The Ghost of Financing Gap: Testing the Growth Model Used in the International Financial Institutions
Posted: 24 Mar 2000
The Harrod--Domar growth model supposedly died long ago. Still today, economists in the international financial institutions (IFIs) apply the Harrod--Domar model to calculate short-run investment requirements for a target growth rate. They then calculate a "financing gap" between the required investment and available resources and often fill the "financing gap" with foreign aid. The financing gap model has two simple predictions: (1) aid will go into investment one for one, and (2) there will be a fixed linear relationship between growth and investment in the short run. The data soundly reject these two predictions of the financing gap model.
JEL Classification: E1, E22, O1, O11, O21, O4, O41
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