, foreign
aid is one that encompasses all official grants and concessional loans,
in currency or in kind, that are broadly aimed at transferring resources
from developed to less developed nations, on development or income
distribution grounds [Todaro (2000), p. 591].
(2) See White (1992) and Addison, et al. (2005) for a comprehensive
survey.
(3) For our own convenience we eliminate "Ln" term.
(4) Other variables such as portfolio investment, worker
remittances etc. may not be considered because of the small sample size.
(5) All the data used in this study is available from the authors
and can be obtained upon request.
(6) Only one limitation of ARDL method is that this technique is
based on single-equation approach.
(7) The results are available from the authors.
(8) In Pakistan there are some misperceptions that the economic
growth remains always high under the military regimes than that of
democratic governments. These sentiments and thinking are very
dangerous. It is true that the growth is reported to be higher under
military governments. It is not a very plausible criterion to judge
economic growth and performance of the governments. However, higher
growth rate is meaningless when other micro and macroeconomic indicator
are not influenced the economy positively [Bilquees (2004)]. The actual
position in Pakistan is that the higher growth rate, poverty and
unemployment are moving in the same directions not only in the
democratic governments but also in the military regimes. Furthermore,
during the military rule either in 1977 or in 1999 some international
developments cause higher growth rates. However, saving to GDP ratio,
domestic investment to GDP ratio remains low despite the inflows of
reasonable foreign assistance for being front line state in the War
against Russia and War against terrorism [for further detail see, Khan
and Khan (2007)].
(9) This could be possible because due to the weak accountability
non-project aid is not utilised as intended.
(10) Iqbal (1997) argued that over-time development expenditure as
percentage of total expenditure was reduced from 38.3 percent in 1975-76
to 18.2 percent in 1995-96 in Pakistan.
(11) Explanation of negative effect is given in case A.
(12) Donor countries granted aid under different motivations. For
example, Australia granted aid to promote economic and social progress
and for political-strategic and commercial interests. Similarly, US
granted aid for humanitarian relief and long-term economic and social
development of low-income countries. US also provide aid to promote
national security. In the context of Pakistan, US increased aid when
Pakistan become front-line state against USSR during 1980s and after
9/11 war against terrorism.
Muhammad Arshad Khan <arshadkhan82003@yahoo.com> is Senior
Research Economist, Pakistan Institute of Development Economics,
Islamabad. Ayaz Ahmed <chayazahmed@yahoo.com> is Senior Research
Economist, Pakistan Institute of Development Economics, Islamabad.
Table 1
Inflows of Foreign Capital in Developing Countries (US$ Billion)
Year FDI FPI Grants *
1970 2.2 0.0 1.9
1980 4.4 0.0 13.1
1990 24.1 2.8 28.2
1998 170.9 15.6 27.1
1999 192.0 27.6 26.4
2000 168.8 14.1 28.7
2002 160.3 5.9 32.5
2003 161.6 25.2 43.7
2004 211.4 37.6 50.3
2005 237.5 61.4 52.6
Source: Global Development Finance (2000, 2006). * Indicate net
flow of grants excluding technical cooperation.
Table 2
Foreign Aid to Pakistan and Other Asian Countries
Aid as Percentage of GNP
Country 1960 1970 1980 1990 2000 2001 2002
Pakistan 6.6 4.2 4.6 2.7 0.97 2.8 3.08
India 2.31 1.37 1.2 0.45 0.32 0.36 0.29
Bangladesh 5.21 * 7.31 6.82 2.39 2.11 1.83
Sri Lanka 0.71 2.18 9.68 9.26 1.8 2.02 2.11
Nepal 1.58 2.71 8.17 11.6 7.03 7.02 6.57
Hong Kong 0.5 0.04 0.04 0.05 0.00 0.00 0.00
Singapore -0.05 1.5 0.12 -0.01 0.00 0.00 0.01
Thailand 1.6 1.04 1.3 0.94 0.58 0.25 0.24
Aid Per Capita (Current US Dollar)
Pakistan 5.5 6.94 14.27 10.43 5.01 13.73 14.69
India 1.7 1.51 3.18 1.65 1.44 1.65 1.37
Bangladesh 0.32 ** 15.66 20.11 9.06 7.79 6.78
Sri Lanka 1.05 3.93 26.24 42.8 14.24 16.69 18.08
Nepal 0.81 1.93 10.55 22.12 12.85 15.64 14.15
Hong Kong 1.9 0.36 2.15 6.69 0.65 0.53 0.58
Singapore -0.2 13.81 5.75 -1.02 0.27 0.21 1.72
Thailand 1.61 2.04 9.02 14.56 11.36 4.53 4.7
Aid as Percentage of GNP
Country 2003 2004 2005
Pakistan 1.32 1.52 1.54
India 0.15 0.1 0.22
Bangladesh 2.55 2.37 2.09
Sri Lanka 3.72 2.7 5.13
Nepal 7.9 6.37 5.77
Hong Kong 0.00 0.00 0.00
Singapore 0.01 0.01
Thailand -0.68 0.02 -0.1
Aid Per Capita (Current
US Dollar)
Pakistan 7.15 9.36 10.7
India 0.85 0.64 1.58
Bangladesh 10.2 10.15 9.31
Sri Lanka 35.16 26.71 60.6
Nepal 17.77 16.08 15.77
Hong Kong 0.74 1.01 --
Singapore 1.69 2.16 --
Thailand -15.18 0.41 -2.66
Source: http://devdata.worldbank.org/query. *, ** Indicate
1977 and 1971 respectively.
