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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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Paper provided by China Economics and Management Academy, Central University of Finance and Economics in its series CEMA Working Papers with number 8.

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Length: 17 pages
Date of creation: May 1999
Date of revision: Apr 2000
Publication status: Published in Annals of Economics and Finance, May 2000, pages 147-163
Handle: RePEc:cuf:wpaper:8
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