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When is foreign aid policy credible : aid dependence and conditionality

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  • Svensson, Jakob

Abstract

The author studies foreign aid policy within a principal-agent framework. He shows that one reason for foreign aid's poor overall record may be a moral hazard problem that shapes the aid recipient s incentive to undertake structural reform. The model's basic prediction is a two-way relationship: Disbursements of foreign aid are guided (in part) by the needs of the poor. Anticipating this, recipients have little incentive to improve the welfare of the poor. Preliminary econometric work shows that the data support this hypothesis. In principle, conditionality could partly solve this problem, but only if the donor can make a binding commitment to increase disbursements in good relative to bad states. Without such a commitment technology, aid disbursements remain guided by the needs of the poor and recipient countries maintain a low effort to reduce poverty. Contrary to the conventional wisdom found in the aid literature, the author shows that the welfare of all parties might be improved by using tied project aid or by delegating part of the aid budget to an (international) agency with less aversion to poverty.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1740.

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Date of creation: 31 Mar 1997
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Handle: RePEc:wbk:wbrwps:1740

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Related research

Keywords: Development Economics&Aid Effectiveness; School Health; Economic Adjustment and Lending; Environmental Economics&Policies; Economic Theory&Research;

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