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

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

MPRA Paper from University Library of Munich, Germany

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: F35 D73 I38 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-afr and nep-dev
Date: 2007-04-12, Revised 2007-05-06
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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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Persistent link: http://EconPapers.repec.org/RePEc:pra:mprapa:3158

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