Though aid continuously plays important role indeveloping countries for example through channeling resources; improvement faces by the third world countries isvery much disappointing (Njeru, 2003).There are tworeasons behind the negative relationship between aid and spending. First,reverse causality that means low expenditures in recipient countries along withprompt donors to disburse more aid to such countries which results endogeneity.Second one is donors’ conditionality,which results reductions in spending (Tagem, 2017).
Different studies on aid and government spendingfocus a problem termed as fungibility. Fungibility refers diversion of aid awayfrom its intended uses for investment and development. That means using the aidin such sectors which was not specified by the donors. This factor limits aideffectiveness in stimulating growth. (Foster and Fozzard, 2000; Njeru, 2003;McGillivray and Ouattara, 2005; Morrissey, 2012). Moreover, fiscal effects ofaid are country-specific and donors are always concerned about the uses of aidand incorporate new conditions’ which also influence government spendingnegatively (Morrissey, 2012). 3.3Impact of Debt on Government SpendingOvermany years, most developing countries face the problem of twin deficits becausethey have failed to collect enough revenues to finance their budgets.
So tomeet the spending they rely on debt flows (Akram, 2016). That refers to thepositive aspect of debt servicing on the other hand aid has direct aid andpositive impact because of providing considerable amount of GDP. Moreover beinga help from the donors, there is no chance of indebtedness in case of aidcirculation in government spending and thus it does not influence fiscalbehavior of the countries (Morrissey, 2012).It is suggested that the inflowswill successfully and positively influence the developing countries only withthe help of proper blending and implication good fiscal as well as monetarypolicies (Burnside and Dollar, 2000). Debt has also negative impact on government spendingbecause huge amount of the budget as well as foreign aid use to repay theloans. For example, it was estimated that South Asia is indebted to over $180 billionand 25 percent of exports are used to repay debt services which constitutesmore than 2 percent of their GDP. With passing time this situation did notchange very much but somehow increase the dependency (Chaudhury and Anwar,2000; McGillivray and Ouattara, 2005).
Moreover, excessive debt burdeninfluence the government behavior and actions of a country through creatingvicious cycle, excessive inflationary financing, excessive taxation on somesectors in the economy. These negativities also reduce the foreign investment inthe productive works of the country (Cassimon and Van Campenhout, 2007). Theincreasing size of debt only increase uncertainty moreover the resources whichcan be used for development activities using for the repayment of the loanwhich is not a good indication for the economy of the developing countries. 3.4Impact of Tax Revenue on Government SpendingTherelationship between tax revenue and government spending is always givensignificant importance in economics. The relation is the base of the budgetaryprocess of a country as tax revenue is regarded as the source of domesticfinancing of a country and has impact on government spending (Mehrara et.
al.,2011). For sound fiscal policy the relationship between tax revenue andspending is a must to know (Eitaand Mbazima, 2008). Over the decades, the relationship between this two is themost analyzing aspect of economics as well as public finance for certainreasons. Around the world especially in Asian countries it has huge importancefrom the policy point of view (Eita and Mbazima, 2008; Mehrara et. al., 2011).
In this regard, causal relationship between revenue and spending is the mostdebatable issue (Eita and Mbazima, 2008; Taha and Loganathan, 2008; Maharajaet. al., 2011). The analysis of this issue is very much debatable and there arefour propositions behind it. The first one is tax-and-spend school, second one is spend-and-tax school, fiscal synchronizationhypothesis is the third one and the fourth and final school is fiscalneutrality school (Chang and Chiang, 2009; Mehrara et. al., 2011).
The role ofgovernment and for the evaluation of it understanding the relationship of thesetwo is very important (Chang and Chiang, 2009). 3.5Foreign Aid, Debt, Tax Revenue, Government Spending and Economic GrowthUndoubtedlythere exists relationship between foreign aid, debt and governments spendingwith economic growth of a country as these are the most important factors ofmacroeconomic perspective. The relationship or impact on economic growth ofthese macroeconomic variables are important irrespective of the income level,social and political condition or the amount of natural resources that onecountry has. In case of developing countries the impact is very much evident asthey get a huge amount of aid and debt every year and it makes changes in thepatterns of government spending.
Most importantly foreign aid and debt aregiven to the recipient countries (developing) with a view to promoting economicdevelopment and welfare of the country and the economic development is measuredby what extent of economic growth has taken place in the country (Durbarry etal., 1998). 3.5.1Foreign Aid and Economic Growth Overthe years, the developing countries always try to promote economic growth andreduce poverty by receiving huge foreign aid from the donor countries becausein the way of development it constitutes an integral part in those countries.This situation is very much evident in the developing countries especially inSub Saharan Africa as well as South Asian economies but only little developmenthas taken place that means few success stories (Chaudhury andAnwar, 2000 ; Njeru, 2003). In the South Asianeconomies from the context of receiving and contributing to the economiesforeign aid plays very important role and thus the relationship with economicgrowth also become an important issue (Asteriou, 2009).
Aidimprove the governments quality and have positive impact on economic growththrough creating scope for new revenues, developing the quality of civilservice, reinforcing policy and planning capacity and making strong centralinstitutions for example South Korea and Taiwan. It also affects negatively byblocking governance system and weakening the institutions rather than making themmore efficient (Bra¨utigam, 2004). Problems offungibility, donors’ conditionality and country specific problems are alsothere.
These positivity and negativity makesaid effectiveness a debatable issue (Foster and Fozzard, 2000; Njeru, 2003;McGillivray and Ouattara, 2005; Chatterjee et al., 2012; Morrissey, 2012).