The Pakistan
Development Review
46 : 3 (Autumn 2007) pp.
215–240
Foreign
Aid—Blessing or Curse: Evidence from
Pakistan
MUHAMMAD ARSHAD KHAN and AYAZ AHMED*
The role of
foreign aid in promoting economic growth is a debatable issue and remains
unsettled at both theoretical and empirical levels. Pakistan has received a
substantial amount of foreign aid since its Independence in 1947 but little
improvement has been observed in its socio-economic development. This study
considers the question as to whether foreign aid is a blessing or a curse for
Pakistan. The empirical analysis is based on the ARDL cointegration approach.
We examine the aid-growth link at the aggregate and disaggregate levels for the
period 1972–2006. The results show negative and insignificant effects of
foreign aid on the growth at the aggregate as well at the disaggregate level.
The findings further suggest that domestic investment, export growth, and
inflows of foreign direct investment are important contributors in enhancing
economic growth in Pakistan.
JEL
classification: C13, C22, F23, F35,
O11
Keywords:
Foreign Aid, Economic Growth, FDI, Cointegration
1. INTRODUCTION
Foreign aid is an important source of
income in developing countries and carries potential to play a key role in
promoting economic growth.[1]
The traditional literature on economic growth emphasises the positive role of
foreign aid in the process of economic development. Foreign aid inflow
influences the process of growth by reducing the saving-investment gap,
increasing productivity and transferring the modern technology. However, in the
neoclassical growth framework the benefits of foreign capital inflows are of temporary
nature. Like many other developing
countries, Pakistan has heavily relied on foreign borrowings to finance its
economic development. This strategy increased its dependency on external
resources. Pakistan has received around US$73.14 billion in the form of foreign
aid from 1960 to 2002 [Anwar and Michaelowa (2006)], but the benefits of this
aid flows have not stretched to the whole society, which means that foreign aid
has
Muhammad
Arshad Khan <arshadkhan82003@yahoo.com> is Senior Research Economist,
Pakistan Institute of Development Economics, Islamabad. Ayaz Ahmed
<chayazahmed@yahoo.com> is Senior Research Economist, Pakistan Institute
of Development Economics, Islamabad.
Authors’ Note: We would like to thank Dr Eatzaz Ahmed, Professor of
Economics, Quaid-i-Azam University, Islamabad, and Dr Muhammad Idrees Khawaja
of the Pakistan Institute of Development Economics, Islamabad, for their
valuable comments and suggestions on an earlier draft of this paper. Thanks are
also due to Mr Muhammad Aziz Khan, Librarian, PIDE, for providing relevant
background literature. We are also
grateful to two anonymous referees of this journal for their helpful comments
and suggestions.
failed to improve the economic conditions
in Pakistan. The literacy rate is still around 50 percent and other social
indicators, such as employment, health and education etc., also do not present
an encouraging picture. Saving rates have remained low, and the trade gap has
widened [Husain (1999)]. Foreign aid has
not been utilised for development of the economy; rather aid has served the
vested interests of influential people. During 1990s, the foreign loans at
commercial rate of interest have exacerbated the foreign debt problem of the
country. The overall situation depicted above cast doubts about the
effectiveness of foreign aid as a tool for economic growth.
The impact of foreign aid on economic
development has always been a controversial issue.[2]
In 1950s, 1960s and 1970s rich countries used foreign aid to fill the gaps in
resources, encouraging domestic investment and industrial development under the
belief that foreign aid could help developing countries to accelerate the
“takeoff” into self-sustained growth by generating new domestic investment
[Rostow (1960) and Waterson (1965)]. Many economists assert that foreign
capital inflow is necessary and sufficient condition for economic growth in
developing countries. They claim that there exist a positive correlation
between foreign aid and economic growth because it complements domestic
resources and also supplements domestic savings to bridge saving-investment gap
and provides additional financial resources which helps to achieve the
short-term growth targets. Besides, it is also held that, foreign aid assists
to close the foreign exchange gap, provide excess to modern technology and
managerial skills and allow easier excess to world markets [see for example,
Chenery and Strout (1966); Papanek (1973); Gulati (1975); Roemer (1989);
Islam (1992) and Thirlwall (1999); among others]. Mosley (1980) observes a
positive relationship between foreign aid and economic growth for UK aided
countries and negative for French and Scandinavian aided countries. However, he
concludes that aid could not improve the economic conditions in Bangladesh,
India and countries like Korea, Malawi and Kenya.
Another strand of literature asserts
that external capital exert significant negative effect on the economic growth
of the recipient countries. According to this view, foreign aid is fully
consumed and substitutes rather than complements domestic resources. It is
argued that foreign aid is used to import inappropriate technology, distorts
domestic income distribution and encourages a bigger, inefficient and corrupt
government in developing countries Foreign aid is also thought to displace
domestic savings, which in turn retards investment and economic growth [Griffin
and Enos (1970); Weisskoff (1972)]. Boone (1996) finds
that aid has no effect on investment and growth—his estimates show that the
marginal propensity to consume from foreign aid is insignificant and marginal
propensity to investment was zero. Easterly (2001) finds no empirical
relationship between foreign aid and economic growth and between aid and
investment. He concludes that aid has not delivered the expected results and
may create the wrong economic incentives. Many studies confirm negative
correlation between foreign aid and economic growth. Negative correlation
between aid and growth is the outcome of factors such as economic policies,
government intervention, business cycle and instability of foreign aid flows in
the recipient countries [Levy (1984)]. Singh (1985) concludes that state
intervention in the economy generate negative impact on economic growth and
makes the aid-growth relationship statistically insignificant. Burnside and Dollar (2000) find that the
relationship between foreign aid and economic growth may depend on whether the
recipient countries have been pursuing sound economic policies. Gounder (2001)
and Lloyd, et al. (2001) find that
foreign aid contributes to long-term growth in private consumption and policy
reforms enhance the effectiveness of economic growth. Mavrotas (2002) finds
that policies impact aid effectiveness in case of India. Lensink and Morrissey
(2000) analyse the impact of aid uncertainty on economic growth in developing
countries. They find that the impact of foreign aid on economic growth depends
on the aid levels and the stability of aid flows. Pallage and Robe (2001)
explain empirical regularities in the foreign aid flows to developing
countries. They reveal that aid flow is a major source of income in the
majority of recipient countries and aid flow is highly volatile and
overwhelmingly pro-cyclical. This means that even if foreign aid helps foster
economic growth, serious problems would nevertheless stem from the fact that
aid disbursement pattern intensify volatility of developing countries’
disposable income which affects growth negatively. Hansen and Tarp (2001) conclude that aid
increases growth via capital accumulation and it does not depend on good
policy. They note that growth regressions are sensitive to choice of control
variables and choice of estimators and that much more theoretical work is
needed before drawing policy insights.
Pack and Pack (1994) asserts that foreign aid is fungible. They claimed
that because of the fungibility of foreign aid, the increase in government
income in the form of aid will be crowded-out.
On the other hand, Cassen (1994) argues
that the relationship between aid and growth is rather weak, and it can be
either positive or negative, depending on the country’s absorption capacity of
aid, economic and political structure and the time period chosen. Studies based
on time series data conclude that foreign aid has been an important determinant
of economic growth. Feyzioglu, et al.
(1998) concludes that sectoral concessional loans are highly fungible.
An alternate strand of literature
points out that foreign economic assistance displaces processes of
institutional maturation that is essential to promote economic development.
