Effect of Foreign Aid on Ugandan public expenditure for the period 1991-2016

Abstract

The study examined the effect of foreign aid on public expenditure by investigating the short and long run effect of foreign aid on public expenditure for the period 1991 to 2016. The study also determined the long run effect of direct and indirect domestic taxes on public expenditure. The approaches used were the Unit root test and Vector Error Correction Model to ascertain the long run relationship among variables. The Error Correction Model established the short run effect of foreign aid on public expenditure using quarterly time series data covering a period of 25 years. The long run model was estimated using the log-log model. In the long-run, there is a negative significant relationship between foreign aid and public expenditure. The study also revealed a long-run positive significant relationship among direct and indirect domestic taxes on public expenditure. In the short-run, the results revealed a negative significant relationship before the structural break and insignificant after the structural break. The study further discovered a positive significant relationship between public expenditures and trade openness in the short-run. The coefficient of elasticity indicates that a 1 percent increase in foreign aid decreased public expenditures by 0.209 percent. Further 1 percent increase in direct and indirect domestic taxes increased public expenditures by 0.434 percent and 0.449 percent after the structural break. Public expenditure in each quarter adjusted by 13.3 and 97.3 percent between the current level and the long run equilibrium level. Based on the findings the study recommends larger portions of aid should go to investment in productive sectors of the economy, adopt an appropriate foreign aid policy and institutional environments to make aid more effective on public expenditure, adopt a strong monitoring unit for supervision and clear course of action on aid, request for information about time and amount of aid fund to be released for public expenditure to enable effective planning, negotiate for affordable user-friendly exchange rate on a decreasing balance format on aid, capacity building in revenue collection and management plus a fair tax collection system.