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Where Has All the Money Gone? Foreign Aid and the Composition of Government Spending

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  • Chatterjee Santanu

    (University of Georgia)

  • Giuliano Paola

    (UCLA, Anderson School of Management)

  • Kaya Ilker

    (American University of Sharjah)

Abstract

This paper examines the link between foreign aid and the composition of government spending in aid-recipient countries. Two questions are addressed: (i) does foreign aid crowd out government spending in aid-recipient countries, and (ii) does the degree of fungibility vary across different categories of aid? Using a panel dataset of 67 countries for 1972-2000 we find that at the aggregate level about 70 percent of total aid is fungible. We also find that aid targeted for public investment crowds out about 80-90 percent of domestic government spending on public investment. Aid does not affect private investment, but has a strong positive impact on household consumption. The results are also robust to checks for causality. These findings are significant, since more than two-thirds of all aid flows to developing countries are tied to public investment projects.

Suggested Citation

  • Chatterjee Santanu & Giuliano Paola & Kaya Ilker, 2012. "Where Has All the Money Gone? Foreign Aid and the Composition of Government Spending," The B.E. Journal of Macroeconomics, De Gruyter, vol. 12(1), pages 1-36, August.
    • Handle: RePEc:bpj:bejmac:v:12:y:2012:i:1:p:1-36:n:31
    DOI: 10.1515/1935-1690.2458
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    3. Sena Kimm Gnangnon, 2019. "Fiscal Space for Trade: How Could the International Trade Community Help?," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 10(01), pages 1-42, February.
    4. Jamiil Jeetoo, 2020. "Spillover effects in public healthcare expenditure in Sub‐Saharan Africa: A spatial panel analysis," African Development Review, African Development Bank, vol. 32(2), pages 257-268, June.
    5. Łukasz Marć, 2017. "The Impact of Aid on Total Government Expenditures: New Evidence on Fungibility," Review of Development Economics, Wiley Blackwell, vol. 21(3), pages 627-663, August.
    6. Ozgur Kaya & Ilker Kaya, 2019. "Aid To Agriculture And Aggregate Welfare," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 64(02), pages 281-300, March.
    7. Łukasz Marć, 2015. "The impact of aid on total government expenditures: New evidence on fungibility," WIDER Working Paper Series wp-2015-010, World Institute for Development Economic Research (UNU-WIDER).
    8. Maiga, Eugenie W.H., 2014. "Does foreign aid in education foster gender equality in developing countries?," WIDER Working Paper Series 048, World Institute for Development Economic Research (UNU-WIDER).
    9. Ozgur Kaya & Ilker Kaya & Lewell Gunter, 2013. "Foreign Aid and the Quest for Poverty Reduction: Is Aid to Agriculture Effective?," Journal of Agricultural Economics, Wiley Blackwell, vol. 64(3), pages 583-596, September.
    10. Jean-Louis Combes & Rasmane Ouedraogo & Sampawende J.-A. Tapsoba, 2016. "Structural shifts in aid dependency and fiscal policy in developing countries," Applied Economics, Taylor & Francis Journals, vol. 48(46), pages 4426-4446, October.
    11. Ahiteme N. Houndonougbo, 2017. "Aid Volatility and Real Business Cycles in a Developing Open Economy," Southern Economic Journal, John Wiley & Sons, vol. 83(3), pages 756-773, January.
    12. Santanu Chatterjee & Mark C. Kelly & Stephen J. Turnovsky, 2022. "Foreign aid, public investment, and the informal economy," Economic Inquiry, Western Economic Association International, vol. 60(1), pages 174-201, January.
    13. Seim, Brigitte & Jablonski, Ryan S. & Ahlback, Johan, 2020. "How information about foreign aid affects public spending decisions: evidence from a field experiment in Malawi," LSE Research Online Documents on Economics 105255, London School of Economics and Political Science, LSE Library.
    14. Bain, Robert & Bartram, Jamie & Luyendijk, Rolf, 2013. "Universal Access to Drinking Water: The Role of Aid," WIDER Working Paper Series 088, World Institute for Development Economic Research (UNU-WIDER).
    15. Gnangnon, Sèna Kimm, 2021. "Aid for trade unpredictability and trade-related government expenditure in recipient-countries," The Quarterly Review of Economics and Finance, Elsevier, vol. 79(C), pages 107-125.
    16. Łukasz Marć, 2017. "The Impact of Aid on Total Government Expenditures: New Evidence on Fungibility," Review of Development Economics, Wiley Blackwell, vol. 21(3), pages 627-663, August.
    17. Jean-Louis Combes & Rasmané Ouedraogo & Mr. Sampawende J Tapsoba, 2016. "What Does Aid Do to Fiscal Policy? New Evidence," IMF Working Papers 2016/112, International Monetary Fund.
    18. Philippe Cyrenne & Manish Pandey, 2015. "Fiscal equalization, government expenditures and endogenous growth," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 22(2), pages 311-329, April.
    19. Loujaina Abdelwahed, 2021. "The fiscal management of permanent and temporary foreign aid: Evidence from sub‐Saharan Africa," Journal of International Development, John Wiley & Sons, Ltd., vol. 33(4), pages 685-716, May.
    20. Jun Wen & Umar Farooq & Suhaib Anagreh & Mosab I. Tabash, 2022. "Quality of governance and corporate real investment: Assessing the impact of foreign aid," Bulletin of Economic Research, Wiley Blackwell, vol. 74(4), pages 1115-1134, October.
    21. Nadeem Abdulmalik Abdulrahman Aljonaid & Fengming Qin & Zhaoyong Zhang, 2022. "The Heterogeneous Impact of Sectoral Foreign Aid Inflows on Sectoral Growth: SUR Evidence from Selected Sub-Saharan African and MENA Countries," JRFM, MDPI, vol. 15(3), pages 1-45, February.
    22. Mfouapon Alassa & Kamdem Cyrille Bergaly & Mohammadou Nourou, 2022. "Agricultural Foreign Aid Allocation in Sub-Saharan Africa: The importance of Democracy and Quality of Governance," International Journal of Research and Innovation in Social Science, International Journal of Research and Innovation in Social Science (IJRISS), vol. 6(3), pages 84-100, March.
    23. repec:oup:jafrec:v:32:y:2022:i:1:p:26-51. is not listed on IDEAS
    24. Kaya, Ilker & Kaya, Ozgur, 2020. "Foreign aid, institutional quality and government fiscal behavior in emerging economies: An empirical investigation," The Quarterly Review of Economics and Finance, Elsevier, vol. 76(C), pages 59-67.
    25. Robert Bain & Rolf Luyendijk & Jamie Bartram, 2013. "Universal Access to Drinking Water: the Role of Aid," WIDER Working Paper Series wp-2013-088, World Institute for Development Economic Research (UNU-WIDER).

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