| By: |
Santanu Chatterjee (University of Georgia);
Paola Giuliano (International Monetary Fund, Harvard University and IZA);
Ilker Kaya (University of Georgia) |
| Abstract: |
This paper examines fungibility as a possible explanation for the "missing
link" between foreign aid and economic growth. The composition of aid plays a
crucial role in determining the composition of government spending and,
consequently, the magnitude of fungibility and its impact on growth. Embedding
fungibility as an equilibrium outcome in an endogenous growth framework, we
show that the substitution away from domestic government investment is higher
than from government consumption. This leads to a reduction in domestic
productive public spending and completely offsets any positive impact that aid
might have on growth. The main predictions of the model are tested using a
panel dataset of 67 countries for 1972-2000. We find strong evidence of
fungibility at the aggregate level: almost 70 percent of total aid is fungible
in our sample. We also find that investment aid is more fungible than other
categories of aid. In the presence of fungibility, there is no statistically
significant relationship between foreign aid and economic growth. |
| Keywords: |
foreign aid, economic growth, fungibility, fiscal policy |
| JEL: |
E6 F3 F4 O1 |
| Date: |
2007–06 |
| URL: |
http://d.repec.org/n?u=RePEc:iza:izadps:dp2858&r=fdg |