Aid and the Financial Crisis: Shall We Expect Development Aid to Fall?

Abstract

This paper estimates the likely consequences of the financial crisis on aid budgets. It uses two different approaches. First, past financial crises are used to compare aid budgets between countries where a crisis broke out and those where it did not. It is shown that a financial crisis not only decreases aid, but also changes its trend. I find that a crisis decreases aid by 13 percent, or that the time trend after the crisis implies aid falls by 5 additional percent per year. Countries that experienced a crisis therefore tended to significantly slow down (and often reverse) their aid budget expansion. Second, vector autoregressions unveil a significant and usually long-lasting consequence of GDP shocks on aid. Five years after a negative GDP growth shock of 1 percent, aid budgets fall by as much as 8 percent. At current aid levels, that is equivalent to a US $7 billion drop in aid disbursements.

The conclusion of the paper is therefore that aid is likely to be significantly reduced by the global financial crisis unless preventive action is taken.

Keywords: Financial crisis, Foreign aid

JEL Classification: F35, O19