AID TIED TO THE DONOR'S EXPORTS

Abstract.  The existing theory of tied aid presupposes that trade and aid are conducted in terms of private consumption goods. However, in such a world aid can be effectively tied only if the recipient government somehow prevents its households from reselling the aid basket on world markets. That weakness of existing theory is here removed by extending the theory to accommodate non-tradable public consumption goods. The most striking result of existing theory – that, even in a world of just two trading countries, the donor might benefit and the recipient suffer from the tying of aid – is preserved.     

Is tied aid bad for the recipient countries?

This paper examines the welfare effects of the exclusivity of foreign aid taking consideration of donor countries' strategic and self-interested economic motivations. Based on an oligopolistic model with strategic interactions between firms and governments providing foreign aid, we demonstrate that a higher exclusivity of foreign aid, taking the form of tied aid, increases the equilibrium amount of aid and the social welfare of the recipient country when the foreign aid policies are decided in a non-cooperative fashion between donor countries. However, when donor countries coordinate aid policies to maximize joint-welfare including recipient country's welfare, the lower exclusivity of foreign aid, taking the form of untied aid, will increase the equilibrium amount of aid and the global social welfare. The results implicate that when a credible enforcement mechanism for the cooperative regime for foreign aid is not available, tied aid is welfare dominant policy for both donor and recipient countries than untied aid.     

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.     

Patterns of multi-agent land conservation: Crowding in/out,agglomeration, and policy

Private agents make large contributions to networks of conserved land, but little is known about how private agents’ decisions might be altered by government actions. This paper explores the impact of public conservation and public policy on the quantity and configuration of private land conservation and the extent to which the social optimum is reached. Because land conservation benefits often have thresholds and spatial characteristics, we consider the impact of different land conservation benefit functions on the patterns of conservation created by the interaction of private and public agents. We find that public conservation crowds private conservation in or out depending on whether marginal conservation benefits increase or decrease with total acreage, and crowding out is mitigated by the presence of budget constraints. We show how land conservation agents might interact strategically in space depending on preferences over fragmentation, and we explore that spatial strategic interaction in a case with a regional land trust and a case with hot-spot parcels. We identify when government policies, such as agglomeration bonuses and mitigating coordination costs, are most likely to increase the social benefits provided by private land conservation agents.     

Composition of Government Budget, Non-Single Peakedness, and Majority Voting

In this paper we study whether majority voting equilibria exist when preferences over public policies are not single peaked. The government levies a proportional income tax. Tax revenue is used to finance a uniform lump-sum transfer and public education. Individuals vote on the composition of the government budget. We show that the single-crossing property cannot be invoked to establish existence of a majority voting equilibrium. In a simple parametric example we find that cycles are pervasive.     

Donor Strategy under the Fungibility of Foreign Aid

We develop a political–economic model of aid fungibility: a part of aid is diverted away from its intended target by lobby groups. The size of this diversion – the degree of aid fungibility – is determined endogenously by the recipient government. The donor can affect the equilibrium degree of fungibility by choosing both the size of aid and the timing of its decision. We derive a condition under which the donor's reaction to fungibility is to reduce the amount of aid. Under this condition, if the donor acts as a follower, both the donor and the target group are better off.     

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.     

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.     

Dancing to the Donors' Tune? Policy Choice in Aid‐Dependent Countries

Current aid rhetoric emphasizes the selective allocation of otherwise unconditional funds in support of the recipients' own plans, in contrast to the old donor practice of bundling money and policies. I show that when recipients have private information, policies reflecting their preferences and knowledge might result in such a regime. However, generous transfers can also induce them to conform to the outcome‐oriented expectations of donors at the expense of lower aid impact. Such behaviour is consistent with an abundance of case‐study evidence. Moderate disagreements over what the optimal policy is could actually produce better results. Certain forms of both donor competition and coordination might also eliminate this distortion, while a donor concern for need only removes incentives for aid‐seeking in the least needy countries. In summary, optimal aid policies are highly context‐specific, and donors should thus concentrate their efforts to practise more informed selectivity.     

Does development aid increase military expenditure?

Using a new instrumental variable strategy, we examine whether bilateral development aid increases military expenditure in recipient countries. The instrument is the interaction of donor government fractionalization and the probability of receiving aid. The dataset includes new data on military expenditure for 124 recipient countries over the 1975–2012 period. When accounting for outliers, our results do not suggest that development aid affects military expenditure in the full sample. However, the effect of aid on military expenditure varies across characteristics of recipient and donor countries, even after excluding outliers. First, aid increases military expenditure in countries that depend on aid and are prone to conflicts. Second, aid provided by coordinated market economies increases military expenditure.     

