Does Foreign Aid Promote the Expansion of Government?

Abstract

Building on the literature on public finance, I seek to advance our understanding of variations in government size by exploring the impact of official development assistance on fiscal policy. I hypothesize that foreign aid operates in accordance with the “flypaper effect,” systematically generating incentives and opportunities for the expansion of government spending. Results from a time‐series cross‐sectional regression analysis of growth in government spending over the 1970–99 time period are consistent with the hypothesis. For middle‐ and lower‐income nations, aid represents an important determinant of government expansion. Looking at the tax and revenue side of the equation, however, reveals a more perverse pattern of response: aid promotes not only increased spending but also reduced revenue generation. The results have important implications from both a theoretical and policy perspective. Inter alia they point to the potentially self‐defeating nature of efforts to promote market‐oriented programs of state retrenchment via development assistance as well as to the importance of incorporating international transfers into future research on government spending.