International Economics

Is Aid the Capital Component Making Countries Efficient? A Non-Parametric Production Theory Approach

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This study attempts to add a piece to the aid effectiveness puzzle by presenting an alternative to the common growth regression approach. Most studies of country performance simply rely on regression analysis and exploit the GDP per capita measure when capturing economic growth. Not only have these cross country regressions failed to provide substantial and conclusive evidence on the effects of aid, they are also characterized by well known methodological drawbacks. Furthermore, the GDP per capita measure is similar in nature to the labour productivity measure and consequently subjected to the drawbacks of such partial measures.

To remedy these shortcomings, we suggest evaluating aid effectiveness in a production theory context, applying the Data Envelopment Analysis (DEA) method. This approach considers all factors of production, and hence also includes the capital and energy components of production, implying that we will evaluate the economic performance considering achieved production in relation to all resources used in the production process.

DEA has several attractive characteristics. Since the technology is non-parametric, there is no need to assume a specific functional form, nor do we need to place any restrictions on the scale properties of the underlying production technology. Furthermore, no assumptions regarding economic behaviour in terms of profit maximization or cost minimization need to be made and we do not need information on input prices. The flexible DEA approach is thus particularly suitable in a context like the present, where price information is weak and where little is known about production technologies and economic behaviour.

The study is organized as follows. We begin with a brief summary of some of the recent work in the field of aid effectiveness and point to the value of trying a different approach to the issue. This is followed by Section 3, a discussion of the efficiency concept. Section 4 is a presentation of data and model specification, while empirical results are found in Section 5. Section 6 concludes.

  • Aid Effectiveness

Aid issues have received renewed political interest during the first years of the 21st century. At the Millennium Summit of 2000, the international community agreed on the Millennium Development Goals (MDG) to be reached by 2015. World leaders have acknowledged that objective attainment depends on increased resource transfers as well as improved aid effectiveness through donor co-ordination. Aid increase has been suggested in the Monterrey Consensus and by the UN. Furthermore, the multilateral debt relief initiative (MDRI) has been introduced to reduce the debt burden of developing countries.

The political interest together with increased resource transfers have resulted in numerous studies on the impact of aid on growth. There is, however, little evidenceof a significant positive effect of aid on the long-term growth of poor countries. The classic view is that aid increases savings, investments and thus the capital stock. There should be no doubt that aid sometimes finances investment. Dalgaard, Hansen and Tarp (2004) have shown that aid transfers improve steady state productivity in partner countries through raising the capital stock per person.



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