CONDITIONING AID ON SOCIAL EXPENDITURES

Aid conditionality forces countries to adopt policies that they would not otherwise choose. We examine how government discretion should be so constrained when the donor cannot fully control public expenditures, but instead can influence a less disaggregated indicator of public policy, namely the allocation of public spending between the social sectors (e.g. education, health, etc.) on the one hand and more traditional public goods (e.g. infrastructure) on the other. We first show how budget allocations will be altered when recipient government preferences are known – i.e. we characterize what policies the donor should "buy"– and how a given aid budget should be allocated between different types of countries. When recipient government preferences are not known by the donor, the permitted policies are distorted due to incentive constraints, and the extent to which aid flows are optimally differentiated between different countries is reduced.     

Impact of health aid in developing countries: The public vs. the private channels

This paper examines the efficient allocation of international health aid. We built a simple macroeconomic model which considers an endogenous allocation of aid mixed between the public and the private channels. We derive a non-cooperative interaction-game involving the private sector, the donor and the recipient government. We compare the equilibrium of the game to the optimal level of health aid allocation, showing a gap between both. The empirical analysis is based on the Institute for Health Metrics and Evaluation (IHME) and World Health Organization (WHO) data sets using dynamic panel data model with fixed effects (system-GMM). Our results show that health aid actually reduces adult mortality in developing countries. Furthermore, we show that the actual allocation of aid-mix between government and private channels is not health efficient and there is room for reallocation.     

Foreign aid and government fiscal behaviour in low-income South Asian countries

The major purpose of this study was to analyse the relationship between foreign aid and government fiscal behaviour using a pooled sample of three low-income South Asian countries: Pakistan, India and Sri Lanka. A simultaneous equation system was developed and estimated using nonlinear three-stage least squares procedure. The results confirm the hypothesis that foreign aid affects both the expenditure and the revenue side of the recipient government budgets. Both grants and loans are used for consumption as well as for investment purposes. However, grants leak into consumption more than loans. Thus, if the purpose of aid is to generate investment, it is more helpful if donors extend loans to the developing countries than by giving grants. The results also indicate that both grants and loans increase the taxation effort. Multilateral aid actually pulls resources out of consumption and places them into investment projects. Thus the results confirm the assertion that a shift from bilateral to multilateral aid will induce a greater increase in investment. This could stem from better economic performance resulting from high-conditionality lending associated with aid from the major multilateral agencies.     

Migration,Foreign Aid and the Welfare State

Aspects related to the links between international migration, foreign aid and the welfare state are highlighted in this paper. Migration is modeled as a costly movement from an aid‐recipient developing country with low income and no welfare state, towards a rich donor, developed country with a well‐developed welfare state. Within this model, it is found, among other things, that the best response of the developed donor country is to increase aid as the co‐financing rate by the recipient country increases. When the immigration cost decreases, e.g. as a result of greater economic integration between the two countries, it is beneficial for the donor country to increase aid and the recipient country to increase the co‐financing rate.     

Relative Effectiveness of Bilateral and Multilateral Aid on Development Outcomes

Aid donors are interested in understanding whether allocating aid via bilateral or multilateral channels might be more effective for achieving development goals. We review 45 papers that empirically test the associations between bilateral and multilateral aid flows and various development outcomes including gross domestic product growth, governance indicators, human development indicators and levels of non‐aid investment flows. Findings suggest that differences between countries and regions, time periods, aid objectives, and individual donor organizations all may influence the effectiveness of aid delivered bilaterally and multilaterally. We find, however, no consistent evidence that either bilateral or multilateral aid is more effective overall.     

When is Foreign Aid Effective in Fighting Terrorism? Threshold Evidence

Building on the previous literature, we assess when foreign aid is effective in fighting terrorism using quantile regressions on a panel of 78 developing countries for the period 1984–2008. Bilateral, multilateral and total aid indicators are used whereas terrorism includes: domestic, transnational, unclear and total terrorism dynamics. We consistently establish that foreign aid (bilateral, multilateral and total) is effective at fighting terrorism exclusively in countries where existing levels of transnational terrorism are highest. This finding is consistent with our theoretical underpinnings because donors have been documented to allocate more aid towards fighting transnational terrorist activities in recipient countries because they are more likely to target their interests. Moreover, the propensity of donor interest at stake is likely to increase with initial levels of transnational terrorism, such that the effect of foreign aid is most significant in recipient countries with the highest levels of transnational terrorism. Policy implications and future research directions are discussed.     

Donor ideology and types of foreign aid

We examine how donor government ideology influences the composition of foreign aid flows. We use data for 23 OECD countries over the period 1960–2009 and distinguish between multilateral and bilateral aid, grants and loans, recipient characteristics such as income and political institutions, tied and untied aid, and aid by sector. The results show that leftist governments increased the growth of bilateral grant aid, and more specifically grant aid to least developed and lower middle-income countries. Our findings confirm partisan politics hypotheses because grants are closely analogous to domestic social welfare transfer payments, and poverty and inequality are of greatest concern for less developed recipient countries.     