Thus, foreign aid promotes aid-dependency [Friedman (1958) and Bauer (1971)].
Foreign assistance represents a side payment to elites in recipient countries,
design to buy compliance in maintaining the economic and political dominance of
the industrialised countries [Frank (1966)]. Brautigam and Knack (2004) point
out that poor quality institutions, weak rule of law, absence of
accountability, controls over information and high level of corruption have
distorted the benefits of foreign aid in most African countries. Similarly,
Wolfensohn the president of World Bank in 2002 observed that “we have learned that corruption; bad
policies and weak governance will make aid ineffective”. However, selective foreign aid has helped to
improve per capita income and lower infant mortality rate in under-developed
nations [Easterly (2003)]. Selective foreign aid means that donor nations put
some conditionalities in the form of low inflation and budget deficit,
non-interference with market prices, privatisation and openness to
international trade [Easterly (2003)].
Svensson (1999) concludes that foreign aid has a positive long-term
impact in democratic countries, but in countries with authoritarian regimes,
aid has often dissipated into unproductive activities. Ranis and Mahmood (1992)
claims that foreign aid retard a country’s ability to adhere to responsible
economic policies.
The bulk of theoretical and empirical
literature has so far produced inconsistent and elusive results regarding the
relationship between foreign aid and economic growth. Empirical findings are
also mixed with respect to the impact of foreign aid in Pakistan. For instance,
Chishti and Hasan (1992) conclude that 28 percent of the domestic borrowings go
towards financing the public sector non-development expenditures. Their results
also indicate that foreign aid in the form of grants has a modest impact on
public investment while loans do not seem to have a significant impact on
public investment. Shabbir and Mahmood (1992) conclude that net foreign capital
inflows, disbursement of grants and external loans have a positive impact on
economic growth of Pakistan. Ali (1993)
points out that there is no significant relationship between inflow of foreign
aid and economic growth. Khan and Rahim (1993) conclude that foreign aid has
negative relationship with domestic savings and it has no significant impact on
economic growth. Iqbal (1997) is of the view that foreign capital that flows
into the public sector has strong positive impact on social and non-development
expenditures and has little effect on development spending. He further suggests
that foreign loans and aid are largely consumed rather than invested
productively and foreign assistance cause a strong shift of public domestic
resources from development projects to nondevelopment expenditures. Khan (1997) has also pointed out that aid has
a robust negative impact on economic growth. Similarly, Ishfaq and Ahmed (2005)
conclude that foreign aid has not contributed favourably to GDP growth rate of
Pakistan. This ineffectiveness of aid is attributed to diversion of aid funds
to non-productive activities and inefficiency in resource allocation especially
in the public sector. Husain (1999) argues that foreign aid exerts positive
impact on growth if the macroeconomic policies are correct, microeconomic
incentives are not distorted and the supporting institutions are in place. In
the absence of these preconditions foreign aid helps to postpone the tough
decisions required for prudent economic management. Under these circumstances,
foreign aid is curse rather than blessing and should be avoided.
These conflicting views have motivated
us to reinvestigate the role of foreign aid in determining economic growth.
This paper seeks to answer the question whether foreign aid is blessing or
curse for Pakistan? Specifically we hypothesise that Pakistan should concentrate
on those external resources that are stable, sustainable and are largely within
the policy control of the authorities, rather than continue to depend on those
resources which are more volatile, less stable and controlled by the external
policymakers. We formulate an empirical
model to test this hypothesis for Pakistan over the period 1972-2006. The
estimation is carried out using autoregressive distributed lag (ARDL)
cointegration technique. This study differs significantly from earlier studies
for Pakistan in three respects. First,
we analyse the impact of foreign aid on economic growth at aggregate as well as
disaggregate level by extending neo-classical production function. Second, the study determines the
relative importance of alternative external financing resources such as exports
growth and foreign direct investment. Third,
the study uses most recent econometric techniques for estimation and covers the
period from 1972 to 2006 and, finally the study extends the body of literature
on aid-growth linkages.
The remainder of the study is organised
as follows: Section 2 overviews the inflows of foreign capital in developing
countries. The brief review of foreign
aid inflows in Pakistan is given in this section. Section 3 discusses the
model, methodology and data. Interpretation of empirical findings is given in
Section 4, while concluding remarks along with policy implications are given in
the final section.
2. FOREIGN CAPITAL INFLOWS TO DEVELOPING COUNTRIES: AN OVERVIEW
Foreign aid and foreign private
investment are the two main sources of capital inflows in developing countries.
Foreign aid could be categorised into grants and relatively low interest rate
loans, while the foreign private investment can be categorised into foreign
portfolio investment (FPI) and foreign direct investment (FDI). The pattern and
trend of such foreign inflows into developing countries have significantly
changed during the past three decades. Grants-type aid to developing countries
increased from US$ 1.9 billion in 1970 to US$ 52.6 billion in 2005. This
increase is, however, modest when compared with the expansion in FDI and FPI
(Table 1).
Table 1
Inflows
of Foreign Capital in Developing Countries (US$ Billion)
|
Year |
FDI |
FPI |
Grants * |
|
1970 |
2.2 |
0.0 |
1.9 |
|
1980 |
4.4 |
0.0 |
13.1 |
|
1990 |
24.1 |
2.8 |
28.2 |
|
1998 |
170.9 |
15.6 |
27.1 |
|
1999 |
192.0 |
27.6 |
26.4 |
|
2000 |
168.8 |
14.1 |
28.7 |
|
2002 |
160.3 |
5.9 |
32.5 |
|
2003 |
161.6 |
25.2 |
43.7 |
|
2004 |
211.4 |
37.6 |
50.3 |
|
2005 |
237.5 |
61.4 |
52.6 |
Source: Global Development Finance (2000, 2006). * Indicate net flow
of grants excluding technical cooperation.
FDI flows increased from US$ 2.2 billion
in 1970 to US$ 237.5 in 2005. Similarly, FPI which was US$ 2.8 billion in 1990
reached to US$ 61.4 billion in 2005, while aid in the form of grants increased
from US$ 1.9 billion in 1970 to US$ 52.6 billion in 2005.
Foreign aid has been an important source
of capital inflows for developing countries during 1960s, 1970s and 1980s.
After the end of cold war, the strategic importance of foreign aid has declined
in 1990s, although the number of donor agencies has increased from 7 to 50 from
1960 to 1990. There is no doubt that
foreign aid helps to promote economic growth and infrastructure of recipient
countries, particularly, at the time of natural disasters. However, the
literature suggests that the impact of foreign aid on economic development is
rather limited because foreign aid is usually directed towards military and
political fields instead of socio-economic fields [Le and Ataullah (2002)]. On
the other hand, the conditionalities imposed by the donor agencies may
constrain the autonomous policies the recipient countries may like to pursue.
Many empirical studies suggest that foreign aid has not contributed profoundly
to the economic growth and development of recipient countries and it has
tendency towards increasing inequalities among different groups [Rana and
Dowling (1990) and Griffin (1991)].
Moreover, foreign aid hurts rather than helps the poor. It goes to their
rulers whose spending policies are determined by their own personal and
political interests, among which the position of the poor has very low priority
[Lappe`, et al. (1980) and Bauer
(1981)]. Similarly, Hayter and Watson (1985) notes that the governments of the
rich countries claims that they are providing ‘aid’ to help the Third World to
escape from the underdevelopment and poverty but much of this aid fails to
alleviate poverty.
