Crowd in or crowd out? The subnational fiscal response to aid

Abstract

The fiscal response of aid recipients is crucially important to understanding the effects of aid. The dynamics of governments’ fiscal response to receiving aid can help reconcile the micro–macro aid puzzle, as well as having important implications for studying the micro effects of aid. I explore, in the context of Uganda from 2010 to 2017, whether IDA aid crowds out or crowds in government spending at the district level. To do so, I use an instrumental variables approach combining subnational variation with temporal variation and rich and detailed data on project aid and government budgets in Uganda. I find evidence that IDA funding leads to increases in government spending, and further evidence that these dynamics are more complex than simple follow-on in the same sector as IDA projects. These results suggest critical and underexplored dynamics in subnational fiscal responses to foreign aid, which may have important implications for the study of aid effectiveness.