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Aid and Two Gap Model

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  • November 2012
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Aid and the Two Gap Model Aid is a burning issue these days. The question of countries accepting foreign aid has intrigued economists and the general public for a quite a while. Television discussions and newspaper articles have frequently focused on this issue while politicians try to fight this matter out in the parliaments. Furthermore, many are trying to unravel the enigma of aid and its effects on growth. This paper, in the little word space provided, will try to establish a relation between aid and growth. It will do so by first defining aid and growth and then moving on to some of the important models which can be used to understand this link. We will discuss the two-gap model and then move on to the Solow and Harrod-Domar model, giving empirical examples in each case. Finally, we will analyze two countries and try to inspect the reasons for their different growth rates using the logic used in the discussed models. Aid can be defined as any voluntary transfer of resources. It can be either public (provided by donor countries or multilateral donor organization such as the IMF and The World Bank) or private (given by NGO’s.).The Organization for Economic Corporation and Development defines aid as any transfer of money or resource that fulfills the following criteria: a) The objective of the transfer should be noncommercial. b) It should be given for the purpose of economic development. c) The terms of the transfer should be concessional (interest rate should be less than the prevailing interest rate in the market OR the maturity period should be longer than usual). Aid should not be mixed with grant which is often used interchangeably with this term. Aid is any transfer that has concessional terms while grant is a form of aid that does not require the repayment of the principal. In this paper, we will often measure aid in the from of official development assistance (ODA) which is a convenient indicator of international aid flow. On the other hand, we will...

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