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Foreign aid's impact on public spending

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  • Feyzioglu, Tarhan
  • Swaroop, Vinaya
  • Min Zhu
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    Abstract

    Using a model of aid fungibility, the authors examine the relationship between foreign aid and public spending. Based on a panel of cross-country and time-series data, their results show that roughly 75 cents of every dollar given in net development assistance goes to current spending and 25 cents to capital spending in the recipient countries. But concessionary loans - a component of development assistance - stimulate far more government spending. Their results also show that aid increases both public and private investment. To test aid fungibility across both public spending categories, they use a newly constructed data series on the net disbursement of concessionary loans. They find that concessionary loans given to the transport and communication sector are fully nonfungible. But loans to the energy sector are converted into fungible monies and part of the funds leak into transport and communications. Loans to agriculture and education are also fungible. There is no evidence of concessionary funds being diverted for military purposes. Their results show that total public spending in the health sector has no impact on reducing infant mortality, but concessionary loans to the health sector do. This finding leads the authors to conclude that linking foreign aid to an agreed-upon public spending program in areas critical to development might be an effective way to transfer resources to developing countries.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1610.

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    Date of creation: 31 May 1996
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    Handle: RePEc:wbk:wbrwps:1610

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    Related research

    Keywords: Decentralization; Gender and Development; Development Economics&Aid Effectiveness; Public Sector Economics&Finance; Economic Theory&Research; Inequality; Development Economics&Aid Effectiveness; Public Sector Economics&Finance; National Governance; Economic Stabilization;

    References

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    1. Heller, Peter S, 1975. "A Model of Public Fiscal Behavior in Developing Countries: Aid, Investment, and Taxation," American Economic Review, American Economic Association, vol. 65(3), pages 429-45, June.
    2. Easterly, William & Rebelo, Sérgio, 1994. "Fiscal Policy and Economic Growth: An Empirical Investigation," CEPR Discussion Papers 885, C.E.P.R. Discussion Papers.
    3. Khilji, Nasir M. & Zampelli, Ernest M., 1994. "The fungibility of U.S. military and non-military assistance and the impacts on expenditures of major aid recipients," Journal of Development Economics, Elsevier, vol. 43(2), pages 345-362, April.
    4. Robert J. Barro, 1991. "Economic Growth in a Cross Section of Countries," NBER Working Papers 3120, National Bureau of Economic Research, Inc.
    5. Devarajan, Shantayanan & Swaroop, Vinaya & Heng-fu, Zou, 1996. "The composition of public expenditure and economic growth," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 313-344, April.
    6. J. A. Hausman, 1976. "Specification Tests in Econometrics," Working papers 185, Massachusetts Institute of Technology (MIT), Department of Economics.
    7. Mosley, Paul & Hudson, John & Horrell, Sara, 1987. "Aid, the Public Sector and the Market in Less Developed Countries," Economic Journal, Royal Economic Society, vol. 97(387), pages 616-41, September.
    8. Levy, Victor, 1987. "Anticipated Development Assistance, Temporary Relief Aid, and," Economic Journal, Royal Economic Society, vol. 97(386), pages 446-58, June.
    9. Maurice Obstfeld., 1998. "Foreign Resource Inflows, Saving, and Growth," Center for International and Development Economics Research (CIDER) Working Papers C98-099, University of California at Berkeley.
    10. Cashel-Cordo, Peter & Craig, Steven G., 1990. "The public sector impact of international resource transfers," Journal of Development Economics, Elsevier, vol. 32(1), pages 17-42, January.
    11. Pack, Howard & Pack, Janet Rothenberg, 1990. "Is Foreign Aid Fungible? The Case of Indonesia," Economic Journal, Royal Economic Society, vol. 100(399), pages 188-94, March.
    12. White, Howard & Luttik, Joke & DEC, 1994. "The countrywide effects of aid," Policy Research Working Paper Series 1337, The World Bank.
    13. Pack, Howard & Pack, Janet Rothenberg, 1993. "Foreign Aid and the Question of Fungibility," The Review of Economics and Statistics, MIT Press, vol. 75(2), pages 258-65, May.
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    Citations

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    Cited by:
    1. Michael Clemens & Steven Radelet & Rikhil Bhavnani, 2004. "Counting Chickens When They Hatch: The Short-term Effect of Aid on Growth," Working Papers 44, Center for Global Development.
    2. Svensson, Jakob, 1997. "When is Foreign Aid Policy Credible? - Aid Dependence and Conditionality," Seminar Papers 600, Stockholm University, Institute for International Economic Studies.
    3. Ghosh Banerjee, Sudeshna & Rondinelli, Dennis A., 2003. "Does Foreign Aid Promote Privatization? Empirical Evidence from Developing Countries," World Development, Elsevier, vol. 31(9), pages 1527-1548, September.
    4. Lyn Squire, 1998. "Professor Mirrlees' Contribution to Economic Policy," International Tax and Public Finance, Springer, vol. 5(1), pages 83-91, February.
    5. Espen Villanger, 2003. "Company interests and foreign aid policy: Playing donors out against each other," CMI Working Papers WP 2003:5, CMI (Chr. Michelsen Institute), Bergen, Norway.
    6. Miroslav Prokopijevic, 2006. "Why Foreign Aid Fails," ICER Working Papers 19-2006, ICER - International Centre for Economic Research.

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