This dissertation is compiled of three chapters in determining the effect of bilateral foreign assistance on the economy of Pakistan. The effect of foreign assistance will be measured in terms of public expenditure and revenue. The factors associated in the provision of aid commitments and disbursements, and the effect of bilateral assistance on the production efficiency of Pakistan. Chapter 1 uses an aid disaggregation approach to examine the impact of different types of bilateral donors on the fiscal sector of Pakistan, an important aid recipient in recent years. The purpose of this study is to determine the impact of bilateral aid on the economy of Pakistan, from the four largest donors, which include the USA, Japan, the United Kingdom, and Germany. Time series data for the period 1972-2010 were analyzed along with an estimation of a fiscal response model following Mavrotas (2005) that combines both aid disaggregation in terms of types of aid and the treatment of endogeneity. The empirical estimation of the structural equations and reduced form equations, using nonlinear three stage least squares estimation clearly suggests the importance of the above approach for delving deeper into aid effectiveness issues. Since different bilateral donors have different effects on key fiscal variables, an impact could not be revealed if a single figure for aid were employed. While aid from Japan increases public investment, aid from the USA, the UK, and Germany appears to cause a reduction in public investment. Similarly, aid from Japan reduces public consumption, but the aid from other donors causes an increase in public consumption. In regards to tax revenue, the aid flows from the USA, the UK and Germany leads to a reduction in tax revenue, but aid flow from Japan increases tax revenue. Chapter 2 investigates the relation between aid disbursements and aid commitments from the fourteen largest donors to Pakistan, and determine the factor that effects commitments and the disbursements. The time series data was employed for the period 1972-2010. The estimation of the model through fixed effect approach and two stage least squares approach showed that aid disbursements, aid commitment from donors to African countries, and Pakistan's membership at the United Nations Security Council effects aid commitments positively and significantly. But, the inverse relation existed between GDP per capita of Pakistan and aid commitments. Similarly, aid commitments relation with the aid disbursements was positive and significant. The war in Afghanistan during any time between1972-2010 increases the aid disbursement to Pakistan. It was also determined that if the level of primary education increases, the aid disbursement to Pakistan decreases. The results also showed that when Pakistan is ruled by the military government the aid disbursements to Pakistan reduces. Chapter 3 focus is to see the impact of different bilateral donors on the production inefficiency of the Pakistan. To empirically estimate the effect of bilateral aid heterogeneity on production inefficiency, we use the time series data for Pakistan for the period 1972-2010. The stochastic frontier analysis was conducted using maximum likelihood estimation. The results determined that the aid from the United Kingdom (UK) and Germany tends to increase production efficiency of Pakistan. However on the contrary aid from Japan tends to decrease production efficiency. It was also concluded from the results that foreign direct investment and public investment also increases production efficiency. But, the relation between human capital and production efficiency was negative. Also, the results indicated that when Pakistan is ruled by the military government the aid flows from the USA and UK reduces production efficiency.

The thesis looks at the macroeconomic impact of foreign aid. It is specially concerned with aid's impact on the public sector of less developed countries < LDCs> . Since the overwhelming majority of aid is directed to the public sector of LDCs, one can only understand the broader macroeconomic impact of aid if one first understands its impact on this sector. To this end, the thesis econometrically estimates " fiscal response" models of aid. These models, in essence, attempt to shed light on public sector fiscal behaviour in the presence of aid inflows, being specially concerned with the way aid is used to finance various categories of expenditures. The underlaying concern is to extent to which aid is " fungible" -that is, whether it finances consumption expenditure and reductions in taxation revenue in LDCs. A number of alternative models are derived from a utility maximisation framework. These alternatives reflect different assumptions regarding the behaviour of LDC public sectors and relate to the endogeniety <as opposed to exogeniety> of aid, whether or not recurrent expenditure is financed from domestic borrowing and the determination of domestic borrowing. The original frameworks of earlier studies are extended in a number of ways, including the use of a public sector utility function which is fully consistent with expected maximising behaviour. Estimates of these models' parameters are obtained using both time-series and cross-section data, dating from the 1960s, for Bangladesh, India, Pakistan and the Philippines. Both structural and reduced-form equations are estimated. Results suggest that foreign aid <defined as all foreign inflows to the official sector> is indeed fungible, albeit at different levels. Moreover, the overall impact of aid <both loans and grants> on public sector investment, consumption, domestic borrowing and taxation varies between countries. Generally speaking, aid leads to increases in investment and consumption expenditure, but reduces taxation and domestic borrowing. Comparative analysis does, however, show that these results are highly sensitive to alternative behavioural assumptions and, therefore, model specification.