Foreign aid and economic growth: Does non-linearity matter?

The age-long consensus, in the literature, that lower level of foreign aid contributes positively to growth while higher level contributes negatively due to diminishing return and absorptive capacity issues brings to the fore the need; to investigate the possible non-linear relationship between foreign aid and growth over the period of 1981 and 2017 using threshold analysis approach; and to determine optimal foreign aid threshold for Nigeria. The conventional Augmented Dickey-Fuller (ADF) and Break-point unit root tests were both employed and compared for consistence. The overall findings showed that there exists one threshold upon which growth impact of aid can be felt, implying that the impact of net foreign aids received depends on the level of foreign aids. This therefore justifies the existence of a non-linear relationship between net foreign aids received and economic growth. Specifically, this is attributed to the fact that productive sectors of economy are not armed with enough liquidity and by implication the role of domestic investment in output growth is undermined. Similarly, results showed that the only significant determinant of growth in Nigeria is government final consumption expenditure, implying that government spending boosts aggregate demand with positive multiplier effect on output in line with the Keynesian theory. The policy implication from this study: optimal levels of foreign aids above 0.11% of GDP should be considered effective for growth, generated, adhered to, and directed to productive sector of the economy; strong institution, robust financial sector and conducive macroeconomic environment should be built to attract and make efficient use of higher aid flows. Besides, government spending should be biased towards stimulating the productiveness of the non-oil sector in the Nigerian economy.