This paper examines the effect of foreign aid on poverty. The impact of aid on poverty is assessed using dynamic panel estimation techniques, which enable us to control for time-invariant country-specific effects and endogeneity of aid. The results suggest that aid has a significant poverty-reducing effect even after controlling for average income. Specifically, foreign aid is associated with a decline in poverty as measured by the poverty rate, poverty gap index and squared poverty gap index. We also find that the composition of aid mattersmultilateral aid and grants do better in reducing poverty than bilateral aid and loans.1 Poverty-efficient allocation of aid is an allocation rule for which the marginal impact of an additional million dollars in aid is equalised across aid-receiving countries (Collier and Dollar, 2002). 7 The highest-aid recipient in our sample was Mozambique in 1993. During the sample years 1981-2004, Mozambique had an average poverty rate of 41.6 per cent, an aid-to-GNI ratio of 28.7 per cent and a GDP per capita of $450.1 in 2005 PPP. The highest poverty rate in our sample corresponds to Uganda in year 1993. Over the reference period, 1981-2004, Uganda had an average poverty rate of 86.4 per cent, an aid-to-GNI ratio of 11.8 per cent and a GDP per capita of $634.5 in 2005 PPP. 8 The basic specification for poverty analysis from Datt and Ravallion (1992) is P t ¼ P Z=μ t ; L t ð Þ , where P t is the poverty measure, Z is the poverty line, μ t is the mean income and L t is the Lorenz curve. Therefore, changes in poverty are decomposed into growth and redistribution components. 9 Because of the persistent nature of poverty, past levels of poverty explain a great deal of the present and future levels. 962 E. Alvi and A. Senbeta

This article studies the effects of remittances on economic growth and the sources of growth:capital accumulation and Total Factor Productivity (TFP) growth. This approach is different from previous studies, in that, it focuses on the transmission mechanism instead of the impact of remittances on economic growth. We find that remittances have conflicting effects on the two sources of growth: capital accumulation and productivity growth. Remittances have a significantly positive impact on capital accumulation while the impact on TFP growth is insignificant. These findings suggest that while remittances enhance investment and contribute to physical capital accumulation, the lack of efficiency enhancing effect or possible adverse impact on TFP growth would make the net effect on economic growth ambiguous.

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