Foreign Aid, Domestic Revenue and Economic Growth in Ghana

Abstract

Various funding sources are available to any government in a developing country. In spite of their availability, each source has its unique way of contributing to economic growth. The objective of this study is to determine the relationship between foreign aid and domestic revenue on one hand and their effect on economic growth in Ghana. Using macroeconomic time series data (for 1970 – 2011) and error correction methodology together with Granger causality tests, the results show that, domestic revenue and foreign aid complement each other for development financing. Moreover, foreign aid cannot be a substitute for domestic revenue generation as domestic revenue is the most important between the two factors. Domestic revenue is the most effective irrespective of the existence of other forms of capital. In addition, the threshold effect of aid becomes non-existent when there is no capital accumulation. There is a positive causal link from both domestic revenue and foreign aid to economic growth. It is recommended that, more attention should be given to the generation of domestic revenue.

Key Words: Foreign Aid, Domestic Revenue, Economic Growth, Error Correction Model, Ghana