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How Should Donors Give Foreign Aid? Project Aidversus Budget Support

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  • Izabela Jelovac
  • Frieda Vandeninden

Abstract

We develop a theoretical model to compare the two major foreign aid modalities: project aid and budget support. These two modalities have a different impact on the production of ‘developmental goods’. Firstly, conditionality can be associated with budget support, but only a subset of the developmental expenses – the observable ones – can be subject to conditionality. Secondly, when using project aid, the donors control the overall allocation of the aid resources. However, we consider that, because of limited harmonisation and coordination, project aid can be associated with a cost of imperfect fit. We develop a unified framework to compare these two modalities where we allow the simultaneous utilisation of both instruments. We show that all the aid should be given via budget support, no matter whether conditionality is used or not. Furthermore, we show that the optimal use of conditionality depends on the recipient’s developmental preferences, the productivity of the inputs and the level of aid compared to the recipient’s budget: when these parameters are relatively high, conditionality should be enforced. Otherwise, the optimal aid allocation is such that all the aid is given through unconditional budget support. We conclude that conditionality does not always improve the aid effectiveness.

Suggested Citation

  • Izabela Jelovac & Frieda Vandeninden, 2008. "How Should Donors Give Foreign Aid? Project Aidversus Budget Support," CREPP Working Papers 0804, Centre de Recherche en Economie Publique et de la Population (CREPP) (Research Center on Public and Population Economics) HEC-Management School, University of Liège.
  • Handle: RePEc:rpp:wpaper:0804
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    References listed on IDEAS

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    Cited by:

    1. Paul Clist & Alessia Isopi & Oliver Morrissey, 2012. "Selectivity on aid modality: Determinants of budget support from multilateral donors," The Review of International Organizations, Springer, vol. 7(3), pages 267-284, September.
    2. Alok Kumar, 2017. "Foreign Aid, Incentives and Efficiency: Can Foreign Aid Lead to the Efficient Level of Investment?," Review of Development Economics, Wiley Blackwell, vol. 21(3), pages 678-697, August.
    3. Axel Dreher & Valentin F. Lang & Sebastian Ziaja, 2017. "Foreign Aid in Areas of Limited Statehood," CESifo Working Paper Series 6340, CESifo.
    4. Bah, El-hadj M. & Ward, Jeremy, 2011. "Effectiveness of foreign aid in Small Island Developing States," MPRA Paper 32062, University Library of Munich, Germany.
    5. Kropelnytska Svitlana & Hryhoriv Olha, 2020. "Research of institutional aspects of the project financing of socio-economic development of the region," Technology audit and production reserves, Socionet;Technology audit and production reserves, vol. 1(4(51)), pages 45-50.
    6. Patrick Legros & Mohamed Mounir Sraieb, 2015. "Money or Projects: How Should Altruistic Donors Give Aid ?," Working Papers ECARES ECARES 2015-18, ULB -- Universite Libre de Bruxelles.
    7. Mikami, Satoru & Furukawa, Mitsuaki, 2016. "Outsourced Technical Cooperation Reconsidered: Agency Problems in the Support of Decentralized Public Service Delivery in Sierra Leone," Working Papers 119, JICA Research Institute.

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • F35 - International Economics - - International Finance - - - Foreign Aid
    • O19 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - International Linkages to Development; Role of International Organizations

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