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Foreign Aid's Impact on Public Spending
by Tarhan Feyzioglu, Vinaya Swaroop, and Min Zhu

ABSTRACT

Using a model of aid fungibility, this paper examines the relationship between foreign aid and public spending. Based on data from 14 developing countries over 20 years we show that roughly three-quarters of a dollar given in development assistance is spent on current expenditure and one-quarter on capital expenditure by the recipient countries. To test aid fungibility across public spending categories, we employ a newly constructed data series on the net disbursement of concessionary loans. We find that concessionary loans given to the transport and communication sector are non-fungible. Loans to agriculture, education and energy sectors are fungible but there is no evidence of funds being diverted for military purposes. We also find that while total public spending in the health sector has no impact in reducing infant mortality, concessionary loans given to the health sector do. In view of these findings, we believe that linking foreign aid with an agreed upon public expenditure program in areas that are critical to development might be an effective way of transferring resources to developing countries.

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