The dynamics of US foreign aid decisions

This paper investigates the importance of bureaucratic inertia in foreign aid allocation. Inertia puts a limit on the ability of foreign aid to alleviate poverty and promote growth. We exploit the 9/11 attacks as a natural experiment that provides a lower bound on the effects of inertia. We make use of a dynamic panel data model combined to a proper treatment of the sample selection problem inherent to virtually all models on aid decisions. The paper moves beyond existing studies and provides an ordering of the donor’s motivations. Interestingly, merit-based motivations have sizable effects on aid decisions. However, inertia is found to drive most of the aid distribution. This may provide a rationale for the weak enforcement of aid contracts. Inertia introduces a time inconsistency problem on the side of the donor. Ex-post, the donor of conditional aid has incentives to deliver it regardless of reforms’ implementation or recipient’s discipline. Anticipation that this will happen destroys the recipient’s incentive to carry out costly policy reforms. This puts the whole aid architecture under strain. Coordination among donor agencies, donors’ investment in reputation and institution building as well as changing aid modalities rather than volumes seems to be promising routes toward re-establishing efficiency.