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Foreign aid and fiscal policy

  • Riccardo Faini

    (Università di Roma Tor Vergata, Centro Studi Luca d’Agliano, IZA and CEPR)

Foreign aid has been on a downward trend since at least the early eighties. Despite the commitments of donor governments, the GDP share of foreign aid for DAC countries has fallen to slightly more than 0,2% in the early part of this decade. The purpose of this paper is to explore the macro determinants of the amount of foreign aid. Surprisingly enough, not much attention has been devoted in the literature to this issue. Most of the research has focussed either on the effectiveness of aid (“does aid promote growth and help alleviating poverty”?) or to the cross country allocation of a given amount of foreign aid (“is foreign aid motivated by donor’s political and commercial interests or by recipients’ needs?”). In both cases, the total aid budget is taken as given and its determinants remain therefore unexplored. Our main finding is that the size of the budget aid is a function of the donor country’s fiscal situation, even after controlling for the government’s political orientation, the cyclical position of the donor economy, and its income per capita level. In light of these results, we argue that advocates of foreign aid should strongly lobby in favour of fiscal discipline. The alternative strategy of pushing for a more lenient budgetary treatment of foreign aid may be loaded with risks, and even turn to be counterproductive, particularly if the list of “virtuous” exceptions becomes exceedingly long. This is exactly what seems to have happened with the revision of the Stability and Growth pact.

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Paper provided by Centro Studi Luca d\'Agliano, University of Milano in its series Development Working Papers with number 212.

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Date of creation: 15 Jun 2006
Date of revision:
Handle: RePEc:csl:devewp:212
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  1. Raghuram G. Rajan & Arvind Subramanian, 2005. "Aid and Growth: What Does the Cross-Country Evidence Really Show?," NBER Working Papers 11513, National Bureau of Economic Research, Inc.
  2. Arvind Subramanian & Raghuram Rajan, 2005. "What Undermines Aid’s Impact on Growth?," IMF Working Papers 05/126, International Monetary Fund.
  3. Carl-Johan Dalgaard & Henrik Hansen & Finn Tarp, 2004. "On The Empirics of Foreign Aid and Growth," Economic Journal, Royal Economic Society, vol. 114(496), pages F191-F216, 06.
  4. Collier, Paul & Hoeffler, Anke & Soderbom, Mans, 2001. "On the duration of civil war," Policy Research Working Paper Series 2681, The World Bank.
  5. Collier, Paul & Dollar, David, 2002. "Aid allocation and poverty reduction," European Economic Review, Elsevier, vol. 46(8), pages 1475-1500, September.
  6. Alberto Alesina & David Dollar, 1998. "Who Gives Foreign Aid to Whom and Why?," NBER Working Papers 6612, National Bureau of Economic Research, Inc.
  7. David Roodman, 2004. "An Index of Donor Performance," Working Papers 42, Center for Global Development.
  8. David Dollar & Craig Burnside, 2000. "Aid, Policies, and Growth," American Economic Review, American Economic Association, vol. 90(4), pages 847-868, September.
  9. Papanek, Gustav F, 1972. "The Effect of Aid and other Resource Transfers on Savings and Growth in Less Developed Countries," Economic Journal, Royal Economic Society, vol. 82(327), pages 934-50, September.
  10. Burnside, Craig & Dollar, David, 2004. "Aid, policies, and growth : revisiting the evidence," Policy Research Working Paper Series 3251, The World Bank.
  11. Lisa CHAUVET & Patrick GUILLAUMONT, 2003. "Aid and Growth Revisited: Policy, Economic Vulnerability and Political Instability," Working Papers 200327, CERDI.
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