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

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  • J. Atsu Amegashie
  • Bazoumana Ouattara
  • Eric Strobl

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.

Suggested Citation

  • J. Atsu Amegashie & Bazoumana Ouattara & Eric Strobl, 2007. "Moral Hazard and the Composition of Transfers: Theory with an Application to Foreign Aid," CESifo Working Paper Series 1996, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_1996
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    File URL: https://www.cesifo-group.de/DocDL/cesifo1_wp1996.pdf
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Geethanjali Selvaretnam & Kannika Thampanishvong & David Ulph, "undated". "Saving and Re-building Lives: an Analysis of the Determinants of Disaster Relief," CRIEFF Discussion Papers 1202, Centre for Research into Industry, Enterprise, Finance and the Firm.
    2. Raschky, Paul A. & Schwindt, Manijeh, 2012. "On the channel and type of aid: The case of international disaster assistance," European Journal of Political Economy, Elsevier, vol. 28(1), pages 119-131.
    3. 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, vol. 39(11), pages 1891-1906.
    4. David Zetland, 2010. "Save the poor, shoot some bankers," Public Choice, Springer, vol. 145(3), pages 331-337, December.
    5. Annen Kurt & Kosempel Stephen, 2009. "Foreign Aid, Donor Fragmentation, and Economic Growth," The B.E. Journal of Macroeconomics, De Gruyter, vol. 9(1), pages 1-32, August.
    6. Gaoussou Diarra, 2011. "Aid unpredictability and absorptive capacity: analyzing disbursement delays in Africa," Economics Bulletin, AccessEcon, vol. 31(1), pages 1004-1017.

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