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Aid Absorption and Spending in Africa: A Panel Cointegration Approach

  • Pedro M G Martins
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    This paper focuses on the macroeconomic management of large inflows of foreign aid. It investigates the extent to which African countries have coordinated fiscal and macroeconomic responses to aid surges. In practice, we construct a panel dataset to investigate the level of aid ‘absorption’ and ‘spending’. This paper departs from the recent empirical literature by utilising better measures for aid inflows and by employing cointegration analysis. The empirical short-run results suggest that, on average, Africa’s low-income countries have absorbed two-thirds of (grant) aid receipts. This suggests that most of the foreign exchange provided by the aid inflows has been used to finance imports. The other third has been used to build up international reserves, perhaps to protect economies from future external shocks. In the long-run, absorption increases but remains below its maximum (‘full absorption’). Moreover, we also show that aid resources have been fully spent, especially in support of public investment. There is only weak evidence that a share of aid flows have been ‘saved’, i.e. substituted domestic borrowing. Overall, these findings suggest that the macroeconomic management of aid inflows in Africa has been significantly better than often portrayed in comparable exercises. The implication is that African countries will be able to efficiently manage a gradual scaling up in aid resources.

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    Paper provided by University of Nottingham, CREDIT in its series Discussion Papers with number 10/06.

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    Handle: RePEc:not:notcre:10/06
    Contact details of provider: Postal: School of Economics University of Nottingham University Park Nottingham NG7 2RD
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    1. Levin, Andrew & Lin, Chien-Fu & James Chu, Chia-Shang, 2002. "Unit root tests in panel data: asymptotic and finite-sample properties," Journal of Econometrics, Elsevier, vol. 108(1), pages 1-24, May.
    2. Pasaran, M.H. & Im, K.S. & Shin, Y., 1995. "Testing for Unit Roots in Heterogeneous Panels," Cambridge Working Papers in Economics 9526, Faculty of Economics, University of Cambridge.
    3. Peter S. Heller, 2005. "“Pity the Finance Ministerâ€," World Economics, World Economics, Economic & Financial Publishing, 1 Ivory Square, Plantation Wharf, London, United Kingdom, SW11 3UE, vol. 6(4), pages 69-110, October.
    4. Rolf Larsson & Johan Lyhagen & Mickael Lothgren, 2001. "Likelihood-based cointegration tests in heterogeneous panels," Econometrics Journal, Royal Economic Society, vol. 4(1), pages 41.
    5. Kapetanios, G. & Pesaran, M. Hashem & Yamagata, T., 2011. "Panels with non-stationary multifactor error structures," Journal of Econometrics, Elsevier, vol. 160(2), pages 326-348, February.
    6. Aiyar, Shekhar & Berg, Andrew & Hussain, Mumtaz, 2008. "The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience," Working Paper Series RP2008/79, World Institute for Development Economic Research (UNU-WIDER).
    7. Pedroni, Peter, 2004. "Panel Cointegration: Asymptotic And Finite Sample Properties Of Pooled Time Series Tests With An Application To The Ppp Hypothesis," Econometric Theory, Cambridge University Press, vol. 20(03), pages 597-625, June.
    8. Kao, Chihwa, 1999. "Spurious regression and residual-based tests for cointegration in panel data," Journal of Econometrics, Elsevier, vol. 90(1), pages 1-44, May.
    9. Catherine A. Pattillo & Stephen A. O'Connell & Christopher Adam & Edward F. Buffie, 2004. "Exchange Rate Policy and the Management of Official and Private Capital Flows in Africa," IMF Working Papers 04/216, International Monetary Fund.
    10. Shekhar Aiyar & Ummul Hasanath Ruthbah, 2008. "Where Did All the Aid Go? An Empirical Analysis of Absorption and Spending," IMF Working Papers 08/34, International Monetary Fund.
    11. Andrew Berg & Mumtaz Hussain & Shaun K. Roache & Amber Mahone & Tokhir N. Mirzoev & Shekhar Aiyar, 2007. "The Macroeconomics of Scaling Up Aid: Lessons from Recent Experience," IMF Occasional Papers 253, International Monetary Fund.
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