The concept of foreign aid became a fundamental component of international affairs and an essential instrument to rebuild the world after the World War II. Many developing countries

including Ghana depend on it in order to support their budget or finance economic projects and programmes in their countries. The study examines the impact of foreign aid inflow on economic growth for the Ghanaian economy for the period 1975 to 2010 by adopting the Burnside and Dollars

model. We indicated that foreign aid has a positive but insignificant effect on economic growth of Ghana. The study concludes by examining and recommending important policy issues that must be given thorough attention in order to achieve significant impact of aid on Ghana’s economic growth

Bondzie, Eric Amoo

Fosu, Gabriel Obed

Obu-Cann, Ernest

Munich Personal RePEc Archive

MPRA
Munich Personal RePEc Archive
Foreign Aid and Aid Policy effectiveness
on Economic Growth of Ghana.
Ernest Obu-Cann and Gabriel Obed Fosu and Eric Amoo
Bondzie
University of Bradford, UK, Kwame Nkrumah University of Science
and Technology, Kumasi, Ghana, Universia` Cattolica del sacro
Cuore-Milan
November 2013
Online at https://mpra.ub.uni-muenchen.de/69283/
MPRA Paper No. 69283, posted 7 February 2016 14:34 UTC
       
 
1 | Page 
 
FOREIGN AID AND AID POLICY EFFECTIVENESS ON   ECONOMIC 
GROWTH OF GHANA. 
Ernest Obu-Cann, Gabriel Obed Fosu, Eric Amoo Bondzie 
 
 
ABSTRACT : The concept of foreign aid became a fundamental component of international affairs and 
an essential instrument to rebuild the world after the World War II. Many developing countries 
including Ghana depend on it in order to support their budget or finance economic projects and 
programmes in their countries.  The study examines the impact of foreign aid inflow on economic 
growth for the Ghanaian economy for the period 1975 to 2010 by adopting the Burnside and Dollars 
model.   We indicated that foreign aid has a positive but insignificant effect on economic growth of 
Ghana. The study concludes by examining and recommending important policy issues that must be 
given thorough attention in order to achieve significant impact of aid on Ghana’s economic growth. 
Keywords- Economic growth, Foreign Aid, Foreign Direct Investment, Human Capital 
I.INTRODUCTION 
The eradication of abject poverty and reduction of income inequality in the world has 
been a topical issue for quite some time now. This was evident when leaders all around the 
world gathered in New York, 2000 to agree on concrete strategies and actions to meet human 
needs and basic rights. This resulted in the Millennium declaration in 2000. The declaration 
increased the contribution commitment of development aid donors that was reduced in the early 
90s due to financial hardship [1].  
Due to the ‘perceived’ role aid plays in achieving the Millennium Development Goal 
(MDGs) of eradicating extreme poverty by 2015, the impact of aid on economic growth has 
received great debate among economic researchers. According to OECD (2009), in 2008 alone, 
the total net bilateral official development assistance (ODA) Development Assistant 
Committee (DAC) donated to Africa was estimated at US$26billion in real terms. Again, it is 
perceived that Africa, has received by far the largest proportion of foreign aid in the world 
(estimated at about 600 billion dollars) on a per capita basis and yet it is still classified as the 
poorest continent in the world [2]. 
Due to the economic and political stability of Ghana, and the historic and geopolitical 
considerations that influenced aid flows, many developed countries, donors and NGO’s have 
used the country as a test ground for their programmes for other African countries.  The 
increasing inflow of development aid into the country has created dependency of the country’s 
budget on aid inflows.  About 50% of Ghana’s budget depends on aid from donors and NGOs 
[3]. Again, Amoako-Tuffour [4], finds evidence to suggest that there is high dependency of 
public investment and imports on foreign aid, as 52% of total net aid in Ghana was invested in 
physical capital formation only in the year 2000. 
2 | Page 
 
