Aid Effectiveness: Revisiting the Trade-off Between Needs and Governance

This paper aims at elucidating the issue of inter-country aid allocation by a single donor when the latter is sensitive to both needs and governance considerations and is moreover able to influence local governance through his own disciplining effort. In a one-donor-two-recipient framework and in conformity with observations from the real world, the poorer recipient country is assumed to be less well governed than the richer one. Many rich insights are gained from the analysis. In particular, the poorer and less well governed country is more likely to receive a higher share of aid if governance is endogenized through external disciplining by the donor. And the share of a country will always increase if it has succeeded in improving its internal governance, or discipline, thanks to its own effort. This is true even in the case where this effort leads to a fall of aggregate governance as a result of an overcompensating reaction of the donor when setting the level of external discipline . Finally, a decrease in the cost of external discipline will favor the poorer and less well governed country but only provided that the inter-country governance gap is large enough.