Table 3
Economic Group-wise Disbursement of Foreign Private Loans since
1990-91 (in Million US$)
Economic Group FY91 FY92 FY93 FY94 FY95
Power -- -- -- 4.2 350.2
Cement 7.4 -- 1.1 -- 18.8
Fertiliser -- 2.0 153.6 1.8 --
Chemicals -- 18.6 9.3 6.2 13.0
Textiles 111.6 291.2 293.5 421.4 150.5
Financial Business 9.0 -- 60.0 21.3 28.0
Oil and Gas Explorations -- 1.1 -- -- --
Paper and Pulp -- -- 0.3 25.8 --
Petroleum Refining -- 0.9 -- -- --
Communications -- -- -- -- --
Transport 13.0 245.0 139.0 139.9 117.0
PIA 13.0 245.0 139.0 124.0 342.0
Sugar 5.0 -- -- 5.7 3.3
Construction -- -- 2.7 -- 4.1
Others 12.1 3.7 0.9 6.7 44.0
Total 158.1 562.5 660.4 633.0 953.9
Economic Group FY96 FY97 FY98 FY99 FY00
Power 367.8 461.0 687.3 121.1 21.1
Cement 130.1 11.8 -- -- 31.5
Fertiliser -- 9.8 5.0 37.2 43.5
Chemicals 50.7 52.0 21.4 1.0 18.6
Textiles 142.9 72.6 23.9 0.8 8.1
Financial Business -- -- -- 6.0 --
Oil and Gas Explorations -- -- -- -- --
Paper and Pulp 32.4 7.5 1.8 -- 6.7
Petroleum Refining -- 17.9 20.3 -- --
Communications -- -- 21.1 16.1 6.6
Transport -- -- -- -- 117.0
PIA -- -- -- -- --
Sugar 9.8 2.7 -- -- --
Construction -- -- -- -- --
Others 24.8 39.4 15.2 18.1 24.4
Total 758.5 674.7 796.0 194.3 284.0
Economic Group FY01 FY02 FY03 FY04 FY05
Power 48.0 70.8 86.5 37.6 18.3
Cement 53.0 5.6 -- 23.2 --
Fertiliser 40.5 3.5 14.7 -- --
Chemicals -- 6.8 -- 45.9 --
Textiles 15.6 2.9 30.0 5.2 --
Financial Business 11.5 -- -- -- --
Oil and Gas Explorations -- -- -- -- --
Paper and Pulp -- 36.5 -- -- --
Petroleum Refining -- -- -- -- --
Communications 12.8 34.0 -- 17.0 --
Transport -- -- 219.0 374.0 --
PIA 117.0 -- 219.0 374.0 --
Sugar -- -- -- -- --
Construction -- -- -- -- --
Others 21.5 13.0 -- -- 1.8
Total 191.4 184.6 350.0 503.0 20.1
Source: State Bank of Pakistan (Handbook for Pakistan's
Economy 2005). FY represents Fiscal Year.
Table 4
Results of ARDL Cointegration Test
Type of Aid Variable Included
Total Aid F ([Y.sub.t] | [FDIY.sub.t], INVY, [AIDY.sub.t],
[L.sub.t], [X.sub.t], D)
Project Aid and F ([Y.sub.t] | [FDIY.sub.t], INVY , [PAIDY.sub.t],
[FDIY.sub.t]t [L.sub.t], [X.sub.t], D)
Non- project Aid
Project Aid F ([Y.sub.t] ] [FDIY.sub.t], INVY, [PAIDY.sub.t],
[L.sub.t], [X.sub.t], D)
Non-project Aid F ([Y.sub.t] | [FDIY.sub.t], INVY, [NAIDY.sub.t],
[L.sub.t], [X.sub.t], D)
Test Optimal
Type of Aid Statistic Lags Decisions
Total Aid 6.35 2 Coinegration
Project Aid and
Non-project Aid 3.76 2 Coinegration
Project Aid 12.20 2 Coinegration
Non-project Aid 6.42 2 Coinegration
Note: The critical values are taken from Pesaran, et al. (2001).
