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Good Donors or Good Recipients? A Repeated Moral Hazard Model of Aid Allocation

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  • Alessia Isopi
  • Fabrizio Mattesini

Abstract

We propose a repeated moral hazard model with full commitment and limited punishment to study the problem of aid allocation in environments characterized by asymmetric information. The donor (principal) finances a three-period development program and the elite of the recipient country (agent), involved in the realization of the project, can affect the final output through adequate policies. The donor has the goal to help the poor of the recipient country, but she may also be conditioned by non altruistic motives. We show that when the moral hazard problem is relevant, under a wide set of parameter values, optimal aid contracts should be conditional on the previous result of the project. We distinguish between weak conditionality, which means that aid depends only on the previous performance of the project and strong conditionality, which means that aid depends on the whole history of the project. Unconditional aid may be an optimal contractual arrangement for the donor if the moral hazard issue is not very important or if the donor gives aid merely for strategic or economic reasons. An entirely altruistic donor will never provide unconditional aid. On the other hand, if she has a strong desire to help the recipient she should never deny aid to it.

Suggested Citation

  • Alessia Isopi & Fabrizio Mattesini, "undated". "Good Donors or Good Recipients? A Repeated Moral Hazard Model of Aid Allocation," Discussion Papers 09/10, University of Nottingham, CREDIT.
  • Handle: RePEc:not:notcre:09/10
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    File URL: http://www.nottingham.ac.uk/credit/documents/papers/09-10.pdf
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    References listed on IDEAS

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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. Alesina, Alberto & Dollar, David, 2000. "Who Gives Foreign Aid to Whom and Why?," Journal of Economic Growth, Springer, vol. 5(1), pages 33-63, March.
    3. Svensson, Jakob, 2000. "Foreign aid and rent-seeking," Journal of International Economics, Elsevier, vol. 51(2), pages 437-461, August.
    4. Henrik Hansen & Finn Tarp, 2000. "Aid effectiveness disputed," Journal of International Development, John Wiley & Sons, Ltd., vol. 12(3), pages 375-398, April.
    5. Isopi, Alessia & Mavrotas, George, 2006. "Aid Allocation and Aid Effectiveness: An Empirical Analysis," WIDER Working Paper Series 007, World Institute for Development Economic Research (UNU-WIDER).
    6. Fudenberg, Drew & Tirole, Jean, 1990. "Moral Hazard and Renegotiation in Agency Contracts," Econometrica, Econometric Society, vol. 58(6), pages 1279-1319, November.
    7. Calmette, Marie-Francoise & Kilkenny, Maureen, 2001. "International charity under asymmetric information," Economics Letters, Elsevier, vol. 74(1), pages 107-111, December.
    8. William Easterly & Tobias Pfutze, 2008. "Where Does the Money Go? Best and Worst Practices in Foreign Aid," Journal of Economic Perspectives, American Economic Association, vol. 22(2), pages 29-52, Spring.
    9. Dollar, David & Levin, Victoria, 2004. "Increasing selectivity of foreign aid, 1984-2002," Policy Research Working Paper Series 3299, The World Bank.
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    Cited by:

    1. Joshua C. Hall & Serkan Karadas & Minh Tam T. Schlosky, 2016. "Is There Moral Hazard in the Heavily Indebted Poor Countries (HIPC) Initiative Debt Relief Process?," Working Papers 16-24, Department of Economics, West Virginia University.

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    Keywords

    Foreign Aid; Conditionality; Moral Hazard;

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