The Development Assistance Committee (DAC) of the Organization for Economic Cooperation and Development (OECD) defines foreign aid as financial flows, technical support, and goods that are intended to encourage economic growth and wellbeing. Foreign aid is generally linked with authorized development support which in turn is a division of the official development finance, and usually given to the poorest countries (World Bank, 1998) (TAB 1).

Various debates about the usefulness of foreign aid dates back decades. Milton Friedman, Peter Bauer, and William Easterly are critics that have given tough reviews, ranging from the decreased impact aid has on government bureaucracies, propagated bad governments, enriched the selected few in poor countries, or wasted. They lay emphasis on extensive poverty in Africa and South Asia despite over thirty years of aid directed to these countries still having a devastating record, e.g. the Democratic Republic of the Congo, Guinea, and Somalia. In their opinion aid programs should be significantly transformed, considerably managed, or eradicated (PAPER 1).

Other researchers oppose these arguments, although partly correct but over emphasised. Jeffrey Sachs, Joseph Stiglitz, Nicholas Stern and others have argued that even though aid has from time to time failed, it has reduced poverty and enhanced growth in some countries and discouraged worse outcome in other countries. They consider the weaknesses of aid to be linked with donors rather than receivers, and identified a couple of successful countries that have received significant aid such as Botswana, Indonesia, Korea, and, more recently, Tanzania and Mozambique, together with thriving ideas such as the Green Revolution, the crusade against river blindness, and the introduction of oral rehydration therapy (PAPER 1).

Review by Papanek (1973) disagreed with the negative outcome of Griffin and Enos (1970) that by not adding capital flow to foreign aid and other inflows, a significantly positive aid coefficient can be achieved. In contrast, using a sample of 22 Less Developed Countries 1956-1968, Voivodas (1973) achieved an insignificant negative aid impact on growth. This early periods can be characterised with poor quality of data thereby causing ambiguity in their results(TAB 5). More recently, Knack (2000) debates that an increase in foreign aid increases corruption, rent-seeking and corrodes institutional quality thus having an adverse effect on growth.

However, with better data, Dowling and Hiemenz (1983) used the pooled data for 13 Asian countries to test for impact of aid on growth and discovered a significantly positive relationship. In their research, they controlled for certain policy variables like government intervention and trade. While Levy (1988) considered Sub-Saharan Africa and also achieved a significantly positive correlation haven used a regression model with income per capita and aid as a ratio of GDP for 1968-1982(TAB 5). Using 41 countries 1986-1992, Hadjimichael et al. (1995) discovered a positive aid-growth relationship. More recently, Burnside and Dollar (1997) used a model with various policy variables and learnt that aid alone does not directly influence growth in LDCs but when policy variables interact with aid will have a significant impact on economic growth (World Bank, 1998) (TAB 1). The potential side effects of foreign aid as well as certain policy variables were captured in the above mentioned models thus making them slightly more sophisticated than previous research.