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Foreign aid, institutional quality and government fiscal behavior in emerging economies: An empirical investigation

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  • Kaya, Ilker
  • Kaya, Ozgur
Abstract
Following the aid disbursements, if the total government spending increases less than the total amount of foreign aid in the recipient developing economies, foreign aid is presumed to be fungible. In this case, aid becomes substitute for the domestic government spending rather than supplement and fails to fully achieve the provision of goods and services intended by the donors. This paper examines the link between foreign aid and government spending in the presence of fungibility and how the quality of governance and institutions affects the degree of aid fungibility. Our results show that fungibility is still an existing problem for the aid recipient economies with higher governance quality but the degree of fungibility (substitution away from the domestic government spending in response to aid inflows) is lower (foreign aid crowds out government spending less) in those countries. We find that government spending is more responsive to increases in foreign aid (i) in the presence of is political stability and free media, (ii) while corruption is reduced, contracts are enforced, property rights are protected and (iii) when the government has a higher regulatory power in implementing sound policies. These results suggest that poor governance quality might be one of the neglected measures in aid’s (in)effectiveness riddle.

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  • Kaya, Ilker & Kaya, Ozgur, 2020. "Foreign aid, institutional quality and government fiscal behavior in emerging economies: An empirical investigation," The Quarterly Review of Economics and Finance, Elsevier, vol. 76(C), pages 59-67.
    • Handle: RePEc:eee:quaeco:v:76:y:2020:i:c:p:59-67
    DOI: 10.1016/j.qref.2019.08.004
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    2. Loujaina Abdelwahed, 2021. "The fiscal management of permanent and temporary foreign aid: Evidence from sub‐Saharan Africa," Journal of International Development, John Wiley & Sons, Ltd., vol. 33(4), pages 685-716, May.
    3. Jun Wen & Umar Farooq & Suhaib Anagreh & Mosab I. Tabash, 2022. "Quality of governance and corporate real investment: Assessing the impact of foreign aid," Bulletin of Economic Research, Wiley Blackwell, vol. 74(4), pages 1115-1134, October.
    4. Mfouapon Alassa & Kamdem Cyrille Bergaly & Mohammadou Nourou, 2022. "Agricultural Foreign Aid Allocation in Sub-Saharan Africa: The importance of Democracy and Quality of Governance," International Journal of Research and Innovation in Social Science, International Journal of Research and Innovation in Social Science (IJRISS), vol. 6(3), pages 84-100, March.
    5. Junyan Tian, 2023. "Does agricultural official development assistance facilitate foreign direct investment in agriculture: Evidence from 63 developing countries," Journal of Agricultural Economics, Wiley Blackwell, vol. 74(3), pages 702-718, September.
    6. Nagae, Akira & Katayama, Hajime & Takase, Koichi, 2022. "Donor aid allocation and accounting standards of recipients," Economic Modelling, Elsevier, vol. 106(C).
    7. Abrams M. E. Tagem, 2023. "The dynamic effects of aid and taxes on government spending," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 30(6), pages 1656-1687, December.
    8. Loujaina Abdelwahed, 2023. "Fiscal Responses to Foreign Aid: Does the Permanence of Aid Matter?," Journal of African Economies, Centre for the Study of African Economies, vol. 32(1), pages 26-51.
    9. Arvin, Mak B. & Pradhan, Rudra P. & Nair, Mahendhiran S., 2021. "Are there links between institutional quality, government expenditure, tax revenue and economic growth? Evidence from low-income and lower middle-income countries," Economic Analysis and Policy, Elsevier, vol. 70(C), pages 468-489.
    10. Folorunsho M. Ajide & Tolulope T. Osinubi, 2022. "Foreign aid and entrepreneurship in Africa: the role of remittances and institutional quality," Economic Change and Restructuring, Springer, vol. 55(1), pages 193-224, February.
    11. Obaike John Ojeka & Tajudeen Egbetunde & Gideon Oseibibi Okoduwa & Aisha Omobolanle Ojeyode & Mumuni Jimoh & Gideon Oladele Ogunbowale, 2024. "Moderating effect of institutional quality on the influence of debt on investment in sub-Saharan Africa," Future Business Journal, Springer, vol. 10(1), pages 1-17, December.
    12. Kalsoom Zulfiqar & Abdul Rehman Nawaz & Madiha Qayyum & Faisal Asghar, 2022. "Pakistan's Development Dilemma: An Empirical Analysis of Aid, Governance, and Human Development," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 27(2), pages 65-90, July-Dec.
    13. repec:oup:jafrec:v:32:y:2022:i:1:p:26-51. is not listed on IDEAS

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    More about this item

    Keywords

    Foreign aid; Aid fungibility; Institutional quality; Governance; Government spending; Fiscal policy;
    All these keywords.

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance
    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development

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