The fact that so many countries register low per capita income after receiving enormous amounts of foreign aid questions its effectiveness as a tool for economic growth and consequently as an instrument of poverty alleviation. The impact of foreign aid on economic growth is ultimately an empirical question and one that will be addressed in this paper. The paper uses the most recent data and incorporates most of the salient features of the new growth literature to test the effect of aid on economic growth. Three important conclusions emerged from the empirical analysis of the paper. First, it shows that the effect of aid on growth is nonlinear. The nonlinearity of the relationship indicates a threshold for foreign aid beyond which more aid is detrimental to economic growth. Second, the empirical results of this paper support Burnside and Dollar’s findings that a good policy environment is important for aid to work effectively. Aid effectiveness can only be sustained in an environment of good economic policy. Finally, using etholinguistic fractionalization as an instrument, the empirical results of the paper indicate that the relationship between AID/GDP and economic growth is sequential. More and more aid leads to lower economic growth. Copyright International Atlantic Economic Society 2005H11, O40,

No abstract

(JEL 017, 040, P51)

ABSTRACT

The impact of political systems on economic growth cannot be understood solely in terms of a simple distinction between democratic and non-democratic regimes. The democratic character of the political regime may be irrelevant when economic freedom is assessed independently from political freedom and civil liberty. This paper uses newly constructed measures of economic freedom by Gwartney-Lawson-Block [1996]. The empirical results of this paper show that economic freedom contributes to economic growth irrespective of the nature of the political regime. The empirical results also indicate that the effect of democracy on economic growth is ambiguous at best. Nonetheless, democracy may have some effect on economic growth, operating indirectly through the investment channel.