The paper presents a theoretical and empirical analysis of a donor’s choice of the composition of unrestricted and in-kind/restricted transfers to a recipient and how this composition is adjusted in response to changes in the moral hazard behavior of the recipient. In-kind or restricted transfers may be used, among others, to control a recipient’s moral hazard behavior but may be associated with deadweight losses. Within the context of foreign aid, we use a canonical political agency model to construct a simple signaling game between a possibly corrupt politician in a recipient country and a donor to illustrate the donor’s optimal choice of tied (restricted) and untied foreign aid. We clarify the condition under which a reduction in the recipient’s moral hazard behavior (i.e., improvement in the level of governance) leads to a fall in the proportion of tied aid. We test the predictions of our theoretical analysis using data on the composition of foreign aid by multilateral and bilateral donors.
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Paper provided by CESifo GmbH in its series CESifo Working Paper Series with number
CESifo Working Paper No. 1996.
Find related papers by JEL classification: D73 - Microeconomics - - Analysis of Collective Decision-Making - - - Bureaucracy; Administrative Processes in Public Organizations; Corruption F35 - International Economics - - International Finance - - - Foreign Aid H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods I38 - Health, Education, and Welfare - - Welfare and Poverty - - - Government Programs; Provision and Effects of Welfare Programs
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Stephen Coate, 1987.
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[Downloadable!]
Schweinberger, A G, 1990.
"On the Welfare Effects of Tied Aid,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(2), pages 457-62, May.
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