Aid and government fiscal behaviour: what does the evidence say?

Author:Morrissey, Oliver

Donors are concerned about how their aid is used, especially how it affects public spending. For low-income countries that receive significant amounts of aid relative to GDP, most of the aid spent in the country is given to the government either directly, or by financing services that would otherwise be a demand on the budget. To illustrate, in 1997 aid accounted for almost a third of government spending on average in low-income or sub-Saharan African countries, and over 100% in some countries. On average during the 1990s aid amounted to over 100% of government spending in Burundi, Ethiopia and Sierra Leone; during 2001-07 it was over 100% in Sierra Leone and Zambia, 70% in Uganda, 50% in Ghana, and 20% in Kenya. It follows that aid should have a direct and significant impact on the level (relative to GDP), evolution (increases over time) and composition (the allocation of spending to different types of public goods and services) of government expenditure.

Aid may also affect the level of tax revenue, either because it influences tax effort or because policy reforms associated with conditional lending affect tax rates or the tax base.

A new UNU-WIDER working paper 'Aid and Government Fiscal Behaviour: What Does the Evidence Say?' reviews the recent evidence on the fiscal effects of aid, on government spending and tax effort, in recipient countries. Given severe data limitations in analysing the relationship between aid and spending, little more can be claimed other than that aid finances government spending. Spending may not increase by the full amount of aid, either because the aid is used to reduce domestic borrowing (often a requirement of multilateral agencies) or is not actually reflected in the budget. Considerable amounts of aid are disbursed through donor projects that do not appear as spending in the budgets; indeed, to the extent the government is aware of these projects it may reduce its own spending in these areas. Thus, the direct link...

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