Buying Influence: Aid Fungibility in a Strategic Perspective

I study equilibria of non‐cooperative games between an aid donor and a recipient when there is conflict over the allocation of their combined budgets. The general conclusion is that a donor's influence over outcomes is increasing in the share of the available resources it controls; if this share is large enough, aid fungibility is not important as the donor achieves its most preferred allocation. The game‐theoretic approach to fungibility is contrasted with the traditional non‐strategic approach. I argue that the former is superior as it derives final allocations instead of assuming them, making analysis of the sources of influence over outcomes possible.     

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.     

Fungibility and the flypaper effect of project aid: Micro-evidence for Vietnam

While most economists assume that aid is fungible, most aid donors behave as if it is not. Recipient government responses to development project aid are studied in the context of a specific World Bank-financed project. We estimate the impact of a rural road rehabilitation project in Vietnam on the kilometers of roads actually rehabilitated and built. Using local-level survey data collected for this purpose, we test whether the evidence supports the standard economic argument that there will be little or no impact on rural roads rehabilitated, given fungibility. Instead of full fungibility, we find evidence for a “flypaper effect”. Although impacts on rehabilitated road kilometers were less than intended, more roads were built in project areas. Our results suggest that there was fungibility within the sector, but that aid largely stuck to that sector.     

Fungibility and the impact of development assistance: Evidence from Vietnam's health sector

The apparent fungibility of aid is a challenge to the evaluation of donor-funded development projects, requiring a comparison of the observed outcomes with the outcomes that would have occurred if the project had not gone ahead. Where projects are targeted on specific geographic areas, counterfactual outcomes in each can differ from observed outcomes because the amount of government spending (gross of aid) differs, the productivity of government spending differs, or both. This paper estimates the benefits of two concurrent World Bank health projects in Vietnam targeted on specific provinces. Estimates are derived from a model linking outcomes (under-five mortality) to government spending before and after the project and in project and nonproject provinces, and are presented for different assumptions regarding fungibility of funds (zero and full fungibility) and the impacts of the project on the productivity of government spending (the project modifies productivity in both sectors equally and in neither sector). The estimated mortality reductions are highly insensitive to the assumed degree of fungibility, but highly sensitive to the assumed productivity effects (the estimates range from 1 to 25%). The wide range reflects the uncertainty due to the lack of a genuine control group of provinces.     

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.     

Rethinking the aid–growth relationship: A network approach

Over 40 years of conventional economic analysis has not reached consensus on the effect of foreign aid on recipient country growth. We provide new insight into this relationship by using a network approach to characterize the topological properties of the Organization for Economic Co‐operation and Development (OECD) foreign aid network. Viewing the OECD foreign aid community as an interdependent and complex system, we characterize not only the amount of aid but also the position of both donor and recipient within the network. We find that the degree centrality of the recipient, with an edge inclusion threshold that sets a minimum share of a donor’s aid to a particular recipient, is significantly correlated with the growth impact of that donor’s aid. Contrarily, aid is uncorrelated with growth with a recipient‐side filter on the importance of the donor to the recipient. These results suggest that the importance of a recipient within the donor’s network, rather than the volume of aid alone, is associated with the growth impact of bilateral aid. We explore mechanisms for these findings that include the complementarity of aid from multiple attentive donors. Our findings speak to the aid–growth puzzle and suggest that network metrics may illuminate non‐obvious channels of aid impact.     

Determinants of Canadian bilateral aid allocations: humanitarian,commercial or political?

Abstract.  In this paper we examine the determinants of the allocation of Canadian bilateral aid over the period 1984–2000. We draw on models of donor behaviour that allow us to incorporate humanitarian, commercial and political considerations – the 'trinity of mixed motives'– that affect Canadian aid. We find that allocations are moderately altruistic. Recipient country human rights and membership in the Commonwealth and La Francophonie also affect aid flows. Most strikingly, our results suggest that Canadian aid flows became less altruistic over this period and commercial motives became increasingly important. JEL Classification: H50, O10     

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.     

Exploring the failure of foreign aid: The role of incentives and information

The stated purpose of foreign aid is to promote economic and human development. Recently, the ability of foreign aid to achieve its goals is called into question. Widespread conceptual and empirical literature suggests that foreign aid is ineffective. This paper explores the failure of foreign aid relying on the role of both incentives and information. The success of aid depends on incentives faced by all parties in donor and recipient countries. In addition, both donors and recipients must obtain the necessary information to actually target and achieve desired goals. This analysis provides a double-edged sword to explain why foreign aid fails to achieve development goals.     

