Foreign Aid and Political Budget Cycles in Developing Countries

• In Event: Foreign Aid and Domestic Politics in Recipient Countries

Abstract

This study examines the impact of foreign aid on the incidence of political budget cycles in developing countries. The extant literature has documented a pattern of pre-electoral fiscal expansion in developing countries. The basic intuition of political budget cycles is that incumbent governments will increase public spending and/or decrease taxation before elections in order to improve their chances of reelection. I argue that foreign aid relaxes budget constraints in developing countries and enables governments to manipulate fiscal policy for electoral purposes. I theorize that foreign aid increases the incidence of political budget cycles due to aid fungibility, credible commitment problems in donor-recipient relations, and the development objectives of donors. The theoretical mechanisms are substantiated using an illustrative case of political budget cycles in Ghana. Using panel data for 85 low-income and lower-middle income democracies over the 1990-2012 period, the empirical analysis tests the effect of foreign aid on government expenditures and tax revenue prior to competitive elections. The analysis also disaggregates foreign aid by type of aid and donor. The empirical results find strong support for the hypothesis that foreign aid is associated with increased expenditures during election years. In particular, budget support, the most fungible type of aid, is estimated to have most substantive effect on recipient country expenditures prior to elections. Contrary to my hypothesis on taxation, the results indicate that foreign aid decreases the incidence and size of political budget cycles in taxation. Together, the findings suggest that dependence on foreign aid may influence incumbents’ choice of electoral strategy. The empirical results suggest that developing democracies that receive significant amounts of foreign aid are more likely to utilize a political budget cycle strategy of increased expenditures during election years and less likely to pursue a strategy of decreased tax collection. The primary findings are robust for both aid from traditional Development Assistance Committee (DAC) donors and non-DAC donors.

Author

• Mitchell Watkins, University of North Carolina at Chapel Hill