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Examining Foreign Aid Fungibility in Small Open Economies

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  • Sharri Byron

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Abstract

The paper uses a non-scale growth model to examine the behavior of a small open economy to varying degrees of foreign aid fungibility. Shifting government resources to public consumption while allocating the aid to either type of public expenditure or as a pure transfer changes the productivity of the private factors in production. Agents respond, as with any government transfer, by adjusting consumption, debt and work effort. Private capital accumulation slows and the welfare effect dominates. The fungibility results maintain for parameterizations that reflect limited substitution in production and where the public capital externality is small. The analysis, which employs extensive numerical simulations, emphasizes the tradeoffs between long-run capital accumulation and welfare that maintain even when aid is fungible. The simulations highlight the complementarity between foreign aid and public expenditure, the tradeoff between welfare and capital accumulation, and that aid cannot replace the government’s own commitment to financing public expenditure. The results suggest that a policy in which the government is required to maintain its expenditure commitment to public capital yields the highest level effects to capital accumulation, consumption and output. Copyright Springer Science+Business Media, LLC 2012

Suggested Citation

  • Sharri Byron, 2012. "Examining Foreign Aid Fungibility in Small Open Economies," Open Economies Review, Springer, vol. 23(4), pages 675-712, September.
  • Handle: RePEc:kap:openec:v:23:y:2012:i:4:p:675-712
    DOI: 10.1007/s11079-011-9209-1
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    File URL: http://hdl.handle.net/10.1007/s11079-011-9209-1
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    More about this item

    Keywords

    Non-scale growth models; Foreign aid; Neo-classical growth models; Aid fungibility; O11; O41; F43; E13;

    JEL classification:

    • O11 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Macroeconomic Analyses of Economic Development
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical

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