Aid and the Financing of Public Social Sector Spending

In the poorest developing countries that are major recipients of aid, and for which aid finances a large proportion of government expenditure, it is inevitable that aid receipts influence public social sector spending. In general, one would expect the level of social spending to be higher in countries that receive more aid, ceteris paribus, especially to the extent that aid is increasingly targeted on supporting social sectors (for example, as part of a poverty reduction strategy). This effect may be direct, if aid finances additional social spending, or indirect, if aid supports growth so that over time social sector spending (as a share of total spending and/or of gross domestic product/GDP) increases. A more interesting question may be on the effect of aid on the efficacy of social spending, that is, on the effectiveness of spending in delivering improved human development (or increasing welfare). This is a more difficult issue to address as available data are quite limited and aid receipts tend to be highest in those countries (the poorest) where human development is lowest, hence where the efficacy of spending appears to be lowest. Recent literature on the effect of aid on welfare and poverty indicators can shed some light on these issues.