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Foreign aid's impact on public spending

  • Feyzioglu, Tarhan
  • Swaroop, Vinaya
  • Min Zhu
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    Using a model of aid fungibility, the authors examine the relationship between foreign aid and public spending. Based on a panel of cross-country and time-series data, their results show that roughly 75 cents of every dollar given in net development assistance goes to current spending and 25 cents to capital spending in the recipient countries. But concessionary loans - a component of development assistance - stimulate far more government spending. Their results also show that aid increases both public and private investment. To test aid fungibility across both public spending categories, they use a newly constructed data series on the net disbursement of concessionary loans. They find that concessionary loans given to the transport and communication sector are fully nonfungible. But loans to the energy sector are converted into fungible monies and part of the funds leak into transport and communications. Loans to agriculture and education are also fungible. There is no evidence of concessionary funds being diverted for military purposes. Their results show that total public spending in the health sector has no impact on reducing infant mortality, but concessionary loans to the health sector do. This finding leads the authors to conclude that linking foreign aid to an agreed-upon public spending program in areas critical to development might be an effective way to transfer resources to developing countries.

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    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1610.

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    Date of creation: 31 May 1996
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    Handle: RePEc:wbk:wbrwps:1610
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    1. Hausman, Jerry A, 1978. "Specification Tests in Econometrics," Econometrica, Econometric Society, vol. 46(6), pages 1251-71, November.
    2. Maurice Obstfeld., 1998. "Foreign Resource Inflows, Saving, and Growth," Center for International and Development Economics Research (CIDER) Working Papers C98-099, University of California at Berkeley.
    3. Heller, Peter S, 1975. "A Model of Public Fiscal Behavior in Developing Countries: Aid, Investment, and Taxation," American Economic Review, American Economic Association, vol. 65(3), pages 429-45, June.
    4. Barro, Robert J, 1991. "Economic Growth in a Cross Section of Countries," The Quarterly Journal of Economics, MIT Press, vol. 106(2), pages 407-43, May.
    5. Pack, Howard & Pack, Janet Rothenberg, 1990. "Is Foreign Aid Fungible? The Case of Indonesia," Economic Journal, Royal Economic Society, vol. 100(399), pages 188-94, March.
    6. Mosley, Paul & Hudson, John & Horrell, Sara, 1987. "Aid, the Public Sector and the Market in Less Developed Countries," Economic Journal, Royal Economic Society, vol. 97(387), pages 616-41, September.
    7. Cashel-Cordo, P. & Craig, S.G., 1988. "The Public Sector Impact Of International Resource Transfers," Papers 24, Houston - Department of Economics.
    8. Devarajan, Shantayanan & Swaroop, Vinaya & Heng-fu, Zou, 1996. "The composition of public expenditure and economic growth," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 313-344, April.
    9. William Easterly & Sergio Rebelo, 1993. "Fiscal Policy and Economic Growth: An Empirical Investigation," NBER Working Papers 4499, National Bureau of Economic Research, Inc.
    10. Khilji, Nasir M. & Zampelli, Ernest M., 1994. "The fungibility of U.S. military and non-military assistance and the impacts on expenditures of major aid recipients," Journal of Development Economics, Elsevier, vol. 43(2), pages 345-362, April.
    11. White, Howard & Luttik, Joke & DEC, 1994. "The countrywide effects of aid," Policy Research Working Paper Series 1337, The World Bank.
    12. Levy, Victor, 1987. "Anticipated Development Assistance, Temporary Relief Aid, and," Economic Journal, Royal Economic Society, vol. 97(386), pages 446-58, June.
    13. Pack, Howard & Pack, Janet Rothenberg, 1993. "Foreign Aid and the Question of Fungibility," The Review of Economics and Statistics, MIT Press, vol. 75(2), pages 258-65, May.
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