Foreign aid and government fiscal behaviour in developing countries: Panel data evidence

This paper examines the impact of foreign aid flows on public sector behaviour in developing countries. It contributes to the fiscal response literature on two main fronts. Firstly, it provides a new fiscal response model. Secondly, on the estimation front, it departs from the existing literature by using panel data technique to test the model in the context of a, relatively, large sample of aid recipient countries over the period 1980-2000. The results derived from this study suggest that: (1) public investment is positively related to aid flows; (2) aid flows exert a positive impact on government developmental expenditure and a negative significant impact on non-developmental expenditure; (3) aid does not discourage revenue collection effort. Finally, borrowing and aid are found substitute.