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The authors would like to thank Robert Flood, Boriana Yontcheva, and the participants of the IVth METU International Economic Conference, as well as the IMF African Department and Department of Economics at Bilkent University seminar participants for helpful comments on earlier versions. The views expressed in this paper do not necessarily reflect those of the institutions with which the authors are affiliated. The authors thank also Tom Walter for helpful editorial suggestions.
White (1992) provides an overview of the results found on the relationship between aid and growth, aid and the real exchange rate, and aid and savings. Boone (1996) analyzes the effects of aid on economic growth. Buliř and Hamann (2001) show that, given the uncertainty in aid flows, large aid flows could create difficulties in fiscal discipline. Lensink (1993) and Pillai (1982) find that total aid flows have a negative effect on government revenue, while Stotsky and Wolde Mariam (1997) find the contrary. Knack (2001) and Alesina and Weder (2002) find empirical support for the argument that higher aid levels erode the quality of governance or increase corruption.
McKinnon (1973), Boyd and Prescott (1986), Greenwood and Jovanovic (1990), and King and Levine (1993), among others, discuss the growth effects of well-functioning financial markets. However, Favara (2003), using a variety of econometric methods, does not find robust support for the notion that finance spurs economic growth.
The small open economy assumption implies that the country will be a price taker in the tradables market; hence the relative price will change on account of the increase in the price of the nontradables.
The assumptions of the underlying model are that domestic prices are fully flexible, and that there is a floating exchange rate regime.
Adam (2001) provides a comprehensive overview of the effects of aid on the macroeconomic management and exchange rate in Uganda.
The figures are obtained from IMF’s staff report for the 2002 Article IV consultation with Uganda (http://www.imf.org/external/pubs/ft/scr/2003/cr0383.pdf). Net donor inflows encompass official assistance to the government, including budget and project grants, concessional official loans, and HIPC initiative assistance, net of interest and amortization due on external public debt to official creditors.
Defined as overall fiscal balance, excluding grants, net of interest payments on external debt and government expenditure on imports.
Among may others, Levine and Renelt (1992) review alternative specifications for empirical growth regressions.
Assassinations were excluded from the analysis since the available data not only restrict the data set in the analysis significantly but also have a very small variation.
Dalgaard and Hansen (2001) have also shown a high correlation between these alternative measures and point out that the measures could be used interchangeably in such analysis.
A monthly publication of Political Risk Services that reports data on the risk of expropriation, level of corruption, rule of law, and bureaucratic quality in an economy.
In testing the robustness of BD result, Easterly, Levine, and Roodman use also longer time periods.
The regression results reported, however, include 42–46 countries, given the limited availability of ICRG data on bureaucratic quality.
A Hausman test for fixed versus random effects favors fixed effects.
Cross-section weights are used to correct for cross-section heteroskedasticity.
The financial development indicators are all in natural logs, as is common in the literature. The average of the natural log of liquid liabilities measure of financial market development is 3.37, while the standard deviation of this measure is 0.50. This suggests that the share of liquid liabilities is below 17.8 percent of GDP for the low financial market development group, above 47.8 percent for the high financial market development group, and between 17.8 percent and 47.8 percent for the average financially developed group. The average of the log of the private sector credit measure of financial market development is 3.15, while the standard deviation of this measure is 0.72.
With aid itself not significant, 0.135 is obtained by multiplying the natural log of 47.8 by the coefficient of the interaction term, 0.035 (see Table 5).
For the average financially developed, we assume a mid-range level of 29.65 percent (average of 48 and 11.3) whose natural log is 3.39. This, together with the 0.23 coefficient on aid and the 0.09 coefficient on the relevant interaction term (Table 5, column (2)), yields a marginal growth impact of aid 0.07. For economies with low financial market development, the natural log of the 11.3 percent upper bound is 2.42. This, together with the coefficients on aid and on the relevant interaction term, yields a negative growth impact of 0.26 percentage point at least.
It suggests that besides the size of the financial sector, the efficiency and quality of financial intermediation may have an impact on aid effectiveness. The efficiency aspects of financial intermediation are beyond the object of our analysis.