What Does Aid to Africa Finance?

Abstract

If a donor gives aid for a project that the recipient government would have undertaken anyway, the aid finances expenditures other than the intended project. The notion that aid in this sense may be"fungible"has recently received empirical support. The authors look at why aid isfungible or nonfungible, and the extent to which it is fungible in Sub-Saharan Africa. Their results suggest that aid may be partially fungible in Africa and suggests some reasons. They find relatively little evidence that aid leads to greater tax relief in Africa. Every dollar of aid leads to a 90-cent increase in government spending. The implications of this result are by no means clear. If the marginal cost of taxation is exceptionally high - which it might be in African countries - using aid for tax relief may be the best use of foreign resources. Aid's effect on the composition of current and capital spending? They increase equally. Even if all aid were intended to finance capital spending, the reallocation to current spending might not necessarily be harmful. The fungible of loans to specific sectors generally mirrors patterns found in a broader sample of countries. Aid to energy, transport, and communication sectors increase public spending in those sectors somewhat but by no means one for one. (By contrast, in the worldwide sample, aid to transport and communications was almost fully nonfungible). Aid to the education sector - which had no discernible effect on education spending in the global sample - had an almost one-for-one effect on education spending in Africa. Even in these partially fungible sectors, governments spend more out of aid resources than they do out of their own resources, at the margin. Governments do not spend all sectoral aid in that sector - nor do they treat such aid as merely budgetary support. The more donors to a country, the more likely aids is to be fungible. If the number of donors represents a proxy for monitoring costs, it is not surprising that most aid is partly fungible.

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