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The implications of foreign aid fungibility for development assistance

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  • Devarajan, Shantayanan
  • Swaroop, vinaya
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    Abstract

    A foreign aid or foreign lending policy that focuses exclusively on project financing may have unintended consequences, report the authors. New research shows that aid intended for crucial social and economic sectors often merely substitutes for spending that recipient governments would have undertaken anyway and the funds that are thereby freed up are spent for other purposes. If the aid funds something that would have been done anyway, traditional ways of evaluating the aid's effectiveness are not really accurate. Ifaid funds are fungible and the recipient's public spending program is unsatisfactory, project lending may not be cost-effective. If the recipient's public spending program is satisfactory, perhaps the donor should finance a portion of it instead of financing individual projects. One solution to the problem of fungibility, then, is that donors could tie assistance to an overall public spending program (in the recipient country) that provides adequate resources to crucial sectors. To make this kind of reform operational, the authors propose a new lending instrument: a public expenditure reform loan (PERL). A PERL would tie an institution's lending strategy to the recipient country's achievement of mutually agreed-upon development goals. Everyone agrees that better donor coordination is needed, but it has been difficult to achieve because some donors tend to prefer projects (usually with the national flag flying over them). By agreeing on a public expenditure program and financing a portion of it, the World Bank credibly ask other donors to do the same.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2022.

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    Date of creation: 31 Dec 1998
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    Handle: RePEc:wbk:wbrwps:2022

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    Related research

    Keywords: Payment Systems&Infrastructure; Development Economics&Aid Effectiveness; Gender and Development; Decentralization; Economic Adjustment and Lending; Development Economics&Aid Effectiveness; Poverty Assessment; National Governance; Economic Adjustment and Lending; Public Sector Economics&Finance;

    References

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    1. 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.
    2. Cashel-Cordo, P. & Craig, S.G., 1988. "The Public Sector Impact Of International Resource Transfers," Papers 24, Houston - Department of Economics.
    3. Shantayanan Devarajan & Vinaya Swaroop & Heng-fu Zou, 1996. "The composition of public expenditure and economic growth," CEMA Working Papers 77, China Economics and Management Academy, Central University of Finance and Economics.
    4. 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.
    5. J. A. Hausman, 1976. "Specification Tests in Econometrics," Working papers 185, Massachusetts Institute of Technology (MIT), Department of Economics.
    6. 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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    Cited by:
    1. Sanjeev Gupta & Catherine A. Pattillo & Smita Wagh, 2006. "Are Donor Countries Giving More or Less Aid?," IMF Working Papers 06/1, International Monetary Fund.
    2. World Bank, 2010. "Malawi - Country Economic Memorandum : Seizing Opportunities for Growth through Regional Integration and Trade - Summary of Main Finding and Recommendations," World Bank Other Operational Studies 2954, The World Bank.
    3. World Bank, 2000. "Guatemala : Expenditure Reform in a Post-Conflict Country," World Bank Other Operational Studies 15481, The World Bank.
    4. Jan Pettersson, 2007. "Child Mortality: Is Aid Fungibility in Pro-Poor Expenditure Sectors Decisive?," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 143(4), pages 673-693, December.
    5. Boriana Yontcheva & Nadia Masud, 2005. "Does Foreign Aid Reduce Poverty? Empirical Evidence From Nongovernmental and Bilateral Aid," IMF Working Papers 05/100, International Monetary Fund.
    6. Katarina Juselius & Niels Framroze & Finn Tarp, 2011. "The Long-Run Impact of Foreign Aid in 36 African Countries: Insights from Multivariate Time Series Analysis," Working Paper Series UNU-WIDER Working Paper W, World Institute for Development Economic Research (UNU-WIDER).
    7. Hans-Rimbert Hemmer & Andreas Lorenz, 2003. "What determines the success or failure of german bilateral financial aid?," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 139(3), pages 507-549, September.

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