In contrast, the British Department for
International Development (2000) argues that development assistance could
contribute to poverty reduction in countries pursuing sound macroeconomic
policies. Canadian International Development Agency (2002) cites World Bank
researchers’ compelling evidence that good governance and sound policy
environment are the most important determinants of aid effectiveness.
Moreover, the increasing tendency
towards providing loans instead of grants and tying aid had left many Third
World countries in debt burden cycle. Given the unequal effects of foreign aid
and limited control over the quantity of aid received, policymakers in LDCs are
increasingly looking for alternate sources of foreign capital including foreign
direct investment and portfolio investment.
2.1.
History of Foreign Aid in Pakistan
Foreign aid began to flow into Pakistan
soon after the independence. During 1950s the flows of aid was very small. But
in 1960s and 1970s, foreign aid remained an important source of capital for
Pakistan. Pakistan was one of the largest aid recipient countries in Asia
during this period, (see Table 2). For example, Pakistan got foreign aid around
6.6 percent of the GNP in 1960. The increase in aid was concomitant with the
increase in the level of private investment, which rose from 42.55 percent of
total investment in 1959-60 to 53.3 percent of the total investment in 1969-70
[Malik, et al. (1994)]. During this
period, huge investment in the physical infrastructure, power, and irrigation
related projects was made with the help of foreign aid which helped to lay down
economic foundation of the country. Mega projects such as Terbala and Mangla
dams were constructed during this period. The inflows of aid picked up momentum
in the early 1970s and remained around 4.2 percent of the GNP. In 1974-75, the
inflow of foreign aid to Pakistan reached US$ 1.00 billion mark, and the
proportion of aid to GNP by then had touched 5.5 percent. Because of the huge
inflow of foreign aid, the government launched public investment programmes
such as roads, electric power, increasing social services, and projects like
Indus Super Highway and Pakistan Steel Mills.
The increase in aid witnessed in the
mid-1970s did not continue for the coming years. Gross disbursements of aid
fell in 1977-78 and 1978-79 as the United States curtailed aid to Pakistan
because of its nuclear policy [Malik, et
al. (1994)]. However, during 1980s
Pakistan again received a large amount of foreign aid (4.6 percent of GNP)
because of its front-line role in the America-Soviet Union conflict over
Afghanistan. The foreign inflows reached to US$2.0 billion mark per annum by
the mid-1980s which enhanced the credit worthiness of Pakistan [Le and Ataullah
(2002); Husain (1999)]. Pakistan and United States signed a six year agreement
in 1985 according to which United States was to provide US$ 4.02 billion in
terms of loans and grants over six-year period beginning September 1987. Of US$
4.02 billions, 57 percent amount was allocated as economic aid and the
remaining in the form of military aid. After signing this agreement, the gross
disbursement of aid increased to US$1.8 billion in 1987-88. The composition of aid over the years has
changed from grants and grants-type assistance to loans on difficult terms.
Table 2
Foreign
Aid to Pakistan and Other Asian Countries
1960 1970 1980 1990
2000 2001 2002 2003
2004 2005
|
Pakistan |
6.6 |
4.2 |
4.6 |
2.7 0.97 2.8 3.08
|
1.32 |
1.52 |
1.54 |
|
India |
2.31 |
1.37 |
1.2 |
0.45 0.32 0.36 0.29
|
0.15 |
0.1 |
0.22 |
|
Bangladesh |
– |
5.21* |
7.31 |
6.82 2.39 2.11 1.83
|
2.55 |
2.37 |
2.09 |
|
Sri Lanka |
0.71 |
2.18 |
9.68 |
9.26 1.8 2.02 2.11
|
3.72 |
2.7 |
5.13 |
|
Nepal |
1.58 |
2.71 |
8.17 |
11.6 7.03 7.02 6.57
|
7.9 |
6.37 |
5.77 |
|
Hong Kong |
0.5 |
0.04 |
0.04 |
0.05 0.00 0.00 0.00
|
0.00 |
0.00 |
0.00 |
|
Singapore |
–0.05 |
1.5 |
0.12 |
–0.01 0.00 0.00 0.01
|
0.01 |
0.01 |
– |
|
Thailand |
1.6 |
1.04 |
1.3 |
0.94 0.58 0.25 0.24
|
–0.68 |
0.02 |
–0.1 |
|
|
|
|
|
Aid Per Capita (Current US Dollar) |
|
|
|
|
Pakistan |
5.5 |
6.94 |
14.27 |
10.43 5.01 13.73 14.69
|
7.15 |
9.36 |
10.7 |
|
India |
1.7 |
1.51 |
3.18 |
1.65 1.44 1.65 1.37
|
0.85 |
0.64 |
1.58 |
|
Bangladesh |
– |
0.32** |
15.66 |
20.11 9.06 7.79 6.78
|
10.2 |
10.15 |
9.31 |
|
Sri Lanka |
1.05 |
3.93 |
26.24 |
42.8 14.24 16.69 18.08
|
35.16 |
26.71 |
60.6 |
|
Nepal |
0.81 |
1.93 |
10.55 |
22.12 12.85 15.64 14.15
|
17.77 |
16.08 |
15.77 |
|
Hong Kong |
1.9 |
0.36 |
2.15 |
6.69 0.65 0.53 0.58
|
0.74 |
1.01 |
– |
|
Singapore |
–0.2 |
13.81 |
5.75 |
–1.02 0.27 0.21 1.72
|
1.69 |
2.16 |
– |
|
Thailand |
1.61 |
2.04 |
9.02 |
14.56 11.36 4.53 4.7
|
–15.18 |
0.41 |
–2.66 |
Source: http://devdata.worldbank.org/query. *, ** Indicate 1977 and
1971 respectively.
In 1990, the United States announced
that it would not enter into any more aid agreement with Pakistan and would
wind up its aid related projects at the end of 1993. This shift in US policy
led to considerable adverse change in aid receipts to Pakistan. The major
reasons for changes in United States contributions were the passage of the
Pressler Amendment and the Brown Amendment in the aid authorisation bills by
the United States Senate in 1985 and 1995 respectively. Because of the Pressler Amendment US aid
disbursement to Pakistan which was US$ 452 million in 1989, fell in early 1990s
to touch rock bottom at only US$ 5.4 million in 1998 [Anwar and Michaelowa
(2006)]. In 199394, aid from consortium and non-consortium sources declined
considerably. In 1998, when Pakistan conducted nuclear tests, further
international aid-sanctions, particularly by the US government, were imposed on
Pakistan. As a consequence, during 1998-2001, both bilateral and multilateral
aid declined significantly.
However, after the 9/11 things changed
dramatically. When Pakistan joined the ‘War against Terrorism’, the volume of
aid increased by 7 times and reached US$ 776.5 million. The US launched another
US$ 3 billion five-year economic assistant package for Pakistan in June 2003.
Other donor countries also sanctioned aid and rescheduled Pakistan’s external
debts. This situation reflects how the flow of foreign aid to Pakistan has
always been subject to conditionalities,
and vulnerable to geopolitical and strategic interests of the donors
particularly, Unites States. Figure 1 clearly depicts the picture of the
composition and structure of foreign aid received by Pakistan during the period
1956– 2005.
[1] Foreign aid may be defined
as the transfers of all governmental resources from one country to another
country. In other words, foreign aid is one that encompasses all official
grants and concessional loans, in currency or in kind, that are broadly aimed at
transferring resources from developed to less developed nations, on development
or income distribution grounds [Todaro (2000), p. 591].
