Foreign Aid Policy and Sources of Poverty: A Quantitative Framework

Abstract

The econometric literature has been unable to establish a robust association between foreign aid and growth and poverty reduction. In this paper, we argue that aid effectiveness must be assessed using methods that go beyond cross-country regressions. We calibrate a dynamic general equilibrium model that is capable of generating large sustained income gaps between rich and poor countries. The model quantifies three sources of poverty: (1) lack of access to international capital, (2) low schooling and high fertility (a poverty trap), and (3) an antigrowth domestic fiscal policy set by an elite. We analyze policies designed to address each source of poverty and compare the aid cost of their implementation. The policies differ dramatically in the extent and timing of their growth effects, and in the aid cost of their implementation.