An economic analysis of aid fungibility : Japan's official development assistance to Indonesia : a research thesis submitted in partial fulfilment of the requirements for the degree of Masters of Applied Economics at Massey University
This study examines aid fungibility of Japan's official development assistance (ODA) to Indonesia for the period 1973 to 1994. Aid fungibility, often known as switching of aid money into non-development purposes, is one of the most controversial issues that impinges upon the macroeconomic effectiveness of foreign aid. In this study Japan's foreign aid to Indonesia is analysed, since Indonesia is one of the largest recipients of Japan's aid, and also since Japan is the largest aid donor to Indonesia. Using the maximum likelihood cointegration econometric procedure and the error correction mechanism (ECM), the study analyses aid fungibility for non-development current expenditure, development expenditure and domestic revenue for Indonesia. The results indicate that none of Japan's total sectoral aid, other donors' total sectoral aid, and non-sectoral aid from all donors, leaks into non-development current expenditure or reduces domestic revenue. Hence, no evidence of aid fungibility at the aggregate level is found. The study further analyses aid fungibility at the sectoral level for four major sections, i.e. social services sector, economic services sector, production sector, and other sectors. The empirical results provide no evidence that Japan's aid to the social services and production sectors is fungible. However, Japan's aid to the economic services sectors and other sectors is fungible. Furthermore, other donors' sectoral aid to all four sectors is fungible. Also, there is diversion of resources into the other sectors from other three combined sectors, i.e. social services sector, economic services sector, and production sector. This suggests that Japan's aid to the economic services sector and other donors' sectoral aid to the social services sector, economic services sector, production sector, may diverge into the other sectors. This study concludes by speculating the importance of aid sources and sectors to which aid is allocated as some of the factors that explain aid fungibility in Indonesia.