Searching for Aid Threshold Effects

Abstract

Is aid subject to diminishing returns? This paper addresses this issue, thereby contributing to the literature on effective allocation of aid. We test the hypothesis of diminishing returns to aid. Using an appropriate econometric technique for detecting thresholds, we find that aid only becomes effective (in contributing to growth) beyond a critical level (two per cent of GNP), and we find no evidence of diminishing returns to aid. Indeed, aid appears to be most effective when the level is high in countries with relatively low levels of human capital, suggesting that aid is more effective in countries at lower levels of development.