[2] See White (1992) and
Addison, et al. (2005) for a comprehensive survey.
.png)
Figures 1 indicates that from 1956-57 to
2004-05, the share of project aid averaged 60 percent of the total aid,
followed by the share of balance of payments support, which is 15 percent. The
shares of non-food and food aid have been 10 percent and 12 percent
respectively. The share of foreign aid for relief was only 3 percent during the
period.
The project/non-project aid and
food/non-food aid are very important components of the total foreign aid
because project aid directly adds to the productive capacity of the aid
recipient country. Contrarily, large proportion of non-project aid adds to the
debt burden of aid receiving country. Figure 2 shows the trend of project and
non-project aid inflows to Pakistan since 1990-91. The project aid depicts a
declining trend during the period 1990-91 to 2005-06, whereas from 2002-03
non-project aid again had been following an increasing trend. Resultantly,
total aid increased from US$ 1270 in 1996-97 to US$ 2316 million in 2005-06.
Fig. 2. Trends of Project, Non-project and Total Aid. From 1990-91 to 2005-06
.png)
The sectoral distribution of foreign private loans, for the period 1990-2005 is shown in Table 3 and Figure 3. The share of, textiles sector in total foreign private loans is almost
15 percent, Petroleum refining 14
percent, Pakistan International Air Line (PIA) 26 percent and transport 23
percent.
During the 1960s, 1970s and 1980s,
Pakistan was among the largest aid recipient countries. But the benefits of
this aid could not stretch to the whole society. The aim of Pakistan’s
five-year Plans for the period 1965-85 was elimination of dependence on foreign
assistance [Le and Ataullah (2002)]. But there had been a significant increase
in foreign economic assistance since then. This increase in foreign aid could
not help in the socio-economic uplift. For example, during the 1960s and 1970s
when Pakistan was the largest aid receiving country among Asian countries, the
average percentage of population living under the poverty line declined
marginally from 43 percent to 39 percent.
Social services and human sector development have remained neglected and
the social indicators have worsened, leaving Pakistan at par with some of the
poorest African countries. Pakistan ranks 120th in the human development index
constructed by UNDP [Husain (1999)]. Physical infrastructure such as
irrigation, electricity, roads and highways, telecommunications, railways, and
other capital assets have been poorly maintained and have neither been
replaced, nor expanded to keep up with the growing demand [Husain (1999)].
Empirical studies suggest that aid has not exerted any significant effect on
economic growth. Khan (1997) finds negative causal effect of aid on economic
growth, while Ishfaq and Ahmed (2005) conclude that economic growth of Pakistan
has remained independent of foreign aid.
|
Fig. 3. Economic Group-wise Disbursement of Foreign
Private Loans Since 1990-91Figure 4: Economic
Group-wise Disbursement of Foreign Private Loans Since 1990-91 |
.png)
Table 3
Economic
Group-wise Disbursement of Foreign Private Loans since 1990-91 (in Million US$)
|
Economic Group |
FY91 |
FY92 |
FY93 |
FY94 |
FY95 |
FY96 |
FY97 |
FY98 |
FY99 |
FY00 |
FY01 |
FY02 |
FY03 |
FY04 |
FY05 |
|
Power |
– |
– |
– |
4.2 |
350.2 |
367.8 |
461.0 |
687.3 |
121.1 |
21.1 |
48.0 |
70.8 |
86.5 |
37.6 |
18.3 |
|
Cement |
7.4 |
– |
1.1 |
– |
18.8 |
130.1 |
11.8 |
– |
– |
31.5 |
53.0 |
5.6 |
– |
23.2 |
– |
|
Fertiliser |
– |
2.0 |
153.6 |
1.8 |
– |
– |
9.8 |
5.0 |
37.2 |
43.5 |
40.5 |
3.5 |
14.7 |
– |
– |
|
Chemicals |
– |
18.6 |
9.3 |
6.2 |
13.0 |
50.7 |
52.0 |
21.4 |
1.0 |
18.6 |
– |
6.8 |
– |
45.9 |
– |
|
Textiles |
111.6 |
291.2 |
293.5 |
421.4 |
150.5 |
142.9 |
72.6 |
23.9 |
0.8 |
8.1 |
15.6 |
2.9 |
30.0 |
5.2 |
– |
|
Financial Business |
9.0 |
– |
60.0 |
21.3 |
28.0 |
– |
– |
– |
6.0 |
– |
11.5 |
– |
– |
– |
– |
|
Oil and Gas Explorations |
– |
1.1 |
– |
– |
– |
– |
– |
– |
– |
– |
– |
– |
– |
– |
– |
|
Paper and Pulp |
– |
– |
0.3 |
25.8 |
– |
32.4 |
7.5 |
1.8 |
– |
6.7 |
– |
36.5 |
– |
– |
– |
|
Petroleum Refining |
– |
0.9 |
– |
– |
– |
– |
17.9 |
20.3 |
– |
– |
– |
– |
– |
– |
– |
|
Communications |
– |
– |
– |
– |
– |
– |
– |
21.1 |
16.1 |
6.6 |
12.8 |
34.0 |
– |
17.0 |
– |
|
Transport |
13.0 |
245.0 |
139.0 |
139.9 |
– |
– |
– |
– |
– |
117.0 |
– |
– |
219.0 |
374.0 |
– |
|
PIA |
13.0 |
245.0 |
139.0 |
124.0 |
342.0 |
– |
– |
– |
– |
– |
117.0 |
– |
219.0 |
374.0 |
– |
|
Sugar |
5.0 |
– |
– |
5.7 |
3.3 |
9.8 |
2.7 |
– |
– |
– |
– |
– |
– |
– |
– |
|
Construction |
– |
– |
2.7 |
– |
4.1 |
– |
– |
– |
– |
– |
– |
– |
– |
– |
– |
|
Others |
12.1 |
3.7 |
0.9 |
6.7 |
44.0 |
24.8 |
39.4 |
15.2 |
18.1 |
24.4 |
21.5 |
13.0 |
– |
– |
1.8 |
|
Total |
158.1 |
562.5 |
660.4 |
633.0 |
953.9 |
758.5 |
674.7 |
796.0 |
194.3 |
284.0 |
191.4 |
184.6 |
350.0 |
503.0 |
20.1 |
Source: State Bank of Pakistan (Handbook for Pakistan’s Economy
2005). FY represents Fiscal Year.
3. MODEL, METHODOLOGY AND DATA
The rationale that foreign aid increases
economic growth is based on Chenery and Strout’s Dual Gap Model. Chenery and
Strout (1966) claimed that foreign aid promotes economic growth by contributing
to domestic savings as well as foreign exchange availability and helping to
close the saving-investment and export-import gaps. In two-gap model,
investment is the cornerstone of growth and requires imported capital goods
[Ali and Isse (2005)]. However, developing countries generally face two
fundamental financial gaps. The first gap is between the investment and
domestic savings, while the second gap is between imports and foreign exchange
earnings [Easterly (2003)] The developing countries cannot overcome the
shortage of savings and foreign exchange earning on their own due to their
limited resources however, foreign aid and other financial flows can fill these
gaps and contribute to achieving target growth rates. In two-gap model the
contribution of foreign aid is to finance investment including imports of capital
goods. Exports growth is also important as it generates foreign exchange to
finance imports.
