The ghost of financing gap: testing the growth model used in the international financial institutions

Abstract

The Harrod–Domar growth model supposedly died long ago. Still today, economists in the international financial institutions (IFIs) apply the Harrod–Domar model to calculate short-run investment requirements for a target growth rate. They then calculate a “financing gap” between the required investment and available resources and often fill the “financing gap” with foreign aid. The financing gap model has two simple predictions: (1) aid will go into investment one for one, and (2) there will be a fixed linear relationship between growth and investment in the short run. The data soundly reject these two predictions of the financing gap model.