Foreign Aid-Growth Nexus in Pakistan: Role of Macroeconomic Policies

Despite receiving the large quantities of foreign aid, like many other Developing Countries, Pakistan has remained stagnant and become more aid dependent. This grim reality provokes vigorous debate on the effectiveness of aid. This study examines the effectiveness of aid, focusing on the ongoing debate on the interactive effect of aid and policy on sustainable economic growth. The empirical analysis is based on the ARDL cointegration approach using the data for the period 1960 to 2008. Based on the empirical results we find that foreign aid and real GDP has negative relationship while aid-policy interactive term and real GDP growth has positive and significant relationship. The interesting results emerge; when Aid/GDP alone is introduced into the growth equation it has insignificant positive coefficient in the long run and negative and weakly significant coefficient in the short run while aid policy interactive term has positive and significant coefficient both in the short run and long run. When we disaggregate aid in term bilateral and multilateral component, bilateral aid is significantly positive in the short run and multilateral aid is insignificant while aid interactive term is positive in both cases. The results strongly support the view that foreign aid does have positive impact on economic growth in Pakistan conditional on sound macroeconomic policies