Foreign Aid Inflow and Domestic Savings in Uganda: Error Correction Modelling

Henry Tumwebaze Karamuriro,Edward Bbaale,Edward Patrick Ssemanda

doi:10.11648/j.jwer.20200901.17

Henry Tumwebaze Karamuriro, Edward Bbaale + Show 1 more

Open Access

https://doi.org/10.11648/j.jwer.20200901.17

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Abstract

The study sought to establish the impact of foreign aid inflow on domestic savings in Uganda. It was motivated by the low savings ratio which was identified as one of the major constraints to future growth in Uganda, under Vision 2025. Error-Correction Modelling was applied on a time series database for the period 1970-2016. Results of the study show that foreign aid has a negative impact on domestic savings in Uganda both in the short-run and long-run. An increase in foreign aid inflow by 1% of GDP leads to 0.71% decrease in gross domestic savings in the long-run. This implies that an increase in foreign aid as a whole crowded-out domestic savings in the short-run and long-run. By making resources easily available, foreign aid encourages relaxation in saving effort and increases consumption. A policy implication of this result is that Uganda should be wary in soliciting for foreign aid. If foreign aid becomes expedient, then it should be channeled to productive ventures.

Highlights

One of the major economic problems of developing countries is inadequate domestic savings
This study contends that the extent to which the level of savings can affect capital formation and economic growth largely depends on the capacity of the economy to channel the savings into productive use
The Error-Correction Term (ECT) in the short-run estimation of gross domestic savings model was obtained from the general error-correction model

Summary

Introduction

One of the major economic problems of developing countries is inadequate domestic savings. In developing economies where the level of domestic savings is low, foreign aid can be used to supplement domestic savings to foster investment and economic growth. Rostow suggested that developing countries lack sufficient domestic savings to finance investment requirements and foreign aid would act as a complement to help them take-off into selfsustaining growth. According to this hypothesis, domestic savings during the take-off stage could be supplemented by foreign aid inflow so as to increase the level of investment required to spur economic growth. Rostow argued that foreign aid is an important source of foreign savings for developing countries which augments their domestic resources available for investment

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