Following Husain (1992) we divide
external resources in to two categories. First, the resources which have
stable, sustainable and positive effect on economic growth and are within the
policy control of the domestic authorities. These include export of goods and
services (X) and foreign direct
investment (FDI). Second, foreign
aid, external borrowings and workers remittances are found to be volatile, less
stable and under the control of external policymakers and their contributions
to economic growth are questionable. The external environment influence exports
demand and FDI supply, but despite short-term fluctuations these resources
remains stable and are relatively more influenced by the domestic policy
variables. Hence, preference may be given to these resources rather than
foreign aid, worker remittances and external borrowings to finance long-term
development [Husain (1992)].
Based on the above arguments we
formulate the link between economic growth and foreign aid following pure
production function theory. Assume that real gross domestic product (GDP) of
Pakistan is:
Y =
F(q) … … … …
… … … … (1)
Where Y
is the real GDP, F is the
transformation rule associating Y and
q, q is the vector of explanatory inputs. Assuming a multiplicative
aid-trade-augmented production function and that {capital (K), labour (L), foreign
aid (A) and exports (X)} ∈q, Equation (1) becomes [Amavilah
(1998)]:
Y =ΘKαLβAδXγeu … … … …
… … (2)
Where u
is the normally distributed random error term.
The inclusion of exports in the conventional production function may be
justified on two grounds. First, exports allow countries to specialise in the
production of such commodities in which they have comparative advantage. Export
sector is assumed to be more competitive and efficient than other sectors.
Exports growth facilitates the exploitation of scale economies, allows for
increased capacity utilisation and encourages efficiency through specialisation
in accordance with the principles of comparative advantage. Second, the export
sector is assumed to generate positive externalities, such as relaxing foreign
exchange constraints
226 Khan and Ahmed
and the introduction of technology and
knowledge. It is also assumed that with the given level of capital and labour,
the larger the size of the export sector, the larger the gross value of
production [Rana and Dowling (1990)]. Edwards (1998) points out that exports
affect economic growth positively through increases in total factor
productivity. The inclusion of foreign aid in the conventional production
function can also be found in Tyler (1981), Feder (1982), Gounder (2001), Amavilah
(1998) and Burke, et al. (2006) among others.
Following Burke, et al. (2006) and Ahmed and Hamdani (2003) we break total capital
stock (K) into domestic capital (Kd) and foreign capital (Kf) i.e., K = Kd + Kf.
|
Now Equation (2) becomes: |
|
|
|
|
Y =ΘKdαKϕf LβAδX γeu … … … …
The log-linear form of Equation (3) is
given by: |
… |
… |
(3) |
|
LnY = LnΘ+αLnKd +φLnK f +βLnL+δLnA+λLnX +u |
… |
… |
(4) |
Since the data for domestic capital
stock and foreign capital stock are not available, therefore we use domestic
investment as a share of GDP (INVY),
foreign investment to GDP (FDIY) as
proxy for the domestic capital and foreign capital. Furthermore, we use foreign aid as a share of GDP (AIDY) to control for the effect of price
changes over time. Edwards and Tabellini (1990) and
Fosu (2001) points out that political
instability is expected to exert negative impacts on growth. To account for political instability we included a
dummy variable (D) taking value one
for the period 1979-1985 and 1999-2002 and zero otherwise. Equation (4) now
takes the following form:[1]
Yt = η0
+η1INVYt +η2 FDIYt + η3
AIDYt +η4 Lt +η5
Xt +η6Dt +ut … (5a)
Equation (5a) represents the
neoclassical growth model expanded to include exports and non-export sectors
and is similar to that of Gounder (2001) and Burke, et al. (2006). The production function includes share of total
investment to GDP (INVY) to measures
its impact on economic growth because investment is one of the principal
determinants of growth [Lensink and Morrissey (2000)]. Thus, investment is
included in the model to capture its affects on growth through the level of
efficiency. Exports and FDI variables
are also included in the model to measure the degree of trade and financial
openness. It can be argued that trade and financial openness is expected to
improve resource allocation and accelerate economic growth.[2]
To examine the impact of various forms
of foreign aid on economic growth, the model incorporates project aid (PAIDY) and non-project aid (NAIDY) in the following specification
form:
Yt =β0 +β1 INVYt +β2PAIDYt +β3 NAIDYt +β4FDIYt +β5Lt +β6Xt +β7Dt +vt (5b)
Where Y
is the real GDP, INVY the domestic
investment as proportion of GDP, PAIDY
the project aid as a share of GDP, NAIDY
the non-project aid as share of GDP, FDIY
the net foreign direct investment as share of GDP, L the labour force, X the
real value of exports and vt
the error term. All the variables are expressed in logarithmic form.
This study employs Autoregressive
Distributed Lag (ARDL) methodology advanced by Pesaran, et al. (2001). The main advantage of this methodology is that it
allows testing for the existence of cointegration irrespective of whether the
variables are I (0) or I (1). This
approach is more appropriate than the Johansen-Juselius multivariate approach
to cointegration when the sample size is small [Pesaran, et al. (2001)]. The estimation procedure involves two steps. First,
long-run relationship between the variables under consideration is tested by
computing F-statistics. If the evidence of longrun relationship is found then
at the second stage the short-run and long-run parameters are estimated using
autoregressive distributed lag (ARDL) method. The final equation is selected
based on the acceptability of various diagnostics.
The study is based on annual data
covering the period 1972-2006. The data are collected from different sources.
GDP, foreign aid, project aid, non-project aid (i.e., sum of non-food, food,
balance of payments, relief and earthquake rehabilitation assistance), ratio of
foreign direct investment to GDP, and exports are taken from the State Bank of
Pakistan (2005) and Pakistan Economic Survey (various issues). Data
on labour force is from Asian Development
Bank─Key Indicators (various issues). The data on consumer price index
(CPI) is from International Financial
Statistics (IFS) CD-ROM (2007). All the flow variables (INV, AID, FDI) are measured as a ratio
of GDP to control for the effect of price changes over time.[3]
4. EMPIRICAL
RESULTS
The cointegration test based on the ARDL
procedure is employed by estimating Equation(s) (5a and 5b) for Pakistan using
annual data over the period 1972-2006.[4]
The number of lags on the first-differenced variables is selected using Akaike Information
Criterion (AIC). Initially, we set 3 lags for the VAR and tested down using
general-tospecific methodology. The final lag is selected when the estimated
equation(s) satisfy all the diagnostic checks including CUSUMSQ test of
stability. On the basis of this criterion, two lags were selected to carry out
ARDL cointegration test. The results of the cointegration test are reported in
Table 4.
Table 4
Results
of ARDL Cointegration Test
|
Type of Aid |
Variable Included |
Test Statistic |
Optimal Lags |
Decisions |
|
Total Aid |
F(Yt |FDIYt,INVY, AIDYt ,Lt, Xt ,D) |
6.35 |
2 |
Coinegration
|
|
Project Aid and Non- project Aid |
F(Yt |FDIYt ,INVY,PAIDYt ,NAIDYt Lt , Xt ,D) |
3.76 |
2 |
Cointegration |
|
Project Aid |
F(Yt |FDIYt ,INVY,PAIDYt,Lt, Xt ,D) |
12.20 |
2 |
Cointegration |
|
Non-project Aid |
F(Yt |FDIYt ,INVY, NAIDYt ,Lt, Xt ,D) |
6.42 |
2 |
Cointegration |
Note: The critical values are taken from Pesaran, et al.
