Foreign Aid, Domestic Savings and Economic Growth (Pakistan: 1960 to 1988)

Naheed Zia Khan, Eric Rahim


One of the core tenets of foreign aid theory, particularly as
encapsulated in the two-gap model, is that the insertion of foreign
resources via free grants, loans, direct investment etc., into a
developing economy sets in motion a causal chain of positive influences
in the following broad mannerl: aid' ~ increase in investible resources
~ increase in domestic investment ~ more rapid rate of economic growth.
Spirited and specific challenges to this approach came from many
critics, supported greatly by a number of broad theoreticaF and
empirical analyses. For a large part of the latter, the available
evidence pointed to a negative relationship between aid and domestic
savings. The evidence was largely based on crosssectional data, 'showing
that, there was, in addition, reason to suggest a negative relationship
between aid and economic growth. 3 The aim of this study is to provide
some quantitative evidence on the relationship between foreign aid,
domestic savings and economic growth for Pakistan. The analysis is
carried out in three parts. Part one contains the methodology and the
description of the data. Part two explores the correlation between aid
and several other explanatory variables with Pakistan's savings rate,
while part three attempts to analyse and explain the regression findings
in terms of the effect of aid on economic growth.

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