Aid, The Public Sector and the Market in Less Developed Countries

The paper in thisJOURNAL by Mosley, Hudson and Horrell (I987) presented a model of the impact of aid on fiscal behaviour and the consequences for the growth of output. The main purpose of this note is to correct an error in the solution to that model. Some observations are also made on the application of the model to an empirical understanding of aid's overall economic impact. Mosley et al.'s model adopts Heller's (I975) formulation of a loss function that the recipient government minimises subject to its budget constraints. The argument of this loss function comprises taxes, borrowing, government investment, and both developmental and non-developmental recurrent government expenditure. The government faces two budget constraints, one for recurrent expenditure and one for capital expenditure. Whereas Heller was explicitly concerned to analyse recipient fiscal response, Mosley et al. explore the consequences of this response for economic performance and so add two further equations to the model: a production function and an equation showing the determination of private investment. However, the authors solve the model incorrectly, leaving an endogenous variable (taxes) in their expression for the reduced form for the change in output. This gives an answer (with only three terms in the coefficient on aid) that is far more manageable than the correct solution, which is

Economics · Economy · Public sector · Fiscal Policy and Economic Growth · International Development and Aid · Local Government Finance and Decentralization