(2001).
228 Khan and Ahmed
It is apparent from Table 4 that for
each type of aid the bound cointegration test rejects the null of no
cointegration because the computed F-statistic is much greater than the upper
bound of the tabulated F-statistic. After finding the evidence of cointegration
between the variables specified in equation(s) (5a and 5b), we have estimated
the longrun and short-run relationships using Autoregressive Distributed Lag
(ARDL) approach. Table 5 reports the long-run and short-run estimates for
various types of aid-growth nexus. The estimated ARDL equations pass all the
diagnostic tests including the CUSUM and CUSUMSQ tests of stability.7
Overall, ARDL equations have a very high adjusted
R2
, F-statistics are significant
and no estimation problem exists as suggested by Lagrange Multiplier test (LM),
functional form (FF), normality (NO) and heteroscedasticity (Het) statistics. A
more detailed interpretation of results is given below:
(A) Real Output and Aggregate Foreign Aid
The estimation of the equation with
total aid (Table 5 case A) suggests that in the long-run foreign direct
investment to GDP (FDIY), total
investment to GDP (INVY), labour
force (L) and real value of exports
exert positive and significant impact on real GDP. The coefficient of foreign
aid to GDP (AIDY) is insignificant
with negative coefficient in the long-run as well as in the short-run. The
negative and insignificant impact of foreign aid on output suggests that
economic growth is independent of foreign aid in case of Pakistan. This raises
many serious questions regarding its justification. The reason could be that in
most developing countries including Pakistan foreign aid is fungible and is
diverted to public consumption [Feyzioglu, et
al. (1998)]. Another reason may be
that foreign aid is channeled through the public sector and is utilised to
finance non-development expenditures. Moreover, when foreign capital inflows
into the public sector are increased, some resources are diverted from
development projects to nondevelopment projects. This diversion of resources
may offset of positive impact of foreign aid on growth. This result suggests
that the economic policies regarding aid utilisation are not appropriate or
perhaps aid inflows have distorted macroeconomic incentives in Pakistan.
The results show that foreign direct
investment and exports, domestic investment and labour force are the main
determinants of real output in the long-run.
The coefficient of the dummy variable (D), introduced to account for
political instability, is negative and significant both in the long-run and
short-run indicating that political instability adversely influenced economic
growth.8
7The results
are available from the authors.
8In Pakistan
there are some misperceptions that the economic growth remains always high
under the military regimes than that of democratic governments. These
sentiments and thinking are very dangerous. It is true that the growth is
reported to be higher under military governments. It is not a very plausible
criterion to judge economic growth and performance of the governments. However,
higher growth rate is meaningless when other micro and macroeconomic indicator
are not influenced the economy positively [Bilquees (2004)]. The actual
position in Pakistan is that the higher growth rate, poverty and unemployment
are moving in the same directions not only in the democratic governments but
also in the military regimes. Furthermore,
during the military rule either in 1977 or in 1999 some international
developments cause higher growth rates. However, saving to GDP ratio, domestic
investment to GDP ratio remains low despite the inflows of reasonable foreign
assistance for being front line state in the War against Russia and War against
terrorism [for further detail see, Khan and Khan (2007)].
Table 5
Long-run
and Short-run Estimates of Real Output and Foreign Aid
A. Real Output and Total Foreign Aid
Real Output with Total Aid: ARDL (1, 0, 2, 0, 2, 1) Based AIC
Yt = 0.57 Yt−1 + 0.03FDIY t −
0.13INVY t +
0.30INVY t−1 + 0.29INVY t−2 − 0.002 AIDY t −
0.18Lt +
0.31Lt−1 + 0.34 Lt−2
(8.77)* (2.33)** (−0.48) (0.81) (1.17) (−1.71)** (−1.47) (2.00)** (2.52)**
+ 0.05 X t +
0.05 X t−1
−
0.02Dt
(2.10)** (1.75)** (−4.13)*
R 2 =
0.99 F
(11, 21) = 6167 .2* RSS = 0.002
LM −χ2 (1) = 1.53 FF −χ2 (1) = 0.06 NO −χ2 (2) = 0.55 Het −χ2 (1) = 2.03
Long-run Estimates
Yt
= 0.08FDIYt +1.09INVYt −0.005
AIDYt +1.11Lt +0.24
Xt − 0.05Dt
(2.07)** (2.77)* (−1.64) (32.26)* (8.10)* (−4.14)*
Error-Correction Representation
∆Yt =
0.03∆FDIYt −0.13∆INVYt − 0.29INVYt−1 − 0.002∆AIDYt −
0.18∆Lt − 0.34∆Lt−1 +0.06∆X t − 0.02∆Dt −0.43ECt−1
(2.33)** (−0.48) (−1.17) (−1.71) (−1.47) (−2.52)** (2.10)** (−4.13)* (−6.59)*
R2
= 0.70
F-stat = 10.79
RSS = 0.002 DW-stat = 2.36
Continued—
B. Real Output, Project Aid
and Non-project Aid : ARDL (2, 2, 0, 0, 1, 2, 1) Based on AIC
Yt = 0.32 Yt−1 + 0.34Yt−2 + 0.05FDIY t +
0.004 FDIY t−1
+
0.04 FDIY t−2
−
0.10 INVY t + 0.008 PAIDY t − 0.005 NAIDY t
(1.62) (1.53) (3.00)* (0.21) (2.16)** (−0.39) (1.68) (−2.12)**
− 0.002 NAIDY t−1 − 0.43Lt +
0.46 Lt−1
+
0.49 Lt−2
+
0.02 X t + 0.08 X t−1 − 0.02 Dt
(−1.15) (−3.30)* (3.00)* (2.80)* (0.80) (2.44)** (−4.46)*
R 2 =
0.99 F (11, 21) = 4986 .3* RSS = 0.002
LM −χ2 (1) = 2.22 FF −χ2 (1) = 0.25 NO −χ2 (2) = 5.22 Het −χ2 (1) = 0.73
Long-run Estimates
Yt
= 0.20FDIYt − 0.22INVYt +0.02PAIDYt − 0.02NAIDYt +1.18Lt +0.24 X t −
0.05Dt
(3.09)* (−0.39) (1.78)*** (−4.08)* (34.10)* (7.30)*
(−4.31)*
Error-Correction Representation
∆Yt = − 0.24∆Yt−1 + 0.05∆FDIY t −
0.04∆FDIY t−1
−0.10∆INVY t +
0.009∆PAIDY t − 0.005∆NAIDY t −
0.45∆Lt
(−1.53) (3.00)* (−2.16)** (−0.39) (1.68) (−2.12)** (−3.30)*
−
0.49∆Lt−1 + 0.02∆X t − 0.02∆Dt −0.44
ECt−1
(−2.80)* (0.80) (−4.45)*
(−6.54)*
R2 =
0.71 F-stat
= 9.24 RSS = 0.002 DW-stat = 2.32
Continued—
C. Real
Output and Project Aid: ARDL (1, 0, 1, 0, 2, 0) Based on AIC
Yt = 0.63Yt−1 + 0.04FDIY t −
0.28INVY t +
0.67INVY t−1 − 0.003PAIDY t −
0.22Lt +
0.33Lt−1 + 0.30Lt−2 + 0.09 X t −
0.02Dt
(11.68)* (2.94)* (−1.10) (3.01)* (−0.76) (−1.96)*** (2.04)** (2.20)** (4.16)* (−3.41)*
R 2 =
0.99 F(11,
21) =
6683.8* RSS =
0.003
LM −χ2 (1) = 3.68 FF −χ2 (1) = 0.62 NO −χ2 (2) = 1.61 Het −χ2 (1) = 3.13
Long-run Estimates
Yt
= 0.11FDIYt +1.06INVYt −0.008PAIDYt + 1.12Lt +0.24
Xt − 0.05Dt
(2.60)** (2.90)* (−0.76) (35.38)* (6.57)* (−3.64)*
Error-Correction Representation
∆Yt = 0.04∆FDIY t −0.28∆INVY t −
0.003∆PAIDY t − 0.22∆Lt −
0.30∆Lt−1 + 0.09∆X t − 0.02∆Dt −0.37
ECt−1
(2.94)* (−1.10) (−0.76) (−1.96)** (−2.20)** (4.16)* (−3.41)* (−6.82)*
2
R = 0.66 F-stat = 10.31 RSS = 0.003 DW-stat = 2.60
Continued—
D. Real
Output and Non-project Aid: ARDL (1, 0, 2, 0, 2, 1) Based on AIC
Yt =0.57Yt−1 +
0.03FDIYt −
0.14INVYt +
0.25INVYt−1 +−0.003NAIDYt − 0.22Lt + 0.33Lt−1
+ 0.30Lt−2 +
0.09X t −
0.02Dt
(11.68)* (2.94)* (−1.10) (3.01)* (−0.76) (−1.96)**
(2.04)** (2.20)** (4.16)*
(−3.41)*
R 2 =
0.99 F(11, 21) = 6683.8* RSS = 0.003
