Natural Disasters, Foreign Aid and Economic Development Valeriu Tomescu Advisor: Mihail Miletkov University of New Hampshire, Department of Accounting and Finance Motivation Capital inflows from foreign aid have been theorized to increase the economic growth of recipient countries. However, the empirical evidence for any such positive relation has been very mixed. Critics of foreign aid claim that it has no effect on growth and may even weaken it. Proponents of aid claim that, on average, it has been an effective tool. A more recent school of thought claims that aid can be effective or ineffective, depending upon a country’s specific circumstances (Burnside and Dollar, 2000). The present research contributes to this discussion by examining the effect of aid on growth in countries experiencing natural disasters. Hypotheses If a country is experiencing a natural disaster, foreign aid inflows are less likely to be mismanaged, and therefore, can have a more positive effect on growth. Countries that suffer from natural disasters, or countries with “good policies” are likely to experience an increase in foreign aid allocations. Following Burnside and Dollar (2000), the finding that countries with “good policies” experience higher growth is tested. Empirical Model These questions are estimated using variants of the following equations: 𝑔 𝑖𝑡 = 𝛼 𝑖 + 𝑎 𝑖𝑡 𝛽 𝑎 + 𝑑 𝑖𝑡 𝛽 𝑑 + 𝑎 𝑖𝑡 𝑑 𝑖𝑡 𝜃 𝑎𝑑 + 𝒑 𝒊𝒕 𝜷 𝒑 + 𝒛 𝒊𝒕 𝜷 𝒛 + 𝜀 𝑖𝑡 𝑔 𝑎 𝑖𝑡 = 𝛼 𝑖 𝑎 + 𝑔 𝑖𝑡 𝛽 𝑔 + 𝑑 𝑖𝑡 𝛽 𝑑 + 𝒑 𝒊𝒕 𝜷 𝒑 + 𝒛 𝒊𝒕 𝜷 𝒛 + 𝜀 𝑖𝑡 𝑎 Where i index countries, t index time, 𝑔 𝑖𝑡 the real GDP growth, 𝑎 𝑖𝑡 aid receipts relative to GDP, 𝒑 𝒊𝒕 a P x 1 vector of policies that affect growth, 𝒛 𝒊𝒕 a Z x 1 vector of other covariates that might affect growth and the allocation of aid, 𝑑 𝑖𝑡 a natural disaster indicator variable, ε 𝑖𝑡 𝑔 and ε 𝑖𝑡 𝑎 as mean zero scalars. 𝒑 𝒊𝒕 includes inflation, budget surplus, government consumption and trade openness, while 𝒛 𝒊𝒕 includes foreign direct investment, the level of broad money (M2) and the total population. To test the third hypothesis, principal component analysis will be used to create an overall measure of economic policy rather than four separate variables. The following equation will be estimated: 𝑔 𝑖𝑡 = 𝛼 𝑖 + 𝑎 𝑖𝑡 𝛽 𝑎 + 𝑑 𝑖𝑡 𝛽 𝑑 + 𝑎 𝑖𝑡 𝑑 𝑖𝑡 𝜃 𝑎𝑑 + 𝑝 𝑖𝑡 β 𝑝 + 𝑎 𝑖𝑡 𝑝 𝑖𝑡 θ 𝑎𝑝 + 𝒛 𝒊𝒕 𝜷 𝒛 + 𝜀 𝑖𝑡 𝑔 Results References Boone, P. (1996). Politics and the effectiveness of foreign aid. European economic review, 40(2), 289-329. Burnside, C. and Dollar, D. (2000). Aid, policies and growth. American Economic Review, (90): 847-868. Easterly, W. (2003). Can foreign aid buy growth?. The journal of economic perspectives, 17(3), 23-48. James, G., Witten, D., Hastie, T., & Tibshirani, R. (2013). An introduction to statistical learning (Vol. 112). New York Residuals Distribution and Tests There is no obvious pattern in the errors plot, while their distribution is fairly normal. The VIFs are around 2 revealing there is little evidence of multicollinearity. White’s test reveals possible error heteroscedasticity; as a solution, Lasso and WLS regressions are used. Both Durbin-Watson and Ljung-Box show there is slight autocorrelation at the first lag. Potential solutions will include estimating GMM regressions or the inclusion of a lagged term for the dependent variable. Test Statistic AC p-value White’s test 74.1   0.0294 Ljung–Box 38.8 0.21 0.0001 D-W 1.61 0.19