This paper develops a model to study the effects of foreign aid on the creation
and distribution of wealth in the recipient country. It considers three
types of foreign aid: permanent grants to all individuals, temporary grants to
uneducated workers, and foreign aid in the form of low interest rate loans to
individuals who invest in education. The model shows that the economy may
have two long-run equilibria, a rich equilibrium and a poor one. All types of
foreign aid can increase the proportion of individuals investing in education,
which means more people converging to the rich equilibrium and higher average
wealth in the economy. In addition, if permanent or temporary grants are
sufficient large, it is possible that the whole economy may converge to the rich
equilibrium.