In 1983, Ghana began it economic and Structural Adjustment Programme (SAP), there 
was a sharp rise in the aid inflow from developed countries and donor agencies to support the 
programme. It is estimated that Ghana’s net aid as a ratio of gross national income of 13% far 
exceeded the 4% average for the sub- Sahara region [4].  Therefore, development aid is 
becoming a dictator of pace in Ghana’s economic growth and development, since a change in 
the inflow to Ghana could have a significant impact on its growth. Regardless of the countries 
good economic policies, it lacks cohesion with the policy conditionalities outlined by donor to 
fully achieve it intended purpose. This has therefore raised the question as to whether, aid 
inflows to Ghana is a blessing or a curse in disguise.  This study therefore intends to establish 
whether there is relationship between aid inflows and growth. 
II.METHODOLOGY 
This study employs the Burnside and Dollar [5] regression model, which is given as: 
Y=βo+β1(A/GDP) + β2(A/GDP)2+ β3P+ β4(A/GDP*P)+ β5X+U 
This can be simplified as: 
g=bo+b1a+ b2a2+ b3p+ b4ap+ b5x+u ........................................ (1) 
where g (Y) is real per capita GDP growth, a= (A/GDP) is aid as a share of GDP, p=(P) is the 
policy index, ap=(A/GDP*P) is the interaction between foreign aid as a share of GDP and 
policy index, x=(X) is the other determining factors of economic growth which were 
considered for this study. These factors are stock of capital human (h), stock of physical capital 
(k) and foreign direct investment (FDI). The error term is represented as u=(U). The policy 
index is exogenously determined and it is given as the weighted average of budget surplus (as 
a proxy for fiscal policy), inflation (as a proxy for monetary policy) and import and export as 
a share of GDP (as a proxy for index of trade).   
                A policy variable is constructed by using these three macroeconomic policy 
variables: budget surpluses relative to GDP as a measure of government fiscal policy (B) by 
Levine and Renelt [6], a measure of trade openness (TO) by Sachs and Warner [7] and inflation 
(N) as a measure of government monetary policy. Thus policy variable is exogenously 
determined in equation (1).  To first model the policy index; budget surplus, trade openness 
and inflation is regress on growth using OLS method to examine their impact on growth as 
shown in (2).  
z=zo+z1B+ z2TA+ z3N+u........................................(2) 
The impact of the independent variables on growth are measured by z1, z2 and z3. These 
indexes are used to construct the policy index using the following expression: 
Policy(Po)=z1Budget surplus/deficit - z2Inflation + z3Trade openness 
 
 
3 | Page 
 
III.ANALYSIS AND DISCUSSION 
 
Secondary data source was used for this research. The annual data was for the period 
of 1980 to 2010. These data were sourced from the World Development Indicators (WDI) and 
International Monetary Fund (IMF) statistics. The study uses Excel and Microfit (5.0 version), 
computer packages for the data analysis. 
Table 1 shows the correlation matrix of all the variables used in the study with much 
emphasis on the independent variables. It is evident that growth has a positive relationship with 
all the variables. However, there seems to be a more positive correlation (0.88416) between 
growth and human capital for the case of Ghana. Similarly, growth is modestly positively 
correlated (0.80368) with FDI. There is however interaction among some of the independent 
variables. For instance, aid and physical capital stock are highly correlated. This may be as a 
result of the component of aid in sub-Sahara countries particularly Ghana. 
  Table 1 Correlation Matrix of all the variables 
Variable                      g                     a                           p                    FDI                    h                               k 
g 
a 
p 
FDI 
h 
k 
1.0000     
0.66529     
0.56957     
0.80368     
0.88416 
0.59748 
0.66529     
1.0000     
0.68017     
0.61094     
0.65353 
0.71645 
0.56957 
0.68017 
1.0000 
0.47227 
0.34173 
0.93719 
0.80368     
0.61094     
0.47227 
1.0000     
0.77840 
0.58076 
0.88416     
0.65353     
0.34173     
0.77840 
1.0000 
0.41589 
        0.59748 
        0.71645 
        0.93719 
        0.58076 
        0.41589 
          1.0000 
 
Also, economic policy is highly correlated with physical capital stock which may also 
occur as a result of the proxies of policy index. There is an interaction between government 
expenditure and physical stock of capital. FDI and human capital are also highly correlated 
(0.77840).   We therefore conduct a regression test to either confirm the multicollinearity 
problem suggested by the pair-wise correlation or otherwise. A policy model is used to find 
evidence to support Burnside and Dollars [5]  assertion that, aid works better in countries with 
good economic policies using the policy index and other factors that affect growth.  
Table 2 Regression Results for Policy Model 
Regressor                                 Coefficient                      Standard Error                    T-Ratio[Prob] 
 Po                                                  235.9783                        26.6321                           8.8607[.000]  
 TO                                                .58689                            .24679                             2.3781[.024] 
 B                                                    2.2631                           2.5879                             .87450[.388] 
 N                                                  -.17109                           .24116                            -.70944[.483] 
             R-Squared        .32441                                                   R-Bar-Squared       .26108 
4 | Page 
 
