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Aid and Sanctions

  • Kletzer, Kenneth
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    Foreign aid donors and recipient governments often have conflicting objectives. Foreign donors may attempt to influence the policies of recipient governments by offering aid or threatening to suspend aid to sovereign states. This paper considers the credibility of such inducements and the conditioning of aid flows on policy behavior by national governments in the presence of opposing objectives. Aid can be conditioned on past policy actions of the recipient and used to influence the distribution of government resources in a simple repeated agency model. In equilibrium, aid flows are backloaded and reward recipient governments for donor-preferred policy actions. The model is extended to a stochastic setting to allow for asymmetric information between donors and recipients regarding government resources and accumulation of private of foreign assets. This allows for unobserved capital flight implicitly financed by foreign aid inflows by constituents favored by the government. Conditional aid is still feasible and can be enforced by aid suspensions in the presence of potential capital flight.

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    Paper provided by Department of Economics, UC Santa Cruz in its series Santa Cruz Department of Economics, Working Paper Series with number qt5hq5d9gp.

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    Date of creation: 01 Apr 2005
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    Handle: RePEc:cdl:ucscec:qt5hq5d9gp
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    1. Azam, Jean-Paul & Laffont, Jean-Jacques, 2003. "Contracting for aid," Journal of Development Economics, Elsevier, vol. 70(1), pages 25-58, February.
    2. Stéphane Pallage & Michel A. Robe & Catherine Bérubé, 2004. "On the Potential of Foreign Aid as Insurance," Cahiers de recherche 0404, CIRPEE.
    3. Svensson, Jakob, 2000. "Foreign aid and rent-seeking," Journal of International Economics, Elsevier, vol. 51(2), pages 437-461, August.
    4. Kenneth M. Kletzer and Brian D. Wright., 1998. "Sovereign Debt as Intertemporal Barter," Center for International and Development Economics Research (CIDER) Working Papers C98-100, University of California at Berkeley.
    5. Cole, Harold L & Kocherlakota, Narayana R, 2001. "Efficient Allocations with Hidden Income and Hidden Storage," Review of Economic Studies, Wiley Blackwell, vol. 68(3), pages 523-42, July.
    6. Murshed, S Mansoob & Sen, Somnath, 1995. "Aid Conditionality and Military Expenditure Reduction in Developing Countries: Models of Asymmetric Information," Economic Journal, Royal Economic Society, vol. 105(429), pages 498-509, March.
    7. Stéphane Pallage & Michel A. Robe, 2003. "Leland & Pyle Meet Foreign Aid? Adverse Selection and the Procyclicality of Financial Aid Flows," Cahiers de recherche 0327, CIRPEE.
    8. Maxim Engers & Jonathan Eaton, 1999. "Sanctions: Some Simple Analytics," American Economic Review, American Economic Association, vol. 89(2), pages 409-414, May.
    9. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August.
    10. Atkeson, Andrew, 1991. "International Lending with Moral Hazard and Risk of Repudiation," Econometrica, Econometric Society, vol. 59(4), pages 1069-89, July.
    11. Pallage, Stephane & Robe, Michel A, 2001. "Foreign Aid and the Business Cycle," Review of International Economics, Wiley Blackwell, vol. 9(4), pages 641-72, November.
    12. Khilji, Nasir M. & Zampelli, Ernest M., 1994. "The fungibility of U.S. military and non-military assistance and the impacts on expenditures of major aid recipients," Journal of Development Economics, Elsevier, vol. 43(2), pages 345-362, April.
    13. Andrew Atkeson & Robert E Lucas, 2010. "On Efficient Distribution with Private Information," Levine's Working Paper Archive 2179, David K. Levine.
    14. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
    15. Giulio Federico, 2001. "Samaritans, Rotten Kids and Policy Conditionality," CSAE Working Paper Series 2001-16, Centre for the Study of African Economies, University of Oxford.
    16. Allen, Franklin, 1985. "Repeated principal-agent relationships with lending and borrowing," Economics Letters, Elsevier, vol. 17(1-2), pages 27-31.
    17. Tony Killick, 1997. "Principals, Agents And The Failings Of Conditionality," Journal of International Development, John Wiley & Sons, Ltd., vol. 9(4), pages 483-495.
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