A PANEL-DATA ANALYSIS OF THE FUNGIBILITY OF FOREIGN-AID

The donor community has been increasingly concerned that development a ssistance intended for crucial social and economic sectors might be us ed directly or indirectly to fund unproductive military and other expe nditures. The link between foreign aid and public spending is not stra ightforward because some aid may be ''fungible.'' This article empiric ally examines the impact of foreign aid on the recipient's public expe nditures, using cross-country samples of annual observations for 1971- 90. For the base sample of 14 developing countries, it finds that aid is not fungible at the aggregate level and there is no associated tax relief Increasing the number of countries, however, makes aid fungible . Moreover, results based on the main sample indicate that aid is fung ible in three out of five sectors examined. Developing-country governm ents receiving earmarked concessionary loans for agriculture, educatio n, and energy reduce their own resources going to these sectors and us e them elsewhere; only loans to the transport and communication sector are fully spent on the purposes intended by donors. Because most aid appears to be fungible, the rare of return on a specific donor-funded project tells little about the impact of that assistance; a better app roach may be to tie foreign aid to an overall public expenditure progr am that provides adequate resources to crucial sectors.