The Impact Of Foreign Aid On Public Spending In Ethiopia A Vector Autoregressive Approach

Foreign aid is an important source of finance to a majority of developing countries since itrnsupports the budgetary process and therefore enhances the development of these countries. In thisrnpaper, a welfare utility maximization function is used to determine how government spendingrnand domestic revenue respond to aid flows. It employs a co-integrated vector autoregressivernmodel to account for potential endogeneity and non stationary problems. The empiricalrnevidence supports the hypotheses that in Ethiopia, during 1966-2008, foreign aid has a positiverneffect on total government expenditure. But disaggregating the data into governmentrndevelopment expenditure and recurrent expenditure, total aid has positive effect on recurrentrnexpenditure where as program aid has negative effect on development expenditure.rnIn totality foreign aid is fungible in Ethiopia. Disaggregating the data in to recurrent andrndevelopment headings also shows aid is more fungible under the recurrent expenditure headingrnthan the development expenditure heading. The study also provides evidence that policy changernincreases development expenditure, and aid flow reduces domestic resource mobilization.rnProvided that foreign aid influences government expenditure and its fungibility the governmentrnhas to design effective economic policy and improve institutional quality.

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