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

J. Atsu Amegashie, Bazoumana Ouattara and Eric Albert Strobl ()

No CESifo Working Paper No. 1996, CESifo Working Paper Series from CESifo Group Munich

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.

Keywords: tied foreign aid; governance; moral hazard; political agency; restricted transfer (search for similar items in EconPapers)
JEL-codes: D73 F35 H87 I38 (search for similar items in EconPapers)
Date: 2007
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Related works:
Working Paper: Moral Hazard and the Composition of Transfers: Theory with an Application to Foreign Aid (2007)
Working Paper: Moral Hazard and the Composition of Transfers: Theory with an Application to Foreign Aid (2007)
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