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 Impact of Aid on Total Government Expenditures: New Evidence on Fungibility

Aid is said to be fungible at the aggregate level if it raises government expenditures by less than the total amount. This happens when the recipient government decreases domestic revenue, decreases net borrowing, or when aid bypasses the budget. This study makes three contributions to both fungibility and fiscal response literature. First, fungibility at the aggregate level is re‐examined on a larger recent panel 1980–2012, distinguishing between short‐ and long‐term impact of aid. The results indicate that aid is partly fungible in the long run and highly fungible in the short run. Second, to account for aid bypassing the budget, technical cooperation is used as a proxy for off‐budget aid. Off‐budget aid is found to be non‐fungible and on‐budget aid is partly fungible. Third, fungibility of bilateral and multilateral aid is analyzed: the results indicate lower fungibility of multilateral aid.     

INTERTEMPORAL COMPETITION AND AID

We study donor–recipient relationships in which the donor finances aid programs from which recipients want to divert funds in order to meet their own objectives. We analyze two economies. In the first one, the donor commits to a program budget for each period. In the second economy, the donor commits to a program budget for two periods. This introduces intertemporal competition among recipient officials. We show that intertemporal competition may weaken recipients' incentives to divert funds from aid programs. Furthermore, we show that this may occur even in the presence of regional competition among recipients.     

Public Preferences for Government Spending Priorities: Survey Evidence from Germany

Employing data from a representative survey conducted in Germany, this paper examines public preferences for the size and composition of government expenditure. We focus on public attitudes towards taxes, public debt incurrence and public spending in six different policy areas. Our findings suggest, first, that individual preferences for the use of additional tax money can be categorised as either capital‐oriented expenditure or public debt reduction. Second, we find that fiscal preferences differ along various dimensions. Specifically, personal economic well‐being, economic literacy, confidence in politicians, political ideology and time preference are significantly related to individual attitudes towards public spending, taxes and debt. The magnitude of the effects is particularly large for time preference, economic knowledge and party preference. Third, public preferences for public spending priorities are only marginally affected when considering a public budget constraint.     

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.     

Aid, Growth and Democracy

To the extent that aid is justified by the benefits to the recipient, rather than to the donor, it might be reasonably judged on two criteria: growth and poverty-alleviation. We study the first of these criteria. We find that the long-run growth impact of aid is conditional on the degree of political and civil liberties in the recipient country. Aid has a positive impact on growth in countries with an institutionalized check on governmental power; that is, in more democratic countries. The data suggest, however, that if this is not the case, aid will be used to satisfy the government's own non-productive goals. We also find that aid on average is not channeled to more democratic countries, even though there are large cross-country differences between major donors.     

Your development or mine? Effects of donor–recipient cultural differences on the aid-growth nexus

Development aid from the West may lead to adverse growth effects in the global South due to the neglected cultural differences between development aid (paradigm) providers and recipients. I test this hypothesis empirically by augmenting an aid-growth model with proxy variables for cultural differences between donors and recipients. First, I use donor–recipient genetic distance, i.e., blood types, to capture the traditional way of cultural transmission. Second, I use western education of recipient country leaders to capture resource-based transmission of culture. Results of the OLS panel estimation in first differences show that a one unit increase in donor–recipient genetic distance reduces the main effect of aid on growth by 0.2 percentage points when aid is increased by one percentage point. In turn, a one percentage point increase in aid yields on average a 0.3 percentage point increase in growth after a decade for countries with western educated leaders.     

Illusory revenues: Import tariffs in resource-rich and aid-rich economies

Where imports are financed predominantly by rents from resource extraction or aid the revenue generated by tariffs is illusory. Revenue earned by the tariff is offset by a reduction in the real value of aid and resource rents. Revenue is however moved between accounts in the government budget which, in the case of aid, may reduce the burden of donor conditionality. We demonstrate this proposition for a simple central case and show that the result is not overturned by generalisations around this case. We argue that trade policy formulation in such economies should recognize the illusory nature of tariff revenues.     

A comparison of compensating surplus and budget reallocation with opportunity costs specified

The use of most nonmarket valuation techniques is predicated on respondents paying additional amounts of money for increased provision of a public good. However, in many circumstances this may not be appropriate. Treaty rights or the capacity of a government to raise and collect taxes in the context of a developing country may preclude the introduction of new taxes. Alternatively, there may be settings where respondents reject the notion of an additional payment and a different approach to estimating nonmarket values is needed. This article demonstrates a methodology for estimating compensating budget reallocation, which is the amount of expenditure on other public goods that respondents are willing to forego for the government to provide more of another public good. One of the main contributions of this article is a demonstration of how to improve the specification of the opportunity costs of budget reallocations. Second, using choice modelling for the estimation of budget reallocations is compared with the standard approach of estimating compensating surplus. The two approaches produce aggregate results that are of a similar magnitude, however the relative importance of the environmental attributes differs. We also investigate the similarity of value estimates across income groups, and similar to Swallow and McGonagle (2006), we find that budget reallocations produce a different set of preferences for lower income earners.     

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.