Aid-Poverty Dynamics a Case Study of Pakistan: A Long Panel Approach

Traditionally, the impact of aid on poverty reduction is preserved through indirect channel, where first aid uplifts economic growth and then economic growth trickle-down its impact on poverty reduction. However, majority of the empirical studies find negative and insignificant relationship between aid and growth which means that the indirect channel of aid-poverty dynamics become ambigious. Nevertheless aid inflow in developing countries and its direct utilization in poverty alleviation projects is yielding positive and significant impact. Thus it becomes important to investigate and build strong theoretical and empirical literature to justify and encourage the inflow of aid in developing countires for poverty alleviation by considering direct channelization concept of aid-poverty dynamics. This paper investigates the direct impact of aid on poverty by controlling the income and income distribution factors. To assess the impact we use the system GMM panel estimation technique that allows controlling econometric restrictions such as endogeneity, long panels and lagged value of the dependent variable as an explanatory variable. Results affirm the positive and significant direct impact of aid on poverty alleviation, where one percentage increase in foreign aid reduces poverty by 2 to 4 percentage points for different measures of poverty; poverty headcount index, poverty gap index and poverty severity index. Aid helps to mitigate poverty measured through the poverty headcount index, poverty gap index and poverty severity index. We also find a more effective impact of aid on poverty reduction under institutional quality and financial development policy applications.