The politics of special purpose trust funds

Over the last decades, bilateral donors of foreign aid have increased their use of special purpose trust funds to provide earmarked aid to multilateral organizations. This paper investigates the incentives and consequences underlying this recent shift toward country‐ or theme‐specific funding and away from bilateral and multilateral aid. We propose a game‐theoretic model with multiple principals and a multilateral agent to study how the interaction between donor preferences, voter concerns in the donor country, the voting rules at the multilateral organization, and the presence of special purpose trust funds influences aid allocation. We show that multilateral organizations with majority rules are more likely to receive discretion and thus voluntary core contributions than those with unanimity requirements and that the possibility of earmarking multilateral aid decreases donors’ contributions to the multilateral's discretionary core budget and the amount of bilateral aid. In contrast to much of the literature dealing with issues of delegation and bi‐ and multilateral aid, our model suggests non‐monotonic effects of preference heterogeneity on the choice of aid channel for some parameter combinations when contributions to special purpose trust funds are an option.     

Is Post-Communist Health Spending Unusual?

What factors determine a country's spending on health? And what factors determine the share of spending financed by the public sector? Taking these factors into account, is post-communist health spending unusual? For the OECD economies, we find that per capita health spending is strongly related to per capita income, with an elasticity of about 1.5. The elasticity for developing economies is close to one. Spending is also positively related to the elderly dependency rate, but the relationship is weaker than a static comparison of spending by the elderly and non-elderly would suggest. Even though health spending as a share of GDP in the post-communist countries of eastern and central Europe is below the OECD average, there is evidence of above normal health spending in most countries when we control for income and demographics. For Hungary, the ‘excess’ spending reached over three percentage points of GDP in 1994. For the OECD sample, four development indicators account for half the variation in the public sector share of total health spending. Political variables help explain the remainder. If the post-communist countries converge to the market economy pattern, the share of public financing will fall, yet still remain well above half.     

The Macroeconomic Management of Increased Aid: Policy Lessons from Recent Experience

The authors investigate the macroeconomic challenges created by a surge in aid inflows. They develop an analytical framework for examining possible policy responses to increased aid, in terms of absorption and spending of aid—where the central bank controls absorption, through monetary policy and the sale of foreign exchange, and where the fiscal authority controls spending. Different combinations of absorption and spending lead to different macroeconomic consequences. Evidence from five countries that recently experienced an aid surge (Ethiopia, Ghana, Tanzania, Mozambique, and Uganda) shows no support for aid-related real exchange rate appreciation in these countries, but it does indicate that the fear of Dutch disease played an important part in the policy reaction to aid surges. Fiscal and monetary authorities should coordinate their responses to an aid surge, because an uncoordinated response—typically when the fiscal authority wants to spend aid while the central bank wants to avoid exchange rate appreciation—can have serious negative macroeconomic consequences.     

The Financing of Foreign Aid and Welfare: Income Versus Consumption Tax

Empirical evidence shows that developed countries use income or consumption taxes to generate tax revenue, of which they transfer a certain fraction as aid to less developed countries. This paper constructs a two-country general equilibrium trade model that takes into account these realities, and examines the terms of trade, employment and welfare effects of international transfers when the donor country increases the fraction of its income or consumption tax revenue transferred as aid. The desirability of each method of aid financing is discussed from the viewpoint of national and world welfare, and conditions are identified under which aid improves world welfare with the one method of financing, and may worsen it with the other.     

Decomposition of total factor productivity in world health production: a stochastic frontier approach

While countries around the globe have increased spending on health care, economists and policy makers have raised concerns over the productivity and efficiency of health care. This article applies a stochastic frontier approach to address this issue using data from 141 countries for the period 1993 to 1997. From the perspective of productivity change, our results suggest that gains in population health will be greater provided that more resources are allocated to investment in human capital. We also show that the scale component accounts for 65–70% of the productivity change. That is, omitting the scale component in our case will result in a significant underestimation of the decline in the productivity of world health production. We do not find evidence supporting the hypothesis that production frontiers differ between Organization for Economic Cooperation and Development (OECD) and non-OECD countries. However, the change in productivity and scale elasticity do vary significantly between these countries.     

