Shifts in Aid Regimes and Fiscal Policy in Developing Countries: A Treatment Effect Approach
Les options politiques de lutte contre la pauvreté et les inégalités en Afrique
- Jean-Louis Combes
- Rasmane Ouedraogo
- Sampawende J. -A. Tapsoba
Foreign aid is a sizable source of government financing for numerous developing countries and its allocation matters for the conduct of fiscal policy. This paper examines the fiscal effects of the shifts in aid regimes in developing countries using a panel of 59 countries from 1960 to 2010. It identifies structural breaks in aid dependency using Bai and Perron’s (1998, 2003) technique, and uses propensity score matching methods to estimate the fiscal effects of structural changes on aid dependency. It finds that changes in aid regimes are frequent in developing countries. Aid “upbreaks” are positively correlated to political closeness with the United States or Russia, the acceptance of the western-led market-oriented economic model, IMF programs, and a recipient country’s national institutions including the force of the opposition parties and the plurality of political parties. Aid “downbreaks” are positively associated with the stage of development, natural resource endowment, and the presence of nationalism and the military in politics. The paper also shows that aid “upbreaks” have crowding-out effects on tax revenue and capital spending in countries with poor governance and weak absorptive capacity. Aid downbreaks lead to unbalanced budgets and also have crowding-out effects on capital expenditure in poor policy environments.