Anticipated Development Assistance, Temporary Relief Aid, and Consumption Behaviour of Low-Income Countries

Abstract

Much debate about the effectiveness of foreign aid to developing countries focuses on the assumption that aid flows mainly enhance current consumption rather than being channelled into investment.' This paper seeks to establish what proportion of foreign assistance is used to finance current consumption. The principal hypothesis to be tested is that aid transfers include very heterogeneous components with different marginal propensity to raise consumption. Estimating the average marginal propensity to consume of all the components of aid, as is commonly done, may lead to erroneous results. The flow of foreign aid from high- to low-income countries can be classified into two types. The first includes income transfers of a 'relief nature' such as emergency and distress relief (including drought-related food transfers, medical and refugee relief, and balance of payments crisis support). These transfers are generally a temporary response to unanticipated events or shocks to the economy. They can be perceived as an attempt by the donor community to help finance what is denoted in the permanent-income theory as transitory consumption (Friedman, I957). In addition, they can be viewed as an attempt to maintain a 'subsistence' level of consumption by absorbing the shocks to income entirely by changes in savings. The low level of savings, however, and the constraints on foreign borrowing lead to dependency on foreign transfers and prevent domestic savings from being the residual; that is, almost all of