Where Has All the Money Gone? Foreign Aid and the Quest for Growth

37 Pages Posted: 20 Feb 2007  

Santanu Chatterjee

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics

Paola Giuliano

University of California, Los Angeles (UCLA) - Anderson School of Management; IZA Institute of Labor Economics

Ilker Kaya

American University of Sharjah - School of Business and Management; University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics

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Date Written: June 2007

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 Classification: E6, F3, F4, O1

Suggested Citation

Chatterjee, Santanu and Giuliano, Paola and Kaya, Ilker, Where Has All the Money Gone? Foreign Aid and the Quest for Growth (June 2007). IZA Discussion Paper No. 2858. Available at SSRN: https://ssrn.com/abstract=963433

Santanu Chatterjee (Contact Author)

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics ( email )

Department of Economics
University of Georgia
Athens, GA 30602
United States
706-542-1709 (Phone)

HOME PAGE: http://www.terry.uga.edu/people/schatt/Home.htm

Paola Giuliano

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Ilker Kaya

American University of Sharjah - School of Business and Management ( email )

P.O. Box 26666
Sharjah
United Arab Emirates

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics ( email )

Athens, GA 30602-6254
United States

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