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.     

Poverty and Governance: The Contest for Aid

Countries compete with one another for funds distributed by non-government organizations (NGOs). The authors consider a competition over poverty and governance conducted by a non-government organization trying to allocate its funds among potential recipient countries. In its decision-making the NGO also takes into account the initial conditions each potential recipient faces, including the current quality of governance and wealth (poverty). For example, all else being equal the poorer country will have a higher probability of obtaining funds; or, the better the applicant's governance, the more its gains. Moreover, the maximum aid a country can obtain depends on its wealth. Investment in good governance, the wealth/poverty status of the applicant, and its current quality of governance will, together, determine the funds potential recipients expect to obtain. The authors also consider recent changes in the levels of these factors. They want to understand the roles these factors play in the competition for aid and the outcome for the quality of governance.     

Why conditional aid does not work and what can be done about it?

This paper studies a simple reform that introduces ex post incentives for the donor to reward good policies—contrary to existing practices. Instead of committing aid to each recipient ex ante and making aid conditional on reform, the donor centralizes the disbursement decision by committing aid to a group of countries. The actual amount disbursed to each individual country would depend on its relative performance. This explicit linkage of the allocation and disbursement decisions has two important advantages as compared to present practices. First, it raises the opportunity cost of disbursing aid ex post, thereby giving the donor stronger incentives to reward good policies. Second, competition among recipients allows the donor to make inferences about common shocks, which otherwise conceal the recipient's choice of action. This enables the donor to give aid more efficiently.     

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.     

Company interests and foreign aid policy: Playing donors off against one another

The evidence on conditionality indicates that this instrument sometimes works, and sometimes does not work. We suggest that third parties to the donor-recipient relationship influence the aid disbursement. The halt in aid that should follow non-compliance could trigger the recipient to cancel contracts with companies from donor countries, which creates incentives for the companies to put pressure towards aid disbursement. We use a multi-agent triadic model of the relationships between a recipient and two donors and two companies to illustrate that recipients may act strategically to make third parties (like companies and others) influence the disbursement decision. Failing to take account of third parties’ role yields the opposite result; conditionality becomes successful.     

DEMOCRATIC AID AND THE DEMOCRATIZATION OF RECIPIENTS

We investigate whether democratic aid flows, which are directed toward the democratization of recipients by covering democracy‐related programs and government and civil society activities, affect the future political regime of recipient countries. We introduce a multinomial multivariate logit model and we use 5‐yr averaged data covering the period 1972–2004 for 59 democracy aid‐recipient countries categorized into three broad classes according to the prevalent political regime. We find strong evidence that democratic aid flows are positively associated with the likelihood of observing a partly democratic or a fully democratic political regime in democratic aid‐recipient countries and that this result is robust to the potential endogeneity of democratic assistance.(JEL D70, F35, C25)     

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.     

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.     

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.     

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.     

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.     

Aid effectiveness and limited enforceable conditionality

This paper analyzes optimal foreign aid policy in a neoclassical growth framework with a conflict of interest between the donor and the recipient government. Aid conditionality is modeled as a limited enforceable dynamic contract. We define the contract to be self-enforcing if, at any point in time, the conditions imposed on aid funds are supportable by the threat of a permanent aid cutoff from then onward. Quantitative results show that optimal self-enforcing conditional aid strongly stimulates the developing economy and substantially increases welfare. However, aid effectiveness comes at a high cost: to ensure enforceability, less benevolent political regimes receive permanently larger aid funds in return for a less intense conditionality.     

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.     

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.     

Welfare effects of tied food aid

An important part of the overall U.S. aid program is Public Law 480 food aid. The design of the program seeks to satisfy numerous and often conflicting objectives. Several constraints have been placed on the use by recipient countries of that aid to insure that the intentions of the program are achieved. This paper examines the implications for recipient country welfare of both the traditional and the proposed restrictions on PL480 aid. It also seeks to clarify the interpretation of empirical work on the effects of this aid. It is shown that the net value of such commodity tied aid is simply the grant component of the subsidized sale and may easily be realized by substituting food aid imports for commercial imports. Restrictions which prevent aid recipients from doing so are costly to the recipient and could lead even to immuserization. Empirical evidence obtained by others is consistent with the notion that such restrictions are circumvented, where possible, by food aid recipients. The results presented indicate that a ‘Schultzian’ disincentive effect is characteristic of a closed economy. Typical interventions on the part of recipient country governments do not effectively reclose the economy. Hence, open economy models are more appropriate frameworks for evaluating the effects of PL480 aid.     

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.     

Aid allocation rules

This paper studies an aid allocation rule used by major development agencies, and investigates optimal allocations when recipients are neoclassical economies undergoing transition dynamics. When recipients face aid absorption constraints, allocations that favor poorer recipients are not always optimal, contrary to what is assumed in assessments of donor performance. The most quantitatively significant factors that determine the optimal sensitivity to recipient characteristics are the generosity of the aid budget and the extent of absorption constraints. In neoclassical recipients, aid can only accelerate growth where there is already growth, so the optimal rule places little weight on growth and optimality is largely a matter of balancing recipient need against absorption constraints.     

Samaritan agents? On the strategic delegation of aid policy

Should a donor delegate the responsibility for allocating its aid budget to a less inequality-averse agent to alleviate the consequences of the Samaritan's Dilemma it is facing? I show that when aid impact differs across recipients the optimal type of agent depends on whether or not committing to a greater share for countries where the productivity of aid is low raises the combined domestic incomes of recipients. This is the case for donors too concerned with efficiency ex post. They therefore delegate the decision on the discretionary aid allocation rule to agents more sensitive to distributional issues than themselves.     

Grants-in-aid and election outcomes in recipient jurisdictions: The impact of EU funds on mayoral elections in Poland

We analyze the impact of EU funds on the outcomes of Polish mayoral elections in 2010 and 2014. We employ an instrumental variable approach to account for the endogeneity of EU funds. Our instruments approximate the availability of EU funds. The first instrument builds on the alignment of the local electorate with the regional donor government. The second instrument uses the funds spent in municipalities in the same sub-region dropped from the sample because the mayors do not run again. We do not find convincing empirical evidence in favor of the notion that EU funds increase the vote shares of mayors. We go on to test whether the electoral effect of EU funds is conditional on the attitude towards the donor institution among the population in the recipient population. This conditional factor is under-researched and politically virulent – given citizens’ skepticism towards the EU that Krastev (2017) describes for Central and Eastern European EU members. Our results are affirmative. EU funds increase the vote shares of mayors in municipalities where Krastev (2017) predicts the degree of EU skepticism to be low while they are not found to do so in municipalities where EU skepticism is predicted to be widespread. These results suggest that citizens’ attitudes towards the donor of vertical grants determine the political gains of recipients from using them.     

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.