Aid, Policies and Growth: Implications of Simultaneity

Abstract

In Chapter 4, we reviewed and extended to our sample, the single equation approach to assess the effectiveness of aid with and without the presence of “good” economic policies. The single equation approach is the most widely used approach in the literature on this topic. And yet, over a quarter century ago, Gupta, 1975 had argued that such an approach, by focussing on direct effects of aid only, did not provide an accurate picture about the effects of aid. He pointed out that a simultaneous equations approach, which allowed for both the direct and the indirect effects, was far more appropriate. His approach expanded by Gupta and Islam, 1983, presented extensive results to show that the results from such an approach led to dramatically different outcomes as compared to single equation results. This chapter builds on Gupta, 1975 but avoids the shortcomings of his work as well as incorporating improvements suggested by subsequent works in the area including the role of economic policy in influencing aid effectiveness.