|
LM −χ2 (1) = 3.68 FF −χ2(1) = 0.62 NO −χ2(2) =1.61 Long-run Estimates Yt
= 0.07FDIYt + 0.97INVYt −0.007
NAIDYt +1.11Lt +0.25
Xt − 0.05Dt ** * −1.89)***
(33.58)* (10.25)* (−4.38)*
(2.04) (2.39) ( |
Het −χ2(1) = 3.13 |
Error-Correction Representation
∆Yt =
0.03∆FDIYt −0.14∆INVYt − 0.31∆INVYt−1 − 0.003∆NAIDYt −
0.18∆Lt − 0.35∆Lt−1 +0.05∆X t −
0.02∆Dt −0.43ECt−1
* *** ** *** * *
(2.28) (−0.52) (−1.45) (−1.96) (−1.50) (−2.61) (1.97) (−4.32) (−6.77)
R2 = 0.71 F-stat = 11.30 RSS = 0.002 DW-stat = 2.37
Note: t-values are given
in parentheses. *, ** and *** indicate
significant at the 1 percent, 5 percent and 10 percent level of significance
respectively.
In short-run the coefficient of domestic
investment is negative and insignificant. Given the dominant share of public
investment in total investment, the inefficient and non-productive nature of
public investment might have contributed to the overall negative impact of
total investment on growth [Ghani and Din (2006)]. Moreover, political
instability may also affect investment growth through the decline in total
factor productivity [Gounder (2001)]. The over all contribution of labour force
(∆L) is negative and significant in the
short-run. This may be due to the higher share of non-productive labour in
total labour force. Another explanation for the negative coefficient on ∆L could be the presence of low quality and unskilled labour
force. Brain drain could be yet another
reason of the negative effect of labour force.
The inflows of foreign direct investment
(FDI) and exports exert positive and significant impact on economic growth in
long-run as well as short-run. This implies that instead of relying on foreign
aid preference be given to attract FDI and boost exports. Both the FDI and
exports are linked to capacity utilisation, research and development (R&D),
increased market access and technological spillover. These benefits are
expected to be more stable than the temporary benefits of foreign aid. Since the magnitude of exports is relatively
larger than the magnitude of the FDI. Therefore, the authorities have paid much
attention on the export growth and than on creating conducive environment for
inflows of FDI. Finally, the adjustment
coefficient possesses expected negative sign and is highly significant. This
indicates that 41 percent of the previous period deviations are eliminated in
the current period.
(B) Real Output, Project Aid and Non-project Aid
The results with project aid and
non-project aid (Table 5 case B) show
that project aid exerts positive and non-project aid exerts negative and
significant impact on real output both in the long-run and short-run. However,
the magnitude of both the variables is very small and negligible. This implies
that project and non-project components of foreign aid may not effectively
promote economic growth. The possible reason could be that the aid flows are in
practiced translated into government consumption.[5]
The other variables such as labour, FDI
and exports play significant role in enhancing real output in long-run as well
as short-run. However, the overall impact of labour force growth in the
short-run is negative and significant. The coefficient of total investment
share is insignificant in both the long-run and short-run. Among exports and
FDI, the relative impact of real exports is larger than FDI in the long-run.
These results confirm the hypothesis that exports and FDI are the main external
sources of growth rather than foreign aid.
The dummy variable, introduced to capture political instability, is also
negative and significant indicating the adverse effect on output both in the
long-run and short-run. The error-correction term is negative and significant,
indicates that about 34 percent of the previous period’s deviations in real
output is eliminated in the current period to keep real GDP at steady state
level.
(C) Real Output and Project Aid
Table 5 (case C) indicates that the
relationship between project aid and real output is negative and insignificant
both in the long-run and short-run. This implies that in Pakistan project aid
is fungible. The amounts of money granted for a particular project by the
donors are transferred to finance social and other non-development
expenditures.[6]
Our result confirms the earlier findings by Iqbal (1997) that foreign capital
inflows have negative impact on development expenditure. This strengthens the
idea that some resources are transferred from development projects to
non-development expenditures when foreign aid is increased. Hence, project aid
exerts negative and insignificant impact on domestic productivity. Our results
also confirm the results obtained by Chishti and Hasan (1992) that in case of
Pakistan the project aid money is fungible and this may have been channeled to
finance government consumption.
In long-run labour force, domestic
investment, FDI and real exports exert positive and significant impact on real
output. In short-run the external financial resources such as FDI and exports
exerts positive and significant impact on domestic productivity. Domestic investment is insignificant while
labour force exerts negative and significant impact on growth.[7] The relative effect of exports is larger than
that of FDI. The findings imply that to reduce dependence on the foreign aid,
the government may concentrate on boosting the exports sector and create
enabling environment to attract foreign investment. The error-correction term is again negative
and highly significant. The coefficient on the term indicates that around 41
percent of the past deviations are eliminated in the current period.
(D) Real Output and Non-project Aid
Table 5 (case D) suggest that
non-project aid is significant and negatively related to real output in both
the long-run and short-run. This finding suggests that non-project aid failed
to produce any significant impact on economic growth. The size of the coefficient
of non-project aid is very small indicating negligible effect on growth in the
long-run and short-run. The reason could be the use of non-project aid to
finance government consumption; therefore it does not contribute to growth.
Other variables are significant and possess expected positive coefficients in
the long-run. In the short-run, FDI and exports are positively correlated to
growth, while domestic investment remains insignificant and labour force
influences growth negatively. A positive coefficient of FDI and exports
supports the argument that to reduce aid dependency on export sector and FDI
may need special attention. The coefficient of dummy variable, introduced to
account for political instability, is negative and significant indicating negative
impact of political instability on growth in the long-run and short-run. The
error-correction term is –0.43 and statistically significant which indicates
that 43 percent of the past deviations are corrected in the current period.