Table 5
Long-run and Short-run Estimates of Real Output and Foreign Aid
A. Real Output and Total Foreign Aid
Real Output with Total Aid: ARDL (1, 0, 2, 0, 2, 1) Based AIC
[Y.sub.t] = 0.57 [Y.sub.t-i] + 0.03 [FDIY.sub.t] - 0.13
[INVY.sub.t] + 0.30 [INVY.sub.t-1] + 0.29 [INVY.sub.t-2] - 0.002
[AIDY.sub.t] - 0.18[L.sub.t] + 0.31[L.sub.t-1] + 0.34 [L.sub.t-2]
(8.77)* (2.33)** (-0.48) (0.81) (1.17) (-1.71)** (-1.47) (2.00)**
(2.52)**
+ 0.05 [X.sub.t] + 0.05 [X.sub.t-1] - 0.02 [D.sub.t]
(2.10)** (1.75)** (-4.13)*
[[bar.R].sup.2] = 0.99 F(11, 21) = 6167.2* RSS = 0.002
LM - [chi square] (1) = 1.53 FF - [chi square](1) =
0.06 NO - [chi square](2) = 0.55 Het - [chi square](1) = 2.03
Long-run Estimates
[Y.sub.t] = 0.08 [FDIY.sub.t] + 1.09[INVY.sub.t] - 0.005[AIDY.sub.t]
+ 1.11[L.sub.t] + 0.24[X.sub.t] - 0.05[D.sub.t]
(2.07)** (2.77)* (-1.64) (32.26)* (8.10)* (-4.14)*
Error-Correction Representation
[DELTA][Y.sub.t] = 0.03[DELTA][FDIY.sub.t] -0.13[INVY.sub.t]
-0.29[INVY.sub.t-1] -0.002[DELTA][AIDY.sub.t] - 0.18[DELTA]
[L.sub.t] - 0.34[DELTA][L.sub.t-1] + 0.06[DELTA][X.sub.t] -0.02
[DELTA][D.sub.t] - 0.43[EC.sub.t-1]
(2.33)** (-0.48) (-1.17) (-1.71) (-1.47) (-2.52)** (2.10)**
(-4.13)* (-6.59)*
[[bar.R].sup.2] = 0.70 F-stat = 10.79 RSS = 0.002 DW-stat = 2.36
B. Real Output, Project Aid and Non-project Aid : ARDL (2, 2, 0, 0,
1, 2, 1) Based on AIC
[Y.sub.t] = 0.32[Y.sub.t-1] + 0.34[Y.sub.t-2] + 0.05[FDIY.sub.t] +
0.004[FDIY.sub.t-1] + 0.04[FDIY.sub.t-2] - 0.10[INVY.sub.t] + 0.008
[PAIDY.sub.t] - 0.005[NAIDY.sub.t]
(1.62) (1.53) (3.00)* (0.21) (2.16)** (-0.39) (1.68) (-2.12)**
- 0.002[NAIDY.sub.t-1] - 0.43[L.sub.t] + 0.46[L.sub.t-1] +
0.49[L.sub.t-2] + 0.02[X.sub.t] + 0.08[X.sub.t-1] - 0.02[D.sub.t]
(-1.15) (-3.30)* (3.00)* (2.80)* (0.80) (2.44)** (-4.46)*
[[bar.R].sup.2] = 0.99 F(11,21) = 4986.3* RSS = 0.002
LM - [chi square](1) = 2.22 FF - [chi square](1) = 0.25
NO - [chi square](2) = 5.22 Het - [chi square](1) = 0.73
Long-run Estimates
[Y.sub.t] = 0.20[FDIY.sub.t] - 0.22[INVY.sub.t] + 0.02[PAIDY.sub.t]
- 0.02[NAIDY.sub.t] + 1.18[L.sub.t] + 0.24[X.sub.t] - 0.05[D.sub.t]
(3.09)* (-0.39) (1.78)*** (-4.08)* (34.10)* (7.30)* (-4.31)*
Error-Correction Representation
[DELTA][Y.sub.t] = -0.24[DELTA][Y.sub.t-1] + 0.05[DELTA]
[FDIY.sub.t] - 0.04[DELTA][FDIY.sub.t-1] - 0.10[DELTA][INVY.sub.t] +
0.009[DELTA][PAIDY.sub.t] - 0.005[DELTA][NAIDY.sub.t] - 0.45[DELTA]
[L.sub.t]
(-1.53) (3.00)* (-2.16)** (-0.39) (1.68) (-2.12)** (-3.30)*
- 0.49[DELTA][L.sub.t-1] + 0.02[DELTA][X.sub.t] - 0.02[DELTA][D.sub.t]
- 0.44[EC.sub.t-1]
(-2.80)* (0.80) (-4.45)* (-6.54)*
