The Impact of Foreign Aid on Economic Growth in Cambodia: A Co-integration Approach

Abstract

The purpose of foreign aid is to stimulate economic growth in aid-recipient countries; yet, literature review reveals mixed results: inconclusive or often controversial findings. By using time series annual data from 1991 to 2012, and applying Johansen’s multivariate co-integration test with vector error correction model (VECM) and the innovative accounting (variance decomposition and impulse response function analysis) techniques, this study aims to examine the long run and short run impact of foreign aid on Cambodia’s aid-dependent economy; two other variables such as inflation, and government consumption expenditure are also included in the model. The results of the model show that foreign aid has a significantly positive impact on economic growth in the long run in Cambodia. In addition, foreign aid also has an influence on inflation and may cause it to rise in the short run and in the long run. The model also confirms that foreign aid and inflation positively affect government expenditure in the long run.