Dancing to the Donors' Tune? Policy Choice in Aid-Dependent Countries

Rune Hagen

Scandinavian Journal of Economics, 2015, vol. 117, issue 1, 126-163

Abstract: Current aid rhetoric emphasizes the selective allocation of otherwise unconditional funds in support of the recipients' own plans, in contrast to the old donor practice of bundling money and policies. I show that when recipients have private information, policies reflecting their preferences and knowledge might result in such a regime. However, generous transfers can also induce them to conform to the outcome-oriented expectations of donors at the expense of lower aid impact. Such behaviour is consistent with an abundance of case-study evidence. Moderate disagreements over what the optimal policy is could actually produce better results. Certain forms of both donor competition and coordination might also eliminate this distortion, while a donor concern for need only removes incentives for aid-seeking in the least needy countries. In summary, optimal aid policies are highly context-specific, and donors should thus concentrate their efforts to practise more informed selectivity.

Date: 2015
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