DP10211 Foreign Aid and Domestic Absorption

Author(s): Jonathan Temple, Nicolas van de Sijpe
Publication Date: October 2014
Keyword(s): absorption, Dutch Disease, foreign aid
JEL(s): F35
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10211

We introduce a new `supply-push' instrument for foreign aid, to be used together with an instrumental variable estimator that filters out unobserved common factors. We use this instrument to study the effects of aid on macroeconomic ratios, and especially the ratios of consumption, investment, imports and exports to GDP. We cannot reject the hypothesis that aid is fully absorbed rather than used to build foreign reserves or exiting as capital flight, nor do we find evidence of Dutch Disease effects. Aid leads to higher consumption, while the evidence that it promotes investment is less robust.