[[bar.R].sup.2] = 0.71 F-stat = 9.24 RSS = 0.002 DW-stat = 2.32
C. Real Output and Project Aid: ARDL (1, 0, 1, 0, 2, 0) Based on AIC
[Y.sub.t] = 0.63[Y.sub.t-1] + 0.04[FDIY.sub.t] - 0.28[INVY.sub.t] +
0.67[INVY.sub.t-1] - 0.003[PAIDY.sub.t] - 0.22[L.sub.t] +
0.33[L.sub.t-1] + 0.30[L.sub.t-2] + 0.09[X.sub.t] - 0.02[D.sub.t]
(11.68)* (2.94)* (-1.10) (3.01)* (-0.76) (-1.96)*** (2.04)** (2.20)**
(4.16)* (-3.41)*
[[bar.R].sup.2] = 0.99 F(11, 21) = 6683.8* RSS = 0.003
LM - [chi square](1) = 3.68 FF - [chi square](1) = 0.62
NO - [chi square] (2) = 1.61 Het - [chi square](1) = 3.13
Long-run Estimates
[Y.sub.t] = 0.11[FDIY.sub.t] - 0.06[INVY.sub.t] - 0.008
[PAIDY.sub.t] - 1.12[L.sub.t] + 0.24[X.sub.t] - 0.05[D.sub.t]
(2.60)** (2.90)* (-0.76) (35.38)* (6.57)* (-3.64)*
Error-Correction Representation
[DELTA][Y.sub.t] = 0.04[DELTA][FDIY.sub.t] - 0.28[DELTA]
[INVY.sub.t] - 0.003[DELTA][PAIDY.sub.t] - 0.22[DELTA][L.sub.t] - 0.30
[DELTA][L.sub.t-1] + 0.09[DELTA][X.sub.t] - 0.02[DELTA][D.sub.t] - 0.37
[EC.sub.t-1]
(2.94)* (-1.10) (-0.76) (-1.96)** (-2.20)** (4.16)* (-3.41)* (-6.82)*
[[bar.R].sup.2] = 0.66 F-stat = 10.31 RSS = 0.003 DW-stat = 2.60
D. Real Output and Non-project Aid: ARDL (1, 0, 2, 0, 2, 1) Based on
AIC
[Y.sub.t] = 0.57[Y.sub.t-1] + 0.03[FDIY.sub.t] - 0.14[INVY.sub.t] +
0.25[INVY.sub.t-1] - 0.003[NAIDY.sub.t] - 0.22[L.sub.t] +
0.33[L.sub.t-1] + 0.30[L.sub.t-2] + 0.09[X.sub.t] - 0.02[D.sub.t]
(11.68)* (2.94)* (-1.10) (3.01)* (-0.76) (-1.96)** (2.04)** (2.20)**
(4.16)* (-3.41)*
[[bar.R].sup.2] = 0.99 F(11, 21) = 6683.8* RSS = 0.003
LM - [chi square](1) = 3.68 FF - [chi square](1) = 0.62
NO - [chi square] (2) = 1.61 Het - [chi square](1) = 3.13
Long-run Estimates
[Y.sub.t] = 0.07[FDIY.sub.t] + 0.97[INVY.sub.t] - 0.007 [NAIDY.sub.t]
+ 1.11[L.sub.t] + 0.25[X.sub.t] - 0.05[D.sub.t]
(2.04)** (2.39)* (-1.89)*** (33.58)* (10.25)* (-4.38)*
Error-Correction Representation
[DELTA][Y.sub.t] = 0.03[DELTA][FDIY.sub.t] - 0.14
[DELTA][INVY.sub.t] - 0.31 [DELTA][INVY.sub.t-1] -0.003[DELTA]
[NAIDY.sub.t] - 0.18[DELTA][L.sub.t] - 0.35 [DELTA][L.sub.t-1] +
0.05[DELTA][X.sub.t] - 0.02[DELTA][D.sub.t] - 0.43[EC.sub.t-1]
(2.28)* (-0.52) (-1.45) (-1.96)*** (-1.50) (-2.61)** (1.97)***
(-4.32)* (-6.77)*
[[bar.R].sup.2] = 0.71 F-stat = 11.30 RSS = 0.002 DW-stat = 2.37
Note: t-values are given in parentheses. *, ** and *** indicate
significant at the 1 percent, 5 percent and 10 percent level of
significance respectively.
Fig. 1. Source-wise Disbursement of Foreign Aid to Pakistan from
1956-57 to 2004-05
Project Aid 60%
Non Food 10%
Food 12%
BOP 15%
Relief 3%
Note: Table made from pie chart.