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.     

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.     

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.     

Tied to Capital or Untied Foreign Aid?

A two-country trade model of foreign aid is developed. The aid-receiving country suffers from Harris-Todaro type unemployment. Aid is either untied, tied to sector-specific capital, or tied to intersectorally mobile capital. These types of aid are compared by examining their terms-of-trade and welfare effects to show that (i) welfare paradoxes are possible, (ii) the world as a whole may gain from aid, (iii) a conflict of interest concerning the type of aid may arise between donor and recipient, and (iv) under plausible conditions untied aid is better for the recipient and the world.     

Foreign Aid under Quantitative Restrictions: Welfare Effects and International Factor Mobility

Using a two‐country, general‐equilibrium model of international trade, this paper incorporates pre‐existing quantitative trade restrictions and international factor mobility into the transfer problem analysis. The effects of foreign aid on the welfare of both the donor and recipient nations are identified under each form of quantitative trade restriction: quotas and voluntary export restraints (VERs). In doing so, this paper identifies conditions under which international transfers are strictly Pareto‐improving (i.e. increase global welfare). A central result of this analysis is the direct welfare effect of a transfer received by a nation with quota‐constrained (VER‐constrained) imports is enhanced (may be enhanced) by a worsening of the recipient’s terms of trade.     

Logic of Aid in an Intertemporal Setting

The paper studies the welfare implications of temporary foreign aid in the context of a simple two‐country model of trade. In addition to its usual effects, a transfer of income in one period is assumed to influence the preferences of the recipient country in the following period. The implied changes in the terms of trade over the two periods are consistent with a number of possible outcomes with respect to the intertemporal welfare of the donor, the recipient, and the world as a whole. Particular attention is devoted to the conditions for strict Pareto improvement and the circumstances under which temporary aid transactions are likely to occur.     

Aid,non‐traded goods,and growth

Abstract We examine the effects of foreign aid in a small recipient country with two traded goods, one non‐traded good, and two factors. Learning by doing and intersectoral knowledge spillovers contribute to endogenous growth. We obtain two main results. First, a permanent increase in untied aid raises (or lowers) the growth rate if and only if the non‐traded good is more capital intensive (or effective labour intensive) than the operating traded good. Second, a permanent increase in untied aid raises welfare if the non‐traded good is more capital intensive than the operating traded good; otherwise, it may raise or lower welfare.     

Foreign Aid,Government Spending,and the Environment

Using an endogenous growth model, this paper examines the growth and welfare effects of the allocation of foreign aid in the recipient economy. As public inputs are a productive factor, a rise in the allocation of aid to the public inputs increases growth and hence the welfare of the economy. However, raising the ratio of aid to pollution abatement may not help an economy, because it crowds out public inputs. Since public inputs are also partly financed by income taxation, the welfare‐maximizing income tax rate is larger than the growth‐maximizing rate, because a portion of the aid constitutes a lump‐sum transfer and can increase household consumption and hence welfare.     

The Transfer Problem and Intergenerational Allocation in an Overlapping Generations Model

We investigate the transfer problem between two countries in the steady state in a one-sector overlapping generations model and explain how transfers should be shared between the young and old generations of the donor country and allocated across the generations of the recipient country. Except at the golden rule of capital accumulation, the ratios of the burden and distribution of transfers between the young and old generations affect welfare. We obtain the following results. First, the sharing of the transfer burden in the donor country depends on the relative size of two effects, namely, a negative direct effect and a positive indirect effect. If the former exceeds the latter, it is preferable for the donor country to allocate all of the transfer burden to the old generation and vice versa. Second, from the viewpoint of welfare maximization, it is preferable for the recipient country to distribute all of the transfers to the young generation. In contrast to the existing literature, these results suggest that the setting whereby the young generation of the donor country defrays all transfer costs may not be justifiable from the viewpoint of donor welfare maximization.     

