Foreign Aid and External Debt–A Bane or a Boom to the Ghanaian Economy? New Insights

Over recent years, the Ghanaian economy has struggled to find its feet on the ground despite rising public debt and unending inflows of foreign aid. Against this backdrop, this study employs the Vector Error Correction Model (VECM) estimation technique on data from 1970 to 2020 to test the usefulness of the debt overhang hypothesis and the dependency theory in the special case of Ghana. The results confirm evidence of the debt overhang hypothesis and the center-periphery wisdom of the dependency theory in Ghana. The findings depict that an increase in external debt stock and total debt service on external debt have both short and long-run growth-limiting effects on the Ghanaian economy. Similarly, foreign aid catalyzes growth only in the short run and later suppresses rather than stimulates economic growth in Ghana over the long run. The study recommends that harnessing domestic resources, maintaining fiscal discipline by cutting down unproductive expenditures, enhancing an effective tax system, and promoting institutional capabilities to counteract corruption and openness to trade are better ways to fast-track growth development in Ghana.