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Aid and Fiscal Instability

Author

Listed:
  • Stephen O’Connell
  • Christopher Adam
  • Edward Buffie

Abstract

We show that a combination of temporariness and spending pressure is intrinsic to the aid relationship. In our analysis, recipients rationally discount the pronouncements of donors about the duration of their commitments because in equilibrium they know that some donors will honor those commitments while others will not. Donor types pool in equilibrium; in sharp contrast to conventional signaling situations, there is no separating equilibrium in pure strategies. Moreover, pooling necessarily creates what we call ex ante fiscal instability: expenditure smoothing is perfect ex post if the donor proves permanent, but if the donor is temporary the recipient faces an aid collapse and a fiscal adjustment problem. The Samaritan’s dilemma is at work here, in the guise of a use-it-or-lose-it restriction on spending out of aid. This restriction can produce ex ante fiscal instability even when information is symmetric.

Suggested Citation

  • Stephen O’Connell & Christopher Adam & Edward Buffie, 2008. "Aid and Fiscal Instability," CSAE Working Paper Series 2008-18, Centre for the Study of African Economies, University of Oxford.
    • Handle: RePEc:csa:wpaper:2008-18
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    References listed on IDEAS

    as
    1. Roemer, Michael, 1989. "The macroeconomics of counterpart funds revisited," World Development, Elsevier, vol. 17(6), pages 795-807, June.
    2. Azam, Jean-Paul & Laffont, Jean-Jacques, 2003. "Contracting for aid," Journal of Development Economics, Elsevier, vol. 70(1), pages 25-58, February.
    3. Mr. Andrew Berg & Mr. Mumtaz Hussain & Mr. Shaun K. Roache & Ms. Amber A Mahone & Mr. Tokhir N Mirzoev & Mr. Shekhar Aiyar, 2007. "The Macroeconomics of Scaling Up Aid: Lessons from Recent Experience," IMF Occasional Papers 2007/002, International Monetary Fund.
    4. C. S. Adam & S. A. O’Connell, 1999. "Aid, Taxation and Development in Sub‐Saharan Africa," Economics and Politics, Wiley Blackwell, vol. 11(3), pages 225-253, November.
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    Citations

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    Cited by:

    1. Giulia Mascagni & Emilija Timmis, 2017. "The Fiscal Effects of Aid in Ethiopia: Evidence from CVAR Applications," Journal of Development Studies, Taylor & Francis Journals, vol. 53(7), pages 1037-1056, July.
    2. Carter Patrick, 2013. "Does Foreign Aid Displace Domestic Taxation?," Journal of Globalization and Development, De Gruyter, vol. 4(1), pages 1-47, August.
    3. Thomas Bwire & Oliver Morrissey & Tim Lloyd, 2013. "A Timeseries Analysis of the Impact of Foreign Aid on Central Government's Fiscal Budget in Uganda," WIDER Working Paper Series wp-2013-101, World Institute for Development Economic Research (UNU-WIDER).
    4. Buffie, Edward F. & O'Connell, Stephen A. & Adam, Christopher, 2010. "Fiscal inertia, donor credibility, and the monetary management of aid surges," Journal of Development Economics, Elsevier, vol. 93(2), pages 287-298, November.
    5. Christopher Adam & Anthony M Simpasa, 2010. "Harnessing Resource Revenues for Prosperity in Zambia," OxCarre Working Papers 036, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
    6. Bwire, Thomas & Lloyd, Tim & Morrissey, Oliver, 2013. "A Timeseries Analysis of the Impact of Foreign Aid on Central Government's Fiscal Budget in Uganda," WIDER Working Paper Series 101, World Institute for Development Economic Research (UNU-WIDER).
    7. Muntasir Murshed, 2019. "An Empirical Investigation of Foreign Financial Assistance Inflows and Its Fungibility Analyses: Evidence from Bangladesh," Economies, MDPI, vol. 7(3), pages 1-25, September.

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    More about this item

    Keywords

    Aid; Fiscal instability; Use it or lose it; Samaritan’s dilemma; Pooling;
    All these keywords.

    JEL classification:

    • O23 - Economic Development, Innovation, Technological Change, and Growth - - Development Planning and Policy - - - Fiscal and Monetary Policy in Development
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D64 - Microeconomics - - Welfare Economics - - - Altruism; Philanthropy; Intergenerational Transfers

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