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Rethinking the debt-aid conundrum: lessons from Côte d'Ivoire

Côte d’Ivoire is a heavily indebted poor country (HIPC). How does this impact on government use of foreign aid? What is the relationship between aid and the debt burden? And what are the policy lessons in terms of making aid work more effectively in Côte d’Ivoire and other HIPCs?

In recent years there has been a shift in the debate on aid effectiveness, with a new emphasis on the importance of good policies as a precondition, not only for the working of aid but also for aid allocation. However, some have contended that the impact of aid on growth is not conditional on good policies. While this debate remains unresolved, much of the literature on aid effectiveness overlooks the fact that aid is given to the government, and therefore any macroeconomic impact will depend on government taxation and expenditure policies.

Addressing this shortcoming is a paper from the World Institute for Development Economics Research (WIDER) which examines the impact of foreign aid on public sector fiscal behaviour in Côte d’Ivoire. As Côte d’Ivoire is an HIPC, particular attention is given to the relationship between aid, debt servicing and debt. The country’s annual debt servicing is about 40 per cent of all government expenditure and this absorbs more than half of all domestic revenue from taxation. The theoretical model used in the paper differs from those of previous studies by highlighting the interaction between debt servicing, government expenditure and taxation. Using data for the period 1975-99, the techniques employed also provide more reliable estimates with regard to the impacts of foreign aid than those of most previous studies.

Key findings include:

A large proportion of the foreign aid provided to Côte d’Ivoire is used for servicing debt rather than for other areas of government expenditure (this may be one of the reasons why aid effectiveness studies have failed to establish a strong relationship between aid and growth).
Aid seems to bring about a decrease in income received by a government via taxation and other recurrent revenue collection, and a decrease in public savings.
In contrast to conventional wisdom, aid does not appear to induce a reduction in public sector borrowing.
Most public borrowing, it was found, is used to finance government expenditure on investment and consumption.
Debt pulls resources (aid in particular) away from domestic expenditure, including investment.

Donors could help Côte d’Ivoire and other HIPCs alleviate their debt burden in order to make aid work more effectively. The main policy recommendation is that more aid should be provided in the form of debt forgiveness. This would help remove the constraints imposed by debt servicing, including making more funds available for consumption and investment expenditure, and would avoid the negative impact of aid on taxation revenues.

Source(s):
‘Aid, Debt Burden and Government Fiscal Behaviour. A New Model Applied to Côte d’Ivoire’, World Institute for Development Economics (WIDER) Discussion Paper No 2003/33, by Mark McGullivray and Bazoumana Ouattara, April 2003 Full document.

Funded by: United Nations’ University (UNU)/World Institute for Development Economics (WIDER) project on New Directions in Development

id21 Research Highlight: 1 December 2003

Further Information:
Mark McGillivray
WIDER
Katajanokanlaituri 6 B
00160 Helsinki

Tel: +358 9 6159 9213
Fax: +358 9 6159 9333
Contact the contributor: Mark@wider.unu.edu

WIDER

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