Aid and Public Sector Behavior in Developing Countries

This paper analyzes developing-country public-sector fiscal behavior. It is concerned specifically with how aid inflows affect various categories of revenue and expenditure. An econometric model is developed, which differs from those used in previous studies by allowing domestic borrowing to finance both capital and recurrent expenditure. Structural and reduced-form equations are derived and estimated using 1956–95 time-series data for Pakistan. Results indicate that aid is allocated mainly to investment, is positively associated with both investment and consumption expenditure, and has no final impact on taxation.