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How Is Foreign Aid Spent? Evidence from a Natural Experiment

Author

Listed:
  • Eric Werker
  • Faisal Z. Ahmed
  • Charles Cohen

Abstract

We use oil price fluctuations to test the impact of transfers from wealthy OPEC nations to their poorer Muslim allies. The instrument identifies plausibly exogenous variation in foreign aid. We investigate how aid is spent by tracking its short-run effect on aggregate demand, national accounts, and balance of payments. Aid affects most components of GDP though it has no statistically identifiable impact on prices or economic growth. Much aid is consumed, primarily in the form of imported noncapital goods. Aid substitutes for domestic savings, has no effect on the financial account, and leads to unaccounted capital flight. (JEL F35, O19)

Suggested Citation

  • Eric Werker & Faisal Z. Ahmed & Charles Cohen, 2009. "How Is Foreign Aid Spent? Evidence from a Natural Experiment," American Economic Journal: Macroeconomics, American Economic Association, vol. 1(2), pages 225-244, July.
  • Handle: RePEc:aea:aejmac:v:1:y:2009:i:2:p:225-44 Note: DOI: 10.1257/mac.1.2.225
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    References listed on IDEAS

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    1. Raghuram G. Rajan, 2005. "Aid and Growth: What Does The Cross-Country Evidence Really Show?," Working Papers id:54, eSocialSciences.
    2. Alesina, Alberto & Dollar, David, 2000. "Who Gives Foreign Aid to Whom and Why?," Journal of Economic Growth, Springer, vol. 5(1), pages 33-63, March.
    3. World Bank, 2005. "World Development Indicators 2005," World Bank Publications, The World Bank, number 12426.
    4. Douglas Staiger & James H. Stock, 1997. "Instrumental Variables Regression with Weak Instruments," Econometrica, Econometric Society, vol. 65(3), pages 557-586, May.
    5. Robert C. Feenstra & Robert E. Lipsey & Haiyan Deng & Alyson C. Ma & Hengyong Mo, 2005. "World Trade Flows: 1962-2000," NBER Working Papers 11040, National Bureau of Economic Research, Inc.
    6. Eric Neumayer, 2003. "What Factors Determine the Allocation of Aid by Arab Countries and Multilateral Agencies?," Journal of Development Studies, Taylor & Francis Journals, vol. 39(4), pages 134-147.
    7. Paul Hallwood & Stuart Sinclair, 2017. "Oil, Debt and Development: OPEC in the Third World," Working papers 2017-16, University of Connecticut, Department of Economics.
    8. Boone, Peter, 1996. "Politics and the effectiveness of foreign aid," European Economic Review, Elsevier, vol. 40(2), pages 289-329, February.
    9. Raghuram G. Rajan & Arvind Subramanian, 2008. "Aid and Growth: What Does the Cross-Country Evidence Really Show?," The Review of Economics and Statistics, MIT Press, pages 643-665.
    10. Pinto, Brian, 1989. "Black Market Premia, Exchange Rate Unification, and Inflation in Sub-Saharan Africa," World Bank Economic Review, World Bank Group, vol. 3(3), pages 321-338, September.
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    More about this item

    JEL classification:

    • F35 - International Economics - - International Finance - - - Foreign Aid
    • O19 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - International Linkages to Development; Role of International Organizations

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