The impact of foreign aid on government fiscal behaviour: evidence from ethiopia

Abstract

The effectiveness of foreign aid in bringing economic and social development is mired in controversy. However, despite the controversial debates on its effectiveness, poor countries of the world have been receiving and using aid as a leverage to relieve themselves from development constraints they faced. Ethiopia is no exception amongst developing countries. Since the time it joined the World Bank group in 1945, foreign capital inflow has remained an important source of revenue for the government. This paper examines the fiscal impact of aid inflow into Ethiopia using time series data for the period 1975-2005. The empirical findings reveal that inflow of foreign aid influences public decision on revenue and expenditure patterns. The result shows that a larger proportion of aid is allocated to capital expenditure and that only a small proportion goes to recurrent expenditure. There is a strong positive association between aid inflow and capital expenditure. The finding also shows that, while a very weak negative association exists between aid and taxation effort, aid and borrowing are used as alternative source of finance.