Aid and the Public Sector in East Africa: Endogenous and Disaggregated Aid

This paper addresses the question of the relationship between foreign aid and the fiscal behavior of the public sector in developing countries. We treat aid as an endogenous variable in the public sector’s utility maximization problem. We also disaggregate the aid variable into three components of official development assistance. Data on the East African countries Ethiopia, Sudan, Kenya, Tanzania, and Uganda for the period 1990-2009 is used to estimate the parameters of the model. The results indicate that aid increases both public investment and recurrent government expenditure. The results also show that aid reduces taxation and domestic borrowing. An incremental aid results in much higher reduction in domestic borrowing than the reduction in Taxation.