IMPACT OF FOREIGN-AID ON THE FISCAL BEHAVIOR OF LDC GOVERNMENTS

The purpose of this paper is to examine the impact of foreign aid on the behavior of the recipient governments. Specifically, we look at a sample of less-developed countries in South and Southeast Asia and study their response to foreign aid received. Their response is measured in terms of their public investment and consumption as well as taxation. Our paper attempts to make two new contributions to the literature. First, we try to estimate the impact of foreign aid on a sample of five South and Southeast Asian countries. Secondly, we improve on the earlier method of a combination of single-equation and two-step least squares by estimating the whole system with a nonlinear three-step least squares method. The results confirm the hypothesis that aid does affect consumption, investment and taxation of these governments, but they also show that the relationship is a complex one. In particular, grants and loans have different effects on investment and taxation.