Essays on aid, growth and welfare

As from early 1960s, the question of whether aid works has been a central theme in development economics. The continued effort to analyse the effects of aid only now appears to be nearing consensus. A close examination of the literature suggests that there are certain aspects that are critical to this strand of studies that have not been fully addressed. In this thesis, we make a contribution by throwing light on three such issues that relate to the macroeconomic effectiveness of aid. Aid does not have a direct effect on growth; it operates via transmission mechanisms. Their role has not been given due consideration in the empirical literature. Our first objective is to revisit the question of aid effectiveness while taking into account the important effects through these mechanisms. Using generated regressors, we purge aid effect on these various mediators and obtain a coefficient on aid that gives a measure of the total effect aid has on growth. Our results consistently show that aid has had a positive effect on growth, largely through aid-financed investment and that Africa's poor growth record should not be attributed to aid ineffectiveness. Our second objective relates to the non-linear aspects that would seem to characterise the aid-growth link. This has consistently been represented by an 'aid squared' term and recently been referred to as the aid Laffer effect as proposed by Lensink and White (2001). Using a threshold model, we directly test the assumptions underlying this hypothesis. Contrary to an aid Laffer curve, we find that aid becomes effective beyond a certain critical level and human capital enhances its effects at higher aid levels. Hence, we find no evidence of diminishing returns in aid. Although, marginal impact of aid on growth does become weaker as human capital exceeds some high level. Overall, it seems that an 'aid squared' term is not an appropriate representation of the non-linearity in aid-growth link. Finally, we contribute to the limited literature on aid and welfare of the poor. Our findings consistently show that aid is associated with increases in welfare indicators. We highlight the role of pro-poor public spending as the channel through which aid improves welfare. These indirect effects are captured using residual generated regressors. Quantile regression estimates suggest that aid effects on human development vary across the welfare distribution; effects are more significant in economies located at the lower end of this distribution. Finally, we find that improving welfare may just be another way to promote growth in developing countries