Good governance and good aid allocation

We model the aid allocation process as a rent-seeking contest between two countries and investigate the effects of differing allocation rules on recipients' behavior in a simple framework. We investigate the aid allocation mechanism design that attempts to increase the governance quality of potential recipient countries: the potential recipients spend costly resources improving governance, while the donor country allocates the fund based on their governance quality. The paper compares two mechanisms: one uses a simple winner-takes-all tournament to award the entire available purse to the country with the best governance; while under the other aid is distributed among countries in proportion to their governance qualities. The paper shows the second mechanism outperforms the first only if competing countries are sufficiently asymmetric. Moreover, the recipient who is most effective in governance – and stands to benefit the most from development assistance – has interests opposite to those of the donor. In addition, the paper shows that if the donor country allocates the fund based on both governance and the levels of poverty, it may result in a poverty trap: the leaders of potential recipient countries deliberately allocate funds away from the poorest so as not to better their position in order to receive more aid.     

Can social spending cushion the inequality effect of globalization?

This paper examines whether social spending cushions the effect of globalization on within‐country inequality. Using information on disposable and market income inequality and data on overall social spending, and health and education spending from the ILO and the World Bank/WHO, we analyze whether social spending moderates the association between economic globalization and inequality. The results confirm that economic globalization—especially economic flows—associates with higher income inequality, an effect driven by non‐OECD countries. Health spending is strongly associated with lower inequality, but we find no robust evidence that any kind of social spending negatively moderates the association between economic globalization and inequality.     

Foreign aid and fiscal behavior in a bounded rationality model: Different policy regimes

We examine how the source of foreign aid affects the composition of the recipient government's spending. Does the source of aid – bilateral or multilateral – influence recipient policy-makers' choice between development and nondevelopment expenditure? We depart from previous literature by introducing strong asymmetries in policy-makers' preferences. With the financial constraints set by foreign aid and domestic revenues, this formalization allows us to model and estimate the fiscal behavior of government policy-makers in the presence of foreign aid.     

The effect of state education finance reform on total local resources

Both the federal government and the states use intergovernmental grants to try to change the composition of local spending across different programs, as well as the distribution of resources across localities. Many states are now under court order to use state education grants to reduce local disparities in education spending. While a substantial body of literature suggests that these court orders increase the level and progressivity of state education spending, there is little evidence on their broader effects on the total resources available not just for schools in low-income districts, but for other programs across all localities. We find that states finance the required increase in education spending in part by reducing their aid to localities for other programs, particularly for wealthier areas. Thus, while court-ordered school finance equalizations do increase total state aid to localities for education, they do so at the expense of drawing state intergovernmental aid away from programs like public welfare, health, hospitals, and general services. These findings provide insight into the effectiveness of using earmarked funds to achieve redistribution.     

Corruption and public spending on education and health

Existing country and regional studies show that the effect of corruption on public spending on health and education is mixed. This letter reveals that the effect of corruption on health and education spending is significant and non-linear in a panel of 134 countries observed over two decades: For an overwhelming majority of countries, corruption has a positive effect on the share of public resources spent on public health and a negative effect in the case of education. The results presented are robust to several econometric challenges ignored in the literature.     

Darlings and Orphans: Interactions across Donors in International Aid

We examine how the bilateral aid flows from an individual donor to a recipient depend on the aid flows from all other bilateral and multilateral donors to that recipient. Thereby, we assess to what extent issues including donor coordination, free‐riding, selectivity, specialization, and common donor interests drive bilateral aid allocations. We find that others’ bilateral flows lead to a significant increase in aid flows from a particular donor, but primarily within a given year. The effects are particularly pronounced for large donors and so‐called “darling” recipients. Overall, the results suggest that herding is a dominant feature of aid inter‐relationships.     

Partner country selection between development narratives and self-interests: A new method for analysing complex donor approaches

Partner country (PC) selection lies in the centre of development policy decision-making of donor countries and institutions, and plays a significant role in shaping aid patterns. This paper proposes a comprehensive analysis contrasting donor intentions in PC selection with actual aid flows. Having analysed selected members of the Development Assistance Committee of the Organization for Economic Cooperation and Development, namely, the European Union, France, Germany, Japan, Netherlands, Sweden, the United Kingdom and the United States of America, we suggest that (1) donors might not only be either altruistic or self-interested but also motivated by an intention to contribute to the provision of global public goods; (2) self-interest in aid provision can be an explicitly-stated strategy, contrary to what has been argued in the majority of the literature, which often treats self-interest as a non-stated donor intention; and (3) donors' self-interested intentions do not always lead to a less development-oriented donor approach.     

Public spending and growth: The role of government accountability

This paper examines the role of institutions in the nexus between public spending and economic growth. Empirical results based on a newly assembled dataset of 80 countries over the 1970–2010 period suggest that particularly when institutions prompt governments to be accountable to the general citizen does public capital spending promote growth. Taking account of the type of financing for this spending, we show that the growth-promoting effect under an accountable government appears to prevail for various financing sources, including a reallocation from current spending, an increase in revenue, and a rise in the budget deficit. However, government accountability does not seem to play a key role in the growth effects of current spending.