Identifying thresholds in aid effectiveness

In this paper, the author focuses on the nonlinear nature of the aid to growth relationship to show that the “Big Push” hypothesis is consistent with capacity constraints in the understanding of aid effectiveness. The Big Push hypothesis proposes the existence of one threshold below which aid is not effective, whereas the constraints inferred by the concept of absorptive capacity suggest the existence of a second threshold above which aid is no longer effective. This paper addresses the issue of these thresholds which characterize the aid to growth relationship. Using a semi-parametric econometric method, the author finds that aid becomes effective only above a critical level, but what is more it becomes detrimental to growth at high aid flows. The author also investigates how the quality of institutions and economic vulnerability modify the level of these two thresholds. He finds that economic vulnerability is a key factor conditioning aid effectiveness. Copyright Kiel Institute 2014