Foreign Aid and the Environment: Still A Curse?

Foreign aid has become a very important source of government revenue for many countries in the world. The academia and policy communities are interested in whether foreign aid has done what it is supposed to do. The aid literature has paid special attention to foreign aid’s effects, if any, on poverty reduction, economic growth, human capital accumulation, to name but a few. One often overlooked area is foreign aid’s environmental impacts. In order to fill this gap, we propose a theoretical model in which we posit that 1) aid is fungible and recipient governments spend foreign aid as a combination of private and public goods; 2) the distribution of aid money between private and public goods is a function of the winning coalition size (W) of aid recipient countries, with large-W systems spending more on public goods; and 3) government public goods spending generally improves environmental quality via the composition, technique, and income effects. The empirical implication from our theory, that is, foreign aid’s environmental effect is conditional on the winning coalition size of the recipient government with foreign aid improving environmental quality in large-W systems, is tested in the context of air pollution. The empirical findings support our theory in the case of common types of air pollutants, especially sulphur dioxide (SO2) and particulates (PM-10). Aid and the Environment