Which types of aid have the most impact? What is the impact of project and food aid on public investment? How is investment affected by programme aid and technical assistance? This paper from the World Institute for Development Economics Research (WIDER) of the United Nations University (UNU) was presented at the WIDER conference in Helsinki September 2003. It uses an aid disaggregation approach to examine the impact of different types of aid on the fiscal sectors of recipient countries. Time series data is used to analyse Uganda, an important aid recipient.
Uganda is used to estimate a model of fiscal response in the presence of aid, combining aid disaggregation and endogenous aid. Empirical findings suggest the validity of this approach as it delves deeply into aid effectiveness issues where different aid categories have different effects on key fiscal variables – an impact that could not be revealed if a single figure for aid was employed.
All forms of aid, except food, can have a positive impact on public investment. Project aid and food aid appear to cause some reduction in public investment whereas programme aid and technical assistance (TA) are positively related to public investment. Further findings from the Ugandan case include:
- Contrary to popular belief, aid does not discourage the tax effort in Uganda. Borrowing falls with increases in foreign aid.
- The results are only partial, they concern the direct effects of different aid categories on the fiscal sector.
- 60 percent of tax revenue in Uganda is used for consumption purposes. The share of project aid and programme aid directed to consumption are 55.7 and 56.4 percent respectively.
- 46 percent of TA is diverted to consumption and food aid is fully consumed. Half of borrowing is used to support consumption.
- Programme aid responds negatively to changes in project aid. Donors will reduce project aid for every increase in programme aid. TA and food aid inflows do not lead to a reduction in project aid disbursements.
Knowing how different types of aid work in recipient countries is vital for designing and implementing policies aimed at improving aid effectiveness. For policy purposes, the derivation of total impacts of the aid variables is most important. Policy pointers from the case of Uganda suggest:
- The empirical findings suggest that within a broader fiscal response model, common assumptions about aid fungibility and the impact of aid on tax revenue behaviour can be shown to be invalid.
- The government will reduce borrowing considerably if additional funds from programme aid, TA and food aid are made available. However, additional project aid funds reduce borrowing only slightly.
- Although a substantial part of programme aid is directed toward investment, there is a need to further increase this share in the near future as well as improve overall effectiveness.
- Internationally, further improvements are needed in social sector reforms, capacity building, financial institutions, good governance and partnership to benefit from further increases in aid inflows.
- Further research would include moving from examining the impact of different types of aid on the fiscal sector to the impact of heterogeneous aid on growth and poverty.