Lobbying by Ethnic Groups and Aid Allocation

We develop a political-economic model of foreign aid allocation. Each ethnic group in the donor country lobbies the government to allocate more aid to its country of origin, and the government accepts political contributions from lobby groups. Initial per-capita income of the recipients and those of the ethnic groups are shown to be important determinants of the solution of the political equilibrium. We also examine the effects of changes in the degree of corruption, aid fatigue, and ethnic composition, in the donor country on the allocation of aid.     

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.     

Promoting Trade Liberalization: Theoretical Analysis of Foreign Aid as Prize

We investigate whether foreign aid can be used to induce trade policy reforms. We develop a two‐period political economic model where promise of aid in period 2 depends on chosen tariff in period 1. We consider three scenarios depending on whether the donor is passive/active and whether the two governments move simultaneously or sequentially. We find a sufficient condition for unconditional aid to increase the level of optimal tariff, and the possibility of unconditional aid increasing optimal tariff decreases when the donor is active rather than passive.     

Foreign Aid as Prize: Incentives for a Pro-Poor Policy

The authors develop a theoretical model of foreign aid to analyze a method of disbursement of aid which induces the recipient government to follow a more pro-poor policy than it otherwise would do. In their two-period model, aid is given in the second period and the volume of it depends on the level of well-being of the target group in the first period. They find that this way of designing aid does increase the welfare of the poor. They also consider the situations where the donor and the recipient governments act simultaneously as well as sequentially, and they find that, by moving first in a sequential game, the donor country can, under certain conditions, increase the welfare of the poor and that of its own country compared to the case of simultaneous moves.     

The effect of foreign aid on corruption: A quantile regression approach

This paper investigates the effect of foreign aid on corruption using a quantile regression method. We show that foreign aid generally reduces corruption, and its reduction effect is greater in less corrupt countries. Moreover, this effect is different by different donor countries.     

The Politics of Foreign Aid: A Median Voter Perspective

The paper presents a model where the median voter in the donor country determines the support of foreign aid. It is first established that an individual in the donor country is affected by the direct benefits (due to altruism) and costs (due to taxes) of giving aid, and by the indirect benefits or costs of a change in the terms of trade. Then it is shown that the latter effect works through changing both the donor country's average income and its distribution of income. Given the stylized facts of a capital-abundant donor country and relatively capital-poor median voter, it is shown how redistribution-of-income effects soften the impact of terms-of-trade changes on the political support for foreign aid.     

Foreign Aid in the Presence of Corruption: Differential Games among Donors

We consider two dynamic games of foreign aid. Model 1 deals with the case where donor countries continually feel the warm glow from the act of giving. Model 2 postulates that donors will stop giving aid when a target level of development is reached. In Model 1 , there are multiple equilibria that can be Pareto ranked. In Model 2 , the equilibrium strategies are nonlinear functions of the level of development. The flow of aid falls at a faster and faster rate as the target is approached. An increase in corruption will increase the flow of aid.     

On the provision of official and private foreign aid

The provision of official relative to private foreign aid varies considerably between donor countries. We explain the variations in terms of country size, household composition, income distribution, and the government's ability to commit to aid, and derive inter alia the results: (1) official aid crowds out private aid, (2) total aid and official aid collected from each household are lower in more populous countries, (3) total aid is lower if (i) the distribution of income favors the more altruistic households, and (ii) the government can credibly commit to a certain level of aid. Evidences suggest that the theoretical results can explain stylized facts.     

Need,Merit, or Self‐Interest—What Determines the Allocation of Aid?

Previous studies of aid allocation have concluded that foreign aid is allocated not only according to development needs but also according to donor self‐interest. We revisit this topic and allow for donor‐ as well as recipient‐specific effects in our analysis. In addition to comments on the statistical significance of our results we assess the relative economic importance of recipient need, merit, and donor self‐interest. Our results indicate that all bilateral donors allocate aid according to their self‐interest and recipient need. However, most bilateral donors seem to place little importance on recipient merit. Less than 1% of the variance of aid is accounted for by merit, ceteris paribus. The UK and Japan are exceptions: they allocate more aid to countries with higher growth, higher democracy scores, and fewer human rights abuses.     

Non-nested models of Australia's overseas aid program

After briefly surveying the existing on overseas aid motivations, some empirical results are presented for Australian bilateral aid in terms of the two competing theories in the aid literature, namely the recipient need model and the donor interest model. The empirical results for Austrlia are atypical in that there is support for both hypotheses. This is contrast to the results of previous studies of ‘large’ nation states, the United States, Britain, Germany, France and Japan, which have found support for the donor interst model but not the recipient need model. Given that the empirical results reported here are consistent with both models, this paper then proceeds to apply the relatively new tests of non-nested hypotheses to the models. The results indicate that Australia's aid program has both recipient need and donor interest concerns. I some years the recipient need motive dominates, and in other years, donor interest dominates.     

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.