A Note on Environmental Awareness and Cross-Border Pollution

Considering a Nash equilibrium in which a developed country chooses the amount of foreign aid and a developing country sets the emission tax rate and the proportion of the received aid allocated to public abatement of pollution, it is shown that an increase in the recipient countrys environmental awareness will reduce the level of cross-border pollution and benefits the donor though its foreign aid is increased.     

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.     

What Determines Bilateral Aid Allocations? Evidence From Time Series Data

This paper models the allocation of bilateral foreign development aid to developing countries. A simple theoretical framework is developed, in which aid is treated as a private good of a donor country bureaucratic group responsible for bilateral aid allocation. This model is applied to time series data for ten principal recipients of bilateral official development assistance. Features of this application are that it caters for the joint determination of aid allocations and for donor allocation behavior to differ among individual recipient countries. Results indicate that both recipient need and donor interest variables determine the amount of foreign aid to developing countries, and that donor allocation behavior often differs markedly among recipients.     

A two-country model of trade and growth with intersectoral knowledge spillovers

We formulate a two-country, two-good, two-factor endogenous growth model with learning by doing and intersectoral knowledge spillovers. Our model exhibits no transitional dynamics because of constant returns to capital, the existence of only one state variable for each country, and the factor price equalization theorem. By applying our model to the problem of aid and growth, we show that a permanent increase in untied aid raises the common growth rate if and only if the propensity to consume the capital-intensive good in the recipient country is larger than in the donor country.     

Aid and the Delegated Fight Against Terrorism

A positive empirical relationship is found between the level of foreign aid received by a country and the number of terrorist attacks originating from it. A simple model is used to explain it, where the donor delegates some actions against terrorism to the aid‐recipient government. Aid is endogenous in an econometric equation explaining participation in terrorist events, as expected from the model, and an attacks‐supply curve in which aid has a negative impact is presented at the end.     

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.     

Population growth and the transfer paradox in an overlapping generations model

This study investigates whether the transfer paradox (donor enrichment and/or recipient impoverishment) occurs when a donor and a recipient have different population growth rates by using a one‐sector, two‐country overlapping generations model. We show that if the population growth rates differ, neither donor enrichment nor recipient impoverishment occurs in the steady state under dynamic efficiency. This result is in stark contrast to the existing results that the transfer paradox might occur when a donor and a recipient country have different marginal propensities to save, assuming that both have the same population growth rate. Furthermore, we present the condition for the transfer problem to occur on the transition path and show that the transfer paradox is less likely to occur as the economy converges to the steady state. Our result shows that the prevailing finding that the transfer paradox can occur in an overlapping generations model is limited to the special case of countries having the same population growth rate.     

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.     

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.     

On the Growth Implications of Foreign Aid for Public Investment Co-Financing

In this paper we present an endogenous growth model with foreign transfers for public capital formation in order to analyze the implications for growth maximization when the public sector in recipient countries co‐finances investment projects. Our main innovation is to show that, first, there is a unique growth‐maximizing absorption rate of funds that decreases with the co‐financing ratio and, second, that high amounts of assistance may be an impediment to growth due to the excess domestic taxation required to co‐finance investment projects. We then derive a policy rule for designing the growth‐maximizing co‐financing share under a given level of assistance. Finally, we also highlight some implications for EU regional policies, which aim at fostering growth in poorer EU countries by co‐financing public capital formation.     

Getting help from abroad: The macroeconomics of foreign direct investment in infrastructure in low‐income countries

Infrastructure financing needs in most low‐income countries are substantial, but funding for such needs is only partly covered by national governments and aid donors. This paper introduces foreign direct investment (FDI) through public–private partnerships as a source of infrastructure financing in low‐income countries. A two‐sector open economy model is developed to assess the macroeconomic performance of FDI in infrastructure. With efficient foreign investment, an increase in revenue‐generating infrastructure investment boosts productivity and spurs private investment while stabilizing domestic prices. A direct comparison between infrastructure financed by domestic versus foreign investment shows that foreign investment creates higher output growth and welfare gains and is preferable to domestically sourced investment, irrespective of the underlying financing instrument the domestic economy is employing. FDI in non‐revenue‐generating infrastructure is also analyzed and discussed.