Overall, the impact of foreign aid at
aggregate and disaggregate level is negative and insignificant. These results
support the hypothesis that aid is fungible in case of Pakistan and growth is
independent of foreign aid. Our results confirms the view expressed by Husain
(2005) that net flows as percentage of gross national income have gradually
declined from 4.3 percent in 1970 to 1.5 percent in 2003 and net transfers from
3.6 percent to 0.7 percent. The deduction from this evidence is quite
obvious—Pakistan’s dependence on foreign aid is so low and insignificant that
it does not make much of a difference to our national economy.
Generally, there may be several reasons
that undermine the impact of foreign aid on growth. For example, the projects
funded by foreign donors may impose conditions including purchase of equipment,
services and technical expertise from them. Consequently, a huge amount of
money is drained out in the form of salaries and other payments. Moreover,
foreign contractors are paid kickbacks on foreign added projects which
encourage and promote the culture of corruption, weaken state institutions and
increase the costs of projects. Alesina and Weder (2002) points out that
foreign aid overtime increases government corruption. The evidence of this
study is not much puzzling because many studies conclude that foreign aid
exerts negative impact on growth [for example Gounder (2001); Burke, et al. (2006); Chishti and Hasan (1992);
Khan (1997) and Ishfaq and Ahmed (2005)]. The findings of the study imply that
foreign aid does not improve economic conditions. One reason could be poor
governance. Many studies point out that foreign aid is extended for “strategic”
reasons rather than real needs of a country.[8]
Besides, foreign aid is highly volatile and its flows depend on the political
ties between recipient and donor countries. So if the impact of foreign aid on
growth is ambiguous or unpredictable, this should not be surprising.
Foreign direct investment and exports
exerts positive and significant impact on growth. The positive and significant
impact of exports on real output supports the argument that export sector is an
engine of growth. Though FDI also exerts positive and
significant impact on real output, however, the magnitude of exports is larger
than that of FDI. These results
demands for the expansion of export sector and encouragement of FDI inflows to
reduce aid dependency. Finally, we conclude that domestic investment, labour,
exports and FDI are important and significant contributors to economic growth
as compared to foreign aid. These results are consistent with the earlier
findings by Husain and Jun (1992) that exports performance contributed more in
economic growth than aid.
This does not mean that foreign aid has
no contribution in the economic development of Pakistan. During the 1950s,
1960s and 1970s foreign aid helped in laying down the physical infrastructure,
which is pre-requisite for future economic development. Aid-financed investment
in water, power and transport strengthened the infrastructure base. The
construction of Terbela and Mangla dams, other irrigation-related projects,
Steel Mills and Indus Super Highway are examples of the contribution of aid.
Since 1990s, aid has helped in carrying out economic reforms. Moreover, during
Afghan War and 2005 earthquake, non-project aid helped to overcome food
shortages and balance of payments deficits.
Despite some positive contributions of
aid, there are some negative aspects which are more serious. Public sector
imbalances have worsened and non-wage component of recurrent expenditure is
squeezing. Saving and investment rates remained low and the trade gap has
widened. Official aid has declined their importance to rectify the economic
conditions, while foreign investment and foreign assets of Pakistanis provide a
much longer volume in the 1990s [Husain (1999)]. Khilji and Zampelli (1991)
pointed out that US-aid is highly fungible and large proportion of aid has been
diverted to meet defense expenditures. Similarly, large sums of aid were wasted
in inefficient projects and controls over the international trade affected
adversely the overall economic environment. Consequently, aid has become less
productive and has put the country into a vicious circle of dependency.
Inelastic revenue structure, large size of non-development expenditures,
reduction in public investment, infrastructure deficiencies, and lack of social
services are the main gifts of aid. To
enhance aid effectiveness there is need to break the vicious circle of
dependency and rehabilitate the economy through prudent macro-management
policies.
To make aid more effective, Pakistan may
rethink its macroeconomic policies, strengthen related institutions, improve
governance and reduce corruption. At present economic growth in Pakistan is
independent of foreign aid. For the economy, foreign aid is curse rather than
blessing because reliance on aid further increases dependency. Hence further
solicitation of foreign aid should be avoided and the authorities may focus on
the encouragement of domestic investment, FDI and exports sector which are less
volatile than foreign aid.
5.
CONCLUSION AND POLICY IMPLICATIONS
Foreign aid effectiveness is a very
critical and unsettled issue at the theoretical and empirical level. Pakistan
has received about US$ 73.14 billions from 1960 to 2002, but its social
indicators still seem to be very poor. Most of the foreign aid components
diverted from development to non-development expenditures, have produced hardly
any significant impact on economic growth. Based on theoretical literature we
specify aidexports-augmented neo-classical production function to examine
aid-growth link. The model is estimated using ARDL approach to cointegration
over the period 1972-2006 for Pakistan.
Result suggests that foreign aid neither
at aggregate nor at disaggregate level influenced economic growth in Pakistan.
These findings confirm the earlier findings by Gounder (2001), Burke, et al. (2006), Movrotas (2002), Chishti
and Hasan (1992), Khan (1997) and Ishfaq and Ahmed (2005). The finding implies
that foreign aid is not a blessing. Further the demerits of foreign aid that
include but are not limited to; harsh covenants from donors that times even
call for compromising the autonomy of the Nation, corruption within the government,
fiscal imprudence and poor institutions turn foreign aid into a curse. Therefore, we can say that foreign aid is not
a blessing but a curse for Pakistan.
Other variables such as, domestic
investment, foreign direct investment and exports exerts positive and
significant impact on economic growth at the aggregate and disaggregate level.
These results confirm the earlier findings of Husain and Jun (1992). The results imply that domestic investment,
labour force, exports and FDI inflows have made an important contribution to
economic growth in Pakistan.
The most important policy implication
derived from the results is that to reduce dependency to foreign aid and to
improve the growth prospects in the country the authorities may provide
enabling environment for domestic investment, expand exportoriented industries
and encourage FDI inflows. Furthermore, Pakistan may focus on those external
financing resources that are much stable, sustainable and have positive impacts
on growth rather than depending on the volatile and unstable sources. Given the
general characteristics of exports and FDI one can expect that these are more
stable external resources relative to foreign aid. The two variables, i.e.,
exports and FDI have not only exerted positive impact on growth but also
generate spillover effects. Hence, there is need to focus on these
sectors.
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[1] For our own convenience we
eliminate “Ln” term.
[2] Other variables such as
portfolio investment, worker remittances etc. may not be considered because of
the small sample size.
[3] All the data used in this
study is available from the authors and can be obtained upon request.
[4]
Only one limitation of ARDL method is that this technique is based on
single-equation approach.
[5] This could be possible
because due to the weak accountability non-project aid is not utilised as
intended.
[6] Iqbal (1997) argued that
over-time development expenditure as percentage of total expenditure was
reduced from 38.3 percent in 1975-76 to 18.2 percent in 1995-96 in Pakistan.
[7] Explanation of negative
effect is given in case A.
[8] Donor countries granted
aid under different motivations. For example, Australia granted aid to promote
economic and social progress and for political-strategic and commercial
interests. Similarly, US granted aid for humanitarian relief and long-term economic
and social development of low-income countries. US also provide aid to promote
national security. In the context of Pakistan, US increased aid when Pakistan
become front-line state against USSR during 1980s and after 9/11 war against
terrorism.
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