The dependent variable is Po. Trade openness and budget surplus/deficit have a positive 
relationship on economic growth while inflation suggest otherwise. This is illustrated in Table 
2 Thus, a percentage change in trade openness for instance increases Ghana’s growth by 
0.58689 percent. Also, growth increases by 2.2631 percent as budget surplus/deficit increases 
by one (1) percent. However, an increase in inflation decreases growth by 0.17109 percent. 
The policy index for Ghana is therefore modelled as follows:    
Po=2.2631B – 0.17109N + 0.58689TO 
However, with the exception of trade openness, all the t-ratios of the independent 
variables are insignificant at 5% level of significance. Thus, the p-values of budget 
surplus/deficit and inflation (0.388 and 0.483) are less than the α-value of 0.050. In terms of 
the R2, the independent variables (trade openness, budget surplus/deficit and inflation) are able 
to explain only about 32% of the explanation in the dependent variable (economic growth). 
This means that, growth is influenced by other factors which are not explained by the regression 
result in Table 2. 
Table 3 Main Regression Result 
Regressors            Coefficient estimate                              Standard Error                      T-Ratio (Prob) 
b0 
a 
p 
ap 
FDI 
h 
k 
-713.864 
1.8947 
1.4038 
-0.0192 
2.8346 
180.6615 
-3.6000 
168.8116 
2.2472 
0.50072 
0.010669 
2.6014 
34.8100 
15.4970 
 -4.2288(0.000) 
 0.84315(0.406) 
   2.8035(0.009) 
  -1.7961(0.083) 
   1.0897(0.285) 
   5.1899(0.000) 
-0.23230(0.818) 
R-Squared                                   .90137                               R-Bar-Squared                            .87671 
                In Table 3, the regression result shows that Ghana’s economic growth would attain 
negative level of growth without the presence of the independent variable. It is also evident 
that, a percentage increase in aid assistance, good economic policy and other factors like FDI 
and human capital increase GDP growth by 1.8947%, 1.01038%, 2.8346% and 180.6615% 
respectively in Ghana. Contrary to Burnside and Dollars (2000) suggestion that aid work 
effectively in countries with good economic policies, an increase in aid-policy in the regression 
however decreases economic growth by 0.0192% even though the parameter estimate is 
statistically highly insignificant. The R2 value of 0.91077 in Table 3 means that, about 91% of 
the variations in economic growth of Ghana are explained by the independent variables. Given 
the high R2, magnitude of some of the parameter estimates particularly human capital (about 
180.7%) and highly insignificant coefficients. 
              The problem of non-stationary series of the variables (both the dependent and the 
independent) may lead to spurious regression problem. We therefore conduct a unit root 
5 | Page 
 
(Dickey-Fuller and Augmented Dickey fuller) test to investigate whether the time series data 
are stationary or not, the results are shown in Table 4. Table 5 also shows the results after first 
differencing. The results after first differencing showed aid does not have any positive impact 
on the economic growth of Ghana.  
 
V.  CONCLUSION 
              In this study we analyzed the impact of foreign aid and good economic policies on 
economic growth, within the time period of 1975 to 2010. To better understand the aid-policy 
nexus, a separate model for policy was estimated as propounded by Burnside and Dollar, 2000. 
The policy model estimated was therefore incorporated into the main growth models to assess 
their respective impact on Ghana’s economic growth.  We realized that human capital (which 
is measured as secondary school enrollment as a percentage of the gross) has a greater impact 
on Ghana’s economic growth and development in general.   It was evident that aid in itself had 
an insignificant impact on growth but the policy coefficient was statistically significant.  The 
empirical result from this study however suggests an insignificant impact of physical capital 
on economic growth. Thus, even though the country is investing, the investment is not yielding 
much positive impact on economic growth. The ADF test suggested the presence of unit root 
(non-stationary). The variables were therefore transformed from their original to the first 
difference form. However, the problem was not resolved. 
 
IV.POLICY IMPLICATION 
Ghana as a country is investing; the investment is not yielding much positive impact on 
economic growth. This result might occur for the following reasons. 
Successive governments divert resources from potentially productive sectors of the 
economy to unproductive sectors and hence decreasing the overall output-generating capacity 
of the investment in order to score political point. As a result this investment does not add to 
the overall output of the economy [8]. Bribery and corruption as Rose-Ackerman [9] indicated 
has characterized many developing economies thereby leading to inefficient returns on 
investment in the economy. This increases the cost of the project which is transferred to the 
price of the project’s output thereby reducing the demand for the product or project. As the 
demand for the product or the project decreases, the incremental output-capital ratio for the 
activity eventually reduces. 
On the basis of the result of this study and the potential reasons given, it is 
recommended to government to invest in productive sectors in order to improve the efficiency 
of the investment so that aid inflows channeled to investment will also have a significant impact 
on economic growth and development of Ghana. It was clear in the result that both aid and 
policy in isolation has a positive effect on growth however, the amalgamation of the two as 
Burnside and Dollar suggested had a negative and insignificant impact on economic growth. 
This suggests that donor agencies and the government must come up with policies and 
strategies that can lead to effective and efficient utilization of the aid funds in Ghana. 
 
 
 
6 | Page 
 
REFERENCES  
[1] United Nations (2010). The Millennium Development Goals Report 2010. New York: 
Oxford Press. 
[2] William Easterly, (2007). Are aid agencies improving?, Economic Policy, CEPR & CES 
& MSH, vol. 22, pp 633-678. 
[3] Ayodele, T., Franklin, C., Nolutshungu, T.A., and Sunwabe, C.K. (2005). African 
perspectives on Aid: Foreign Assistance will not pull Africa out of Poverty. Economic 
Development Bulletin. September. pp 1-4 
[4] Amoako-Tuffour, J. (2005). Multi-Donor Direct Budget Support in Ghana: the 
implications for aid delivery and aid effectiveness. Centre for Policy Analysis, No. 11, pp.1-
22. 
[5] Burnside, C., and Dollar, D. (2000).. Aid, Policies, and Growth. American Economic 
Review, Vol.90, no.4, September. pp. 847-868. 
[6] Levine, Ross & Renelt, David, (1992). A Sensitivity Analysis of Cross-Country Growth 
Regressions, American Economic Review, American Economic Association, vol. 82(4), pp 
942-63. 
[7] Sachs, J.D. and A.M. Warner.(1995). Economic Reform and the Process of Global 
Integration,  Brookings, Papers on Economic Activity, vol. 1, pp. 1-118. 
[8] Robert Osei, (2003). IMF and World Bank Sponsored Structural Adjustment Programs in 
Africa: Ghana's Experience. Journal of International Development, John Wiley & Sons, Ltd., 
vol. 15(2), pages 261-262. 
[9] Rose-Ackerman, Susan, and Andrew Stone. (1996). The Costs of Corruption for Private 
Business: Evidence from World Bank Surveys.  Manuscript (May). 
 
Appendix  
 
Table 4 ADF tests for variable G 
The Dickey-Fuller regressions include no intercept and no trend 
        Test statistic                    LL                           AIC                         SBC                  HQC 
 df           2.7180                 -120.9010                 -121.9010                -122.6642       -122.1613   
 adf(1)     1.7689                 -116.4557                -118.4557                -119.9821        -118.9762 
LL  = Maximized log-likelihood        AIC = Akaike Information Criterion 
SBC = Schwarz Bayesian Criterion    HQC = Hannan-Quinn Criterion 
   
 
 
 
 
7 | Page 
 
 
ADF tests for variable G 
The Dickey-Fuller regressions include an intercept but not a trend 
 Test                   Statistic               LL                     AIC                        SBC                      HQC 
 DF                     2.6317             -118.4573        -120.4573                -121.9837             -120.9778 
 ADF(1)             1.2412             -115.9086        -118.9086                -121.1982              -119.6894 
 
 
 
ADF tests for variable G 
The Dickey-Fuller regressions include an intercept and a linear trend 
 Test                    Statistic                      LL                   AIC                     SBC                HQC 
 DF                      -.25236                 -114.4815         -117.4815            -119.7711       -118.2623 
 ADF(1)              -.42956                  -113.3945         -117.3945           -120.4473       -118.4356 
 
Table 5 Regression Results After  First Differencing 
Regressor                     Coefficient                Standard Error                     T-Ratio[Prob] 
b0                                   -1.4980                         1.5880                               .94334[.353] 
 DA                                -.12837                         0.18047                             -.71127[.483] 
 DP                                 -.25471                         0.18076                             -1.4091[.169] 
 DFDI                             -2.6302                         1.3530                             -1.9440[.062] 
 DLH                             -59.0241                      36.4866                             -1.6177[.117] 
 DLK                                3.6419                       7.5787                                .48054[.634] 
     
 
 


Foreign Aid and Aid Policy effectiveness on Economic Growth of Ghana.

https://mpra.ub.uni-muenchen.de/69283/1/MPRA_paper_69283.pdf

Foreign Aid and Aid Policy effectiveness on Economic Growth of Ghana.

Abstract

Similar works

Full text

Available Versions

Munich Personal RePEc Archive