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Foreign Aid Fiscal Policy: Theory and Evidence

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Abstract

The paper provides theoretical and empirical justifications for the instrumentality of foreign aid in stimulating private investment and fixed capital formation through fiscal policy mechanisms. We propose an endogenous growth theory based on an extension of Barro (1990) by postulating that the positive effect of aid mitigates the burden of the taxation system on the private sector of recipient countries. The empirical validity is based on data from 53 African countries for the period 1996–2010. While the findings on the tax effort channel are overwhelmingly consistent with theory across specifications and fundamental characteristics, those of the ‘government expenditure’ channel are a little heterogeneous but broadly in line with the theoretical postulations. Justification for the slight heterogeneity and policy implications are discussed.

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Notes

  1. For instance Snyder (1996) has concluded from a panel of 36 developing countries that nations that receive large aid allocations are associated with lower levels of private investment.

  2. The debate has recently been reframed by Koechlin (2007) who has examined three ambitious book (Sachs’s The End of Poverty, Bhagwati’s In Defense of Globalization, and Easterly’s The Elusive Quest for Growth) and concluded that, the insights and drawbacks of underlying books remind us that the ‘status quo’ is not working. The author has concluded that a rich understanding of globalization and development requires a serious reconsideration of alternative visions of each phenomenon. For instance, new ways of theorizing development in light of the globalized system of food production has involved the European Union heavily criticizing the USA-led ‘genetically modified food aid’ program to the Southern African region (Herrick, 2008).

  3. As a case in point, China’s policy in Africa of non-interference in development assistance and foreign direct investment is perceived as a better alternative (Asongu and Ssozi, 2016). Hence, the results of this study could either confirm or reject the narrative.

  4. The conditionality-oriented debate has recently intensified when some Western governments (British and US for instance) have threatened to cut-off aid from some African countries because of the prosecution of gays, lesbians and transsexuals by governments of recipient countries. In response, activists, analysts and African government officials have viewed the threat as an insult to African values in particular and moral well-being in general.

  5. Accordingly, structural adjustment policies by the IMF have also been criticized. There is a wealth of literature documenting that the IMF’s neoliberal policies have not been: (i) sound for South Korean development after the 1997 crisis (Crotty and Lee, 2002, 2006, 2009); (ii) the principal cause of the Argentinean crisis in the late 1990s and early 2000s (Levy and Duménil, 2006) and (iii) responsible for the failed privatization projects across Africa (Bartels et al., 2009).

  6. Whereas Okada and Samreth (2012) have concluded that aid mitigates corruption in developing countries, Asongu (2012a) in response has established that the Okada and Samreth (2012) findings may not be relevant for Africa because aid fuels (mitigates) corruption (the control of corruption) on the continent. In response to some informal discussions that the Okada and Samreth and Asongu (2012a) findings are not directly comparable, Asongu (2013a) has maintained his position in the African context without partially negating the empirical underpinnings of Okada and Samreth on the one hand and extending the horizon of inquiry from corruption to eight government quality variables.

  7. Addison et al. (2005) have established that development assistance encourages pro-poor public spending and has a positive effect on economic prosperity (growth) since it broadly aligns with poverty reduction. Their position that poverty would be higher in the absence of aid had earlier been raised by Ishfaq (2004). Among proponents of a positive aid-development nexus in the first strand of Table 1, Fielding et al. (2006) have been the most optimistic in their conclusion that aid has a straight forward positive effect on development objectives.

  8. The time span is consistent with those employed by Okada and Samreth (2012), Asongu (2012a) and Asongu (2013a) in the highlighted debate. The first authors have use data from 120 developing countries for the period 1995–2009, the second has used data from 52 African countries for the period 1996–2010 whereas the third has used data for the period 1996–2010 from 53 African countries.

  9. Please see last paragraph of the ‘Methodology’ section for further insights.

  10. Insignificant estimate or variable not included in model.

  11. °: negative coefficient of determination, significant Sargan OIR test (invalid instruments) or insignificant Fisher statistics.

  12. It is therefore not surprising that the worst post-apartheid corruption scandal that has embroiled the current president (Jacob Zuma) has been linked to the purchase of military equipment. In the same line of thinking (from a high technology standpoint), the ‘Albatross’ jet affair that has rocked the Cameroonian institutional landscape has seen the arrest of many high profile politicians over the spectacular disappearances of $ 25 million destined for the purchase of a presidential plane.

  13. To further illustrate this point, a recent budget scandal in South Africa has resulted from the government’s spending of R4 billion on entertainments, travel allowance and catering in 2011 while under-spending in health initiatives, which has left about 47% of metropolitan South Africans dissatisfied.

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Acknowledgements

The authors are highly indebted to Paul Wachtel and reviewers for constructive comments.

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Authors and Affiliations

  1. African Governance and Development Institute, P.O. Box 8413, Yaoundé, Cameroon

    Simplice Asongu

  2. Department of Economics, Business School, Oxford Brookes University, Wheatley Campus, Wheatley, OX33 1HX, Oxford, UK

    Simplice Asongu

  3. Al Makrîzi Institut d′économie, Rabat, Morocco

    Mohamed Jellal

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Table A1

Table A1 Categorization of countries
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Asongu, S., Jellal, M. Foreign Aid Fiscal Policy: Theory and Evidence. Comp Econ Stud 58, 279–314 (2016). https://doi.org/10.1057/ces.2016.7

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