Where Has All the Money Gone? Foreign Aid and the Quest for Growth
AbstractThis paper examines fungibility as a possible explanation for the "missing link" between foreign aid and economic growth. The composition of aid plays a crucial role in determining the composition of government spending and, consequently, the magnitude of fungibility and its impact on growth. Embedding fungibility as an equilibrium outcome in an endogenous growth framework, we show that the substitution away from domestic government investment is higher than from government consumption. This leads to a reduction in domestic productive public spending and completely offsets any positive impact that aid might have on growth. The main predictions of the model are tested using a panel dataset of 67 countries for 1972-2000. We find strong evidence of fungibility at the aggregate level: almost 70 percent of total aid is fungible in our sample. We also find that investment aid is more fungible than other categories of aid. In the presence of fungibility, there is no statistically significant relationship between foreign aid and economic growth.
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Bibliographic InfoPaper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2858.
Length: 37 pages
Date of creation: Jun 2007
Date of revision:
Publication status: published as 'Where Has All the Money Gone? Foreign Aid and the Composition of Government Spending' in: B.E. Journal of Macroeconomics, 2012, 12 (1), Article 26
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Find related papers by JEL classification:
- E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
- F3 - International Economics - - International Finance
- F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
- O1 - Economic Development, Technological Change, and Growth - - Economic Development
This paper has been announced in the following NEP Reports:
- NEP-AFR-2007-07-07 (Africa)
- NEP-ALL-2007-07-07 (All new papers)
- NEP-DEV-2007-07-07 (Development)
- NEP-FDG-2007-07-07 (Financial Development & Growth)
- NEP-MAC-2007-07-07 (Macroeconomics)
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