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American Economic Journal: Macroeconomics: Vol. 1 No. 2 (July 2009)

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How Is Foreign Aid Spent? Evidence from a Natural Experiment

Article Citation

Werker, Eric, Faisal Z. Ahmed, and Charles Cohen. 2009. "How Is Foreign Aid Spent? Evidence from a Natural Experiment." American Economic Journal: Macroeconomics, 1(2): 225-44.

DOI: 10.1257/mac.1.2.225

Abstract

We use oil price fluctuations to test the impact of transfers from wealthy OPEC nations to their poorer Muslim allies. The instrument identifies plausibly exogenous variation in foreign aid. We investigate how aid is spent by tracking its short-run effect on aggregate demand, national accounts, and balance of payments. Aid affects most components of GDP though it has no statistically identifiable impact on prices or economic growth. Much aid is consumed, primarily in the form of imported noncapital goods. Aid substitutes for domestic savings, has no effect on the financial account, and leads to unaccounted capital flight. (JEL F35, O19)

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Authors

Werker, Eric (Harvard U)
Ahmed, Faisal Z. (U Chicago)
Cohen, Charles (Sankaty Advisors, Boston, MA)

JEL Classifications

F35: Foreign Aid
O19: International Linkages to Development; Role of International Organizations

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