Analysis of the Moderating Roles of Human and Physical Capital on the Impact of Foreign Aid on Economic Growth in Nigeria

Abstract

Though the impact of foreign aid on economic growth has been examined in several studies, the roles of human and physical capital in aid-growth nexus has not been investigated. This is important because the effectiveness of foreign aid could be contingent upon the absorption capacity of the recipient country. We fill this research gap by examining the moderating roles of human and physical capital on aid-growth nexus in Nigeria during 1980 to 2020. Our study deploys the Autoregressive Distributed Lag approach on the interaction models. It shows that the variables are cointegrated. Though aid has a positive impact on growth, human and physical capital have significant moderating roles on the impact of aid on growth. Precisely, the marginal effect of aid on growth varies with the levels of human and physical capital. However, if human and physical capital surpass the threshold levels of 55% and 65%, respectively, an increase in aid cannot accelerate growth. These findings are robust to alternative proxies, structural breaks as well as diagnostic tests. This research implies that, given the requisite levels of human and physical capital, foreign aid can complement domestic capital to enhance growth. Hence, for nations to obtain the long-term benefits of aid, they should create the enabling environment by adequately investing in human and physical capital to attain sustainable economic development. JEL Classification: O47; F35; E22; J24