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Foreign Aid Reduces Domestic Capital Accumulation and Increases Foreign Borrowing: A Theoretical Analysis

  • Liutang Gong

    (Guanghua School of Management, Peking University
    Institute for Advanced Study, Wuhan University)

  • Heng-fu Zou

    (Guanghua School of Management, Peking University
    Institute for Advanced Study, Wuhan University)

In an infinite-horizon model with endogenous time preferences, foreign aid, foreign borrowing, and domestic capital accumulation, a permanent increase in foreign aid leads to a reduction in long-run capital accumulation, a rise in domestic consumption, and an increase in foreign borrowing. Short-run analysis shows that an initial increase in foreign aid leads to a rise in investment, and a reduction in consumption and external borrowing. On the other hand, a temporal increase in foreign aid results in an increase in consumption and foreign borrowing, and a reduction in investment.

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Article provided by Society for AEF in its journal Annals of Economics and Finance.

Volume (Year): 1 (2000)
Issue (Month): 1 (May)
Pages: 147-163

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Handle: RePEc:cuf:journl:y:2000:v:1:i:1:p:147-163
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