Foreign Aid and the Business Cycle

Abstract

This paper documents empirical regularities in the foreign aid flows to developing countries over three decades. In spite of a large body of literature on foreign aid and its impact on recipients, surprisingly little is known about its business cycle characteristics. The authors show that for the vast majority of African recipients, aid flows are a major source of income that is highly volatile and, most importantly, overwhelmingly procyclical. For recipients outside of Africa, there is a similar—if somewhat less pronounced—pattern of aid procyclicality. In contrast, there is little evidence of aid procyclicality with the business cycle of donors. In light of the very high volatility of output in developing countries, the procyclicality of foreign aid flows from the recipients’ perspective raises serious questions related to their welfare and growth.

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