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Moral Hazard and the Composition of Transfers: Theory with an Application to Foreign Aid

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  • Amegashie, J. Atsu
  • Ouattara, Bazoumanna
  • Strobl, Eric

Abstract

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 University Library of Munich, Germany in its series MPRA Paper with number 3158.

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Date of creation: 12 Apr 2007
Date of revision: 06 May 2007
Handle: RePEc:pra:mprapa:3158

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Keywords: tied foreign aid; governance; moral hazard; political agency; restricted transfer;

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Cited by:
  1. David Zetland, 2010. "Save the poor, shoot some bankers," Public Choice, Springer, Springer, vol. 145(3), pages 331-337, December.
  2. Knack, Stephen & Smets, Lodewijk, 2012. "Aid tying and donor fragmentation," Policy Research Working Paper Series, The World Bank 5934, The World Bank.
  3. Gaoussou Diarra, 2011. "Aid unpredictability and absorptive capacity: analyzing disbursement delays in Africa," Economics Bulletin, AccessEcon, AccessEcon, vol. 31(1), pages 1004-1017.
  4. Paul A. Raschky & Manijeh Schwindt, 2010. "On the Channel and Type of Aid: The Case of International Disaster Assistance," Development Research Unit Working Paper Series, Monash University, Department of Economics 06-10, Monash University, Department of Economics.
  5. Geethanjali Selvaretnam & Kannika Thampanishvong & David Ulph, . "Saving and Re-building Lives: an Analysis of the Determinants of Disaster Relief," CRIEFF Discussion Papers, Centre for Research into Industry, Enterprise, Finance and the Firm 1202, Centre for Research into Industry, Enterprise, Finance and the Firm.
  6. Paul A. Raschky & Manijeh Schwindt, 2009. "On the Channel and Type of International Disaster Aid," Working Papers, Faculty of Economics and Statistics, University of Innsbruck 2009-16, Faculty of Economics and Statistics, University of Innsbruck.
  7. Tierney, Michael J. & Nielson, Daniel L. & Hawkins, Darren G. & Roberts, J. Timmons & Findley, Michael G. & Powers, Ryan M. & Parks, Bradley & Wilson, Sven E. & Hicks, Robert L., 2011. "More Dollars than Sense: Refining Our Knowledge of Development Finance Using AidData," World Development, Elsevier, Elsevier, vol. 39